[Analytical Perspectives]
[Federal Receipts and Collections]
[19. Tax Expenditures]
[From the U.S. Government Printing Office, www.gpo.gov]
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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 2005-2011 using two methods of
accounting: revenue effects 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, 2005, and 2006 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, 2005. Expired or repealed provisions
are not listed if their revenue effects result only from taxpayer
activity occurring before fiscal year 2005. 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 2005-
2011 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 income 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
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the special tax provisions in proportion to the respective tax
expenditure amounts shown. Rather, these breakdowns show the specific
tax accounts through which the various provisions are cleared. The
ultimate beneficiaries of corporate tax expenditures could be
shareholders, employees, customers, or other providers of capital,
depending on economic forces.
Table 19-3 ranks the major tax expenditures by the size of their 2007-
2011 revenue effect. Outlay Equivalent Estimates of Income Tax
Expenditures, which were included in prior volumes of Analytical
Perspectives, are no longer included in this chapter.\1\
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\1\ The Administration has dropped the estimates of the outlay
equivalents because they were often the same as the normal tax
expenditure estimates, and the criteria for applying the concepts as to
when they should differ were often judgmental and hard to apply with
consistency across time and across tax expenditure items.
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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:
First, 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.
Second, 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.
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Table 19-1. ESTIMATES OF TOTAL INCOME TAX EXPENDITURES
(in millions of dollars)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Total from corporations and individuals
--------------------------------------------------------------------------------
2005 2006 2007 2008 2009 2010 2011 2007-11
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National Defense
1 Exclusion of benefits and allowances to armed forces 2,990 3,020 3,050 3,070 3,110 3,140 3,170 15,390
personnel..............................................
International affairs:
2 Exclusion of income earned abroad by U.S. citizens...... 2,750 2,810 2,940 3,100 3,270 3,450 3,640 16,400
3 Exclusion of certain allowances for Federal employees 900 950 1,000 1,050 1,100 1,160 1,230 5,540
abroad.................................................
4 Extraterritorial income exclusion....................... 5,220 4,370 1,720 110 50 50 40 1,970
5 Inventory property sales source rules exception......... 1,560 1,680 1,840 2,040 2,230 2,380 2,540 11,030
6 Deferral of income from controlled foreign corporations 10,500 11,160 11,940 12,770 13,650 14,600 15,620 68,580
(normal tax method)....................................
7 Deferred taxes for financial firms on certain income 2,190 2,260 960 ........ ........ ........ ........ 960
earned overseas........................................
General science, space, and technology:
8 Expensing of research and experimentation expenditures 4,110 7,920 6,990 6,260 5,360 4,800 4,840 28,250
(normal tax method)....................................
9 Credit for increasing research activities............... 5,160 2,160 920 390 180 50 ........ 1,540
Energy:
10 Expensing of exploration and development costs, fuels... 390 680 870 830 650 500 380 3,230
11 Excess of percentage over cost depletion, fuels......... 590 670 690 660 640 620 620 3,230
12 Alternative fuel production credit...................... 2,320 2,390 2,460 990 ........ ........ ........ 3,450
13 Exception from passive loss limitation for working 40 40 40 40 40 40 40 200
interests in oil and gas properties....................
14 Capital gains treatment of royalties on coal............ 90 90 90 100 70 60 80 400
15 Exclusion of interest on energy facility bonds.......... 80 90 90 100 100 110 110 510
16 Enhanced oil recovery credit............................ 300 ........ ........ ........ ........ ........ 20 20
17 New technology credit................................... 240 510 690 800 850 860 860 4,060
18 Alcohol fuel credits \1\................................ 40 40 40 50 50 60 30 230
19 Tax credit and deduction for clean-fuel burning vehicles 70 90 200 140 140 -20 -40 420
20 Exclusion of utility conservation subsidies............. 80 80 80 80 80 70 70 380
21 Credit for holding clean renewable energy bonds......... ........ ........ 10 30 40 50 50 180
22 Deferral of gain from dispositions of transmission 490 620 530 230 -100 -360 -510 -210
property to implement FERC restructuring policy........
23 Credit for production from advanced nuclear power ........ ........ ........ ........ ........ ........ ........ .........
facilities.............................................
24 Credit for investment in clean coal facilities.......... ........ 50 50 100 150 200 280 780
25 Temporary 50% expensing for equipment used in the ........ 10 30 120 240 260 180 830
refining of liquid fuels...............................
26 Pass through low sulfur diesel expensing to cooperative 40 ........ -10 ........ -10 ........ -10 -30
owners.................................................
27 Natural gas distribution pipelines treated as 15-year ........ 20 50 90 120 150 150 560
property...............................................
28 Amortize all geological and geophysical expenditures ........ 40 150 180 140 100 60 630
over 2 years...........................................
29 Allowance of deduction for certain energy efficient ........ 80 190 140 30 -10 -10 340
commercial building property...........................
30 Credit for construction of new energy efficient homes... ........ 10 20 10 10 ........ ........ 40
31 Credit for energy efficiency improvements to existing ........ 220 380 150 ........ ........ ........ 530
homes..................................................
32 Credit for energy efficient appliances.................. ........ 120 80 ........ ........ ........ ........ 80
33 30% credit for residential purchases/installations of ........ 10 10 10 ........ ........ ........ 20
solar and fuel cells...................................
34 Credit for business installation of qualified fuel cells ........ 80 130 50 -10 -10 -10 150
and stationary microturbine power plants...............
35 Alternative Fuel and Fuel Mixture tax credit............ 150 170 ........ ........ ........ ........ ........ .........
Natural resources and environment:
36 Expensing of exploration and development costs, nonfuel ........ ........ ........ ........ ........ ........ ........ .........
minerals...............................................
37 Excess of percentage over cost depletion, nonfuel 270 280 300 310 310 330 340 1,590
minerals...............................................
38 Exclusion of interest on bonds for water, sewage, and 450 480 500 550 580 600 620 2,850
hazardous waste facilities.............................
39 Capital gains treatment of certain timber income........ 90 90 90 100 70 60 80 400
40 Expensing of multiperiod timber growing costs........... 350 370 380 400 410 430 430 2,050
41 Tax incentives for preservation of historic structures.. 350 370 380 400 420 440 470 2,110
42 Expensing of capital costs with respect to complying 10 10 10 30 50 30 ........ 120
with EPA sulfur regulations............................
43 Exclusion of gain or loss on sale or exchange of certain ........ ........ 10 30 40 70 60 210
brownfield sites.......................................
Agriculture:
44 Expensing of certain capital outlays.................... 110 130 130 130 140 140 150 690
45 Expensing of certain multiperiod production costs....... 60 70 70 80 80 80 90 400
46 Treatment of loans forgiven for solvent farmers......... 10 10 10 10 10 10 10 50
47 Capital gains treatment of certain income............... 880 870 900 1,050 750 590 780 4,070
48 Income averaging for farmers............................ 40 40 40 40 40 40 50 210
49 Deferral of gain on sale of farm refiners............... 10 10 20 20 20 20 20 100
50 Bio-Diesel and small agri-biodiesel producer tax credits 30 90 100 90 40 20 20 270
Commerce and housing:
Financial institutions and insurance:
51 Exemption of credit union income....................... 1,290 1,370 1,450 1,540 1,640 1,740 1,850 8,220
52 Excess bad debt reserves of financial institutions..... 10 10 10 ........ ........ ........ ........ 10
53 Exclusion of interest on life insurance savings........ 19,200 19,970 20,770 22,600 26,100 28,990 31,350 129,810
54 Special alternative tax on small property and casualty 20 20 20 20 20 20 30 110
insurance companies...................................
55 Tax exemption of certain insurance companies owned by 210 220 230 240 250 260 270 1,250
tax-exempt organizations..............................
56 Small life insurance company deduction................. 60 60 60 60 60 60 50 290
57 Exclusion of interest spread of financial institutions. 1,450 1,540 1,620 1,710 1,800 1,890 1,990 12,000
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Housing:
58 Exclusion of interest on owner-occupied mortgage 930 990 1,040 1,140 1,210 1,240 1,280 5,910
subsidy bonds.........................................
59 Exclusion of interest on rental housing bonds.......... 410 430 450 500 530 540 550 2,570
60 Deductibility of mortgage interest on owner-occupied 62,160 72,060 79,860 87,820 94,490 100,980 108,280 471,430
homes.................................................
61 Deductibility of State and local property tax on owner- 19,110 15,020 12,810 12,910 12,830 12,720 22,930 74,200
occupied homes........................................
62 Deferral of income from post 1987 installment sales.... 1,120 1,130 1,160 1,180 1,200 1,310 1,430 6,280
63 Capital gains exclusion on home sales.................. 35,990 39,750 43,900 48,490 59,900 78,860 87,100 318,250
64 Exclusion of net imputed rental income................. 28,600 29,720 33,210 36,860 40,630 44,785 49,364 204,849
65 Exception from passive loss rules for $25,000 of rental 6,470 6,370 6,230 6,060 5,880 5,700 5,510 29,380
loss..................................................
66 Credit for low-income housing investments.............. 3,880 4,060 4,250 4,460 4,710 4,950 5,220 23,590
67 Accelerated depreciation on rental housing (normal tax 9,610 10,630 11,470 12,660 13,820 14,710 15,920 68,580
method)...............................................
Commerce:
68 Cancellation of indebtedness........................... 30 160 110 40 40 40 40 270
69 Exceptions from imputed interest rules................. 50 50 50 50 50 50 50 250
70 Capital gains (except agriculture, timber, iron ore, 26,170 25,990 26,760 31,280 22,340 17,580 23,410 121,370
and coal).............................................
71 Capital gains exclusion of small corporation stock..... 200 230 260 300 320 350 470 1,700
72 Step-up basis of capital gains at death................ 26,820 29,510 32,460 35,700 36,480 34,560 38,010 177,210
73 Carryover basis of capital gains on gifts.............. 410 540 640 750 790 1,270 6,370 9,820
74 Ordinary income treatment of loss from small business 50 50 50 50 50 50 50 250
corporation stock sale................................
75 Accelerated depreciation of buildings other than rental -910 -280 90 550 360 950 1,580 3,530
housing (normal tax method)...........................
76 Accelerated depreciation of machinery and equipment 20,220 40,520 52,230 61,940 73,480 81,090 88,460 353,600
(normal tax method)...................................
77 Expensing of certain small investments (normal tax 5,390 4,720 4,360 350 868 1,110 1,460 8,148
method)...............................................
78 Graduated corporation income tax rate (normal tax 3,160 3,450 3,590 3,940 4,180 4,300 4,390 20,400
method)...............................................
79 Exclusion of interest on small issue bonds............. 390 420 440 480 510 530 540 2,500
80 Deduction for US production activities................. 6,220 5,150 10,670 12,190 13,110 20,320 22,270 78,560
81 Special rules for certain film and TV production....... 90 110 90 70 -40 -90 -60 -30
Transportation:
82 Deferral of tax on shipping companies................... 20 20 20 20 20 20 20 100
83 Exclusion of reimbursed employee parking expenses....... 2,590 2,730 2,880 3,030 3,180 3,330 3,420 15,840
84 Exclusion for employer-provided transit passes.......... 480 550 630 710 790 880 960 3,970
85 Tax credit for certain expenditures for maintaining 70 140 150 110 50 30 10 350
railroad tracks........................................
86 Exclusion of interest on bonds for Financing of Highway ........ 25 50 75 95 95 100 415
Projects and rail-truck transfer facilities............
Community and regional development:
87 Investment credit for rehabilitation of structures 40 40 40 40 40 40 40 200
(other than historic)..................................
88 Exclusion of interest for airport, dock, and similar 800 860 910 990 1,060 1,080 1,120 5,160
bonds..................................................
89 Exemption of certain mutuals' and cooperatives' income.. 60 60 70 70 70 70 70 350
90 Empowerment zones and renewal communities............... 1,120 1,210 1,340 1,480 1,740 1,130 420 6,110
91 New markets tax credit.................................. 430 610 830 870 790 670 520 3,680
92 Expensing of environmental remediation costs............ 70 60 40 ........ -20 -10 -10 .........
93 Credit to holders of Gulf Tax Credit Bonds.............. ........ ........ 10 10 10 10 10 50
Education, training, employment, and social services:
Education:
94 Exclusion of scholarship and fellowship income (normal 1,380 1,450 1,510 1,580 1,640 1,720 1,790 8,240
tax method)...........................................
95 HOPE tax credit........................................ 3,710 3,650 3,060 3,090 3,220 3,240 3,480 16,090
96 Lifetime Learning tax credit........................... 2,330 2,340 2,020 2,030 2,060 2,090 2,220 10,420
97 Education Individual Retirement Accounts............... 70 90 110 140 180 230 280 940
98 Deductibility of student-loan interest................. 780 800 810 820 830 840 780 4,080
99 Deduction for higher education expenses................ 1,830 1,840 ........ ........ ........ ........ ........ .........
100 State prepaid tuition plans............................ 430 540 620 710 810 930 1,090 4,160
101 Exclusion of interest on student-loan bonds............ 280 300 320 350 370 380 390 1,810
102 Exclusion of interest on bonds for private nonprofit 1,080 1,160 1,220 1,330 1,410 1,450 1,500 6,910
educational facilities................................
103 Credit for holders of zone academy bonds............... 110 130 140 150 150 150 150 740
104 Exclusion of interest on savings bonds redeemed to 10 20 20 20 20 20 20 100
finance educational expenses..........................
105 Parental personal exemption for students age 19 or over 3,760 2,500 1,760 1,650 1,510 1,420 2,740 9,080
106 Deductibility of charitable contributions (education).. 3,420 3,680 4,030 4,260 4,550 4,870 5,210 22,920
107 Exclusion of employer-provided educational assistance.. 560 590 620 660 690 730 40 2,740
108 Special deduction for teacher expenses................. 160 150 ........ ........ ........ ........ ........ .........
109 Discharge of student loan indebtedness................. 20 20 20 20 20 20 20 100
Training, employment, and social services:
110 Work opportunity tax credit............................ 160 210 190 130 110 70 30 530
111 Welfare-to-work tax credit............................. 70 80 70 40 10 ........ ........ 120
112 Employer provided child care exclusion................. 610 810 920 960 1,010 1,060 1,070 5,020
113 Employer-provided child care credit.................... 10 10 10 20 20 20 10 80
114 Assistance for adopted foster children................. 310 320 350 370 400 430 470 2,020
115 Adoption credit and exclusion.......................... 360 540 560 570 580 600 540 2,850
116 Exclusion of employee meals and lodging (other than 850 890 930 970 1,010 1,060 1,110 5,080
military).............................................
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117 Child credit \2\....................................... 41,790 42,090 42,120 42,070 41,830 41,870 31,730 199,620
118 Credit for child and dependent care expenses........... 3,060 2,740 1,820 1,750 1,660 1,590 1,540 8,360
119 Credit for disabled access expenditures................ 30 30 30 40 40 40 40 190
120 Deductibility of charitable contributions, other than 29,670 32,550 34,500 36,790 39,410 42,210 45,210 198,120
education and health..................................
121 Exclusion of certain foster care payments.............. 440 440 450 450 450 460 470 2,280
122 Exclusion of parsonage allowances...................... 460 480 510 540 580 610 640 2,880
123 Employee retention credit for employers affected by ........ 140 20 20 ........ ........ ........ 40
Hurricane Katrina, Rita, and Wilma....................
Health:
124 Exclusion of employer contributions for medical 118,420 132,730 146,780 161,120 176,290 191,980 212,820 888,990
insurance premiums and medical care....................
125 Self-employed medical insurance premiums................ 3,790 4,240 4,630 5,080 5,570 6,050 6,730 28,060
126 Medical Savings Accounts / Health Savings Accounts...... 1,050 1,830 2,650 3,510 3,960 3,910 3,860 17,890
127 Deductibility of medical expenses....................... 6,110 4,410 5,310 6,490 7,720 9,220 12,260 41,000
128 Exclusion of interest on hospital construction bonds.... 1,880 2,010 2,110 2,300 2,450 2,520 2,600 11,980
129 Deductibility of charitable contributions (health)...... 3,350 3,670 3,890 4,150 4,450 4,770 5,110 22,370
130 Tax credit for orphan drug research..................... 210 230 260 290 320 360 410 1,640
131 Special Blue Cross/Blue Shield deduction................ 710 780 850 920 760 830 920 4,280
132 Tax credit for health insurance purchased by certain 20 20 30 30 30 30 30 150
displaced and retired individuals......................
Income security:
133 Exclusion of railroad retirement system benefits........ 390 390 380 360 370 370 350 1,830
134 Exclusion of workers' compensation benefits............. 5,770 6,000 6,180 6,390 6,630 6,860 7,090 33,150
135 Exclusion of public assistance benefits (normal tax 430 450 470 490 510 530 550 2,550
method)................................................
136 Exclusion of special benefits for disabled coal miners.. 50 50 50 40 40 40 40 210
137 Exclusion of military disability pensions............... 100 110 110 120 120 130 130 610
Net exclusion of pension contributions and earnings:
138 Employer plans......................................... 50,630 50,360 52,470 48,100 45,760 44,760 36,910 228,000
139 401(k) plans........................................... 37,440 37,330 39,800 43,100 48,810 53,870 47,290 232,870
140 Individual Retirement Accounts......................... 3,100 4,230 5,970 7,180 8,300 8,840 8,060 38,350
141 Low and moderate income savers credit.................. 1,310 1,380 830 ........ ........ ........ ........ 830
142 Keogh plans............................................ 9,400 9,990 10,670 11,630 12,670 13,800 15,040 63,810
Exclusion of other employee benefits:
143 Premiums on group term life insurance.................. 2,020 2,070 2,180 2,250 2,310 2,380 2,490 11,610
144 Premiums on accident and disability insurance.......... 280 290 300 310 320 330 340 1,600
145 Income of trusts to finance supplementary unemployment 20 20 20 20 20 20 20 100
benefits..............................................
146 Special ESOP rules..................................... 1,650 1,760 1,890 2,030 2,170 2,330 2,490 10,910
147 Additional deduction for the blind..................... 40 30 30 40 40 40 50 200
148 Additional deduction for the elderly................... 1,850 1,740 1,740 1,880 1,930 1,980 2,940 10,470
149 Tax credit for the elderly and disabled................ 20 20 20 10 10 10 10 60
150 Deductibility of casualty losses....................... 250 980 640 300 320 330 360 1,950
151 Earned income tax credit \3\........................... 4,925 5,050 5,150 5,445 5,640 5,810 6,070 28,115
152 Additional exemption for housing Hurricane Katrina ........ 110 20 ........ ........ ........ ........ 20
displaced individuals.................................
Social Security:
Exclusion of social security benefits:
153 Social Security benefits for retired workers........... 19,110 19,350 19,590 20,250 20,700 21,000 23,330 104,870
154 Social Security benefits for disabled.................. 3,600 3,810 4,110 4,330 4,570 4,960 5,530 23,500
155 Social Security benefits for dependents and survivors.. 3,940 3,980 4,040 4,070 4,100 4,180 4,360 20,750
Veterans benefits and services:
156 Exclusion of veterans death benefits and disability 3,320 3,600 3,770 3,900 4,050 4,140 4,350 20,210
compensation...........................................
157 Exclusion of veterans pensions.......................... 130 140 140 140 140 150 150 720
158 Exclusion of GI bill benefits........................... 150 170 210 240 280 330 400 1,460
159 Exclusion of interest on veterans housing bonds......... 40 40 50 50 50 50 50 250
General purpose fiscal assistance:
160 Exclusion of interest on public purpose State and local 26,360 28,180 29,640 32,330 34,410 35,440 36,510 168,330
bonds..................................................
161 Deductibility of nonbusiness state and local taxes other 36,460 30,310 27,210 27,730 28,260 29,000 49,510 161,710
than on owner-occupied homes...........................
162 Tax credit for corporations receiving income from doing 800 400 40 ........ ........ ........ ........ 40
business in U.S. possessions...........................
Interest:
163 Deferral of interest on U.S. savings bonds.............. 1,350 1,340 1,350 1,360 1,380 1,390 1,440 6,920
Addendum: Aid to State and local governments:
Deductibility of:
Property taxes on owner-occupied homes................. 19,110 15,020 12,810 12,910 12,830 12,720 22,930 74,200
Nonbusiness State and local taxes other than on owner- 36,460 30,310 27,210 27,730 28,260 29,000 49,510 161,710
occupied homes........................................
Exclusion of interest on State and local bonds for:
Public purposes........................................ 26,360 28,180 29,640 32,330 34,410 35,440 36,510 168,330
Energy facilities...................................... 80 90 90 100 100 110 110 510
Water, sewage, and hazardous waste disposal facilities. 450 480 500 550 580 600 620 2,850
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Small-issues........................................... 390 420 440 480 510 530 540 2,500
Owner-occupied mortgage subsidies...................... 930 990 1,040 1,140 1,210 1,240 1,280 5,910
Rental housing......................................... 410 430 450 500 530 540 550 2,570
Airports, docks, and similar facilities................ 800 860 910 990 1,060 1,080 1,120 5,160
Student loans.......................................... 280 300 320 350 370 380 390 1,810
Private nonprofit educational facilities............... 1,080 1,160 1,220 1,330 1,410 1,450 1,500 6,910
Hospital construction.................................. 1,880 2,010 2,110 2,300 2,450 2,520 2,600 11,980
Veterans' housing...................................... 40 40 50 50 50 50 50 250
Credit for holders of zone academy bonds.................. 110 130 140 150 150 150 150 740
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\1\ In addition, the alcohol fuel credit results in a reduction in excise tax receipts (in millions of dollars) as follows: 2005 $1,500; 2006 $2,110;
2007 $2,400; 2008 $2,740; 2009 $3,080; 2010 $3,410 and 2011 $870.
\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: 2005 $14,620; 2006 $14,110; 2007 $13,540; 2008 $12,950; 2009 $12,760 and 2010 $12,330:2011 $12,110
\3\ The figures in the table indicate the effect of the earned income tax credit on receipts. The effect of the credit on outlays (in millions of
dollars) is as follows: 2005 $34,559;2006 $35,098; 2007 $35,645; 2008 $36,955; 2009 $38,048; 2010 $38,823; and 2011 $40,278.
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.
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 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 2005 which cause the deferrals or other long-term revenue
effects. For instance, a pension contribution in 2005 would cause a
deferral of tax payments on wages in 2005 and on pension earnings on
this contribution (e.g., interest) in later years. In some future year,
however, the 2005 pension contribution and accrued earnings will be paid
out and taxes will be due; these receipts are included in the present-
value estimate. In general, this conceptual approach is similar to the
one used for reporting the budgetary effects of credit programs, where
direct loans and guarantees in a given year affect future cash flows.
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Table 19-2. ESTIMATES OF TAX EXPENDITURES FOR THE CORPORATE AND INDIVIDUAL INCOME TAXES
(in millions of dollars)
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Corporations Individuals
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2005 2006 2007 2008 2009 2010 2011 2007-11 2005 2006 2007 2008 2009 2010 2011 2007-11
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National Defense
1 Exclusion of benefits and allowances to armed ....... ....... ......... ......... ......... ......... ......... ......... 2,990 3,020 3,050 3,070 3,110 3,140 3,170 15,390
forces personnel............................
International affairs:
2 Exclusion of income earned abroad by U.S. ....... ....... ......... ......... ......... ......... ......... ......... 2,750 2,810 2,940 3,100 3,270 3,450 3,640 16,400
citizens....................................
3 Exclusion of certain allowances for Federal ....... ....... ......... ......... ......... ......... ......... ......... 900 950 1,000 1,050 1,100 1,160 1,230 5,540
employees abroad............................
4 Extraterritorial income exclusion............ 5,220 4,370 1,720 110 50 50 40 1,970 ......... ......... ......... ......... ......... ......... ......... .........
5 Inventory property sales source rules 1,560 1,680 1,840 2,040 2,230 2,380 2,540 11,030 ......... ......... ......... ......... ......... ......... ......... .........
exception...................................
6 Deferral of income from controlled foreign 10,500 11,160 11,940 12,770 13,650 14,600 15,620 68,580 ......... ......... ......... ......... ......... ......... ......... .........
corporations (normal tax method)............
7 Deferred taxes for financial firms on certain 2,190 2,260 960 ......... ......... ......... ......... 960 ......... ......... ......... ......... ......... ......... ......... .........
income earned overseas......................
General science, space, and technology:
8 Expensing of research and experimentation 4,010 7,770 6,850 6,140 5,250 4,700 4,740 27,680 100 150 140 120 110 100 100 570
expenditures (normal tax method)............
9 Credit for increasing research activities.... 5,110 2,120 920 390 180 50 ......... 1,540 50 40 ......... ......... ......... ......... ......... .........
Energy:
10 Expensing of exploration and development 340 590 760 720 560 430 330 2,800 50 90 110 110 90 70 50 430
costs, fuels................................
11 Excess of percentage over cost depletion, 530 600 620 600 580 560 560 2,920 60 70 70 60 60 60 60 310
fuels.......................................
12 Alternative fuel production credit........... 2,220 2,290 2,360 950 ......... ......... ......... 3,310 100 100 100 40 ......... ......... ......... 140
13 Exception from passive loss limitation for ....... ....... ......... ......... ......... ......... ......... ......... 40 40 40 40 40 40 40 200
working interests in oil and gas properties.
14 Capital gains treatment of royalties on coal. ....... ....... ......... ......... ......... ......... ......... ......... 90 90 90 100 70 60 80 400
15 Exclusion of interest on energy facility 20 20 20 20 20 20 20 100 60 70 70 80 80 90 90 410
bonds.......................................
16 Enhanced oil recovery credit................. 270 ....... ......... ......... ......... ......... 20 20 30 ......... ......... ......... ......... ......... ......... .........
17 New technology credit........................ 220 470 640 750 800 810 810 3,810 20 40 50 50 50 50 50 250
18 Alcohol fuel credits \1\..................... 30 30 30 40 40 50 20 180 10 10 10 10 10 10 10 50
19 Tax credit and deduction for clean-fuel 50 30 -10 -10 -20 -30 -30 -100 20 60 210 150 160 10 -10 520
burning vehicles............................
20 Exclusion of utility conservation subsidies.. ....... ....... ......... ......... ......... ......... ......... ......... 80 80 80 80 80 70 70 380
21 Credit for holding clean renewable energy ....... ....... 10 30 40 50 50 180 ......... ......... ......... ......... ......... ......... ......... .........
bonds.......................................
22 Deferral of gain from dispositions of 490 620 530 230 -100 -360 -510 -210 ......... ......... ......... ......... ......... ......... ......... .........
transmission property to implement FERC
restructuring policy........................
23 Credit for production from advanced nuclear ....... ....... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... .........
power facilities............................
24 Credit for investment in clean coal ....... 50 50 100 150 200 280 780 ......... ......... ......... ......... ......... ......... ......... .........
facilities..................................
25 Temporary 50% expensing for equipment used in ....... 10 30 120 240 260 180 830 ......... ......... ......... ......... ......... ......... ......... .........
the refining of liquid fuels................
26 Pass through low sulfur diesel expensing to ....... ....... ......... ......... ......... ......... ......... ......... 40 ......... -10 ......... -10 ......... -10 -30
cooperative owners..........................
27 Natural gas distribution pipelines treated as ....... 20 50 90 120 150 150 560 ......... ......... ......... ......... ......... ......... ......... .........
15-year property............................
28 Amortize all geological and geophysical ....... 30 120 140 110 80 50 500 ......... 10 30 40 30 20 10 130
expenditures over 2 years...................
29 Allowance of deduction for certain energy ....... 60 150 110 20 -10 -10 260 ......... 20 40 30 10 ......... ......... 80
efficient commercial building property......
30 Credit for construction of new energy ....... 10 20 10 10 ......... ......... 40 ......... ......... ......... ......... ......... ......... ......... .........
efficient homes.............................
31 Credit for energy efficiency improvements to ....... ....... ......... ......... ......... ......... ......... ......... ......... 220 380 150 ......... ......... ......... 530
existing homes..............................
32 Credit for energy efficient appliances....... ....... 120 80 ......... ......... ......... ......... 80 ......... ......... ......... ......... ......... ......... ......... .........
33 30% credit for residential purchases/ ....... ....... ......... ......... ......... ......... ......... ......... ......... 10 10 10 ......... ......... ......... 20
installations of solar and fuel cells.......
34 Credit for business installation of qualified ....... 60 100 40 -10 -10 -10 110 ......... 20 30 10 ......... ......... ......... 40
fuel cells and stationary microturbine power
plants......................................
35 Alternative Fuel and Fuel Mixture tax credit. ....... ....... ......... ......... ......... ......... ......... ......... 150 170 ......... ......... ......... ......... ......... .........
Natural resources and environment:
36 Expensing of exploration and development ....... ....... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... .........
costs, nonfuel minerals.....................
37 Excess of percentage over cost depletion, 250 260 280 290 290 310 320 1,490 20 20 20 20 20 20 20 100
nonfuel minerals............................
38 Exclusion of interest on bonds for water, 100 100 100 110 110 110 120 550 350 380 400 440 470 490 500 2,300
sewage, and hazardous waste facilities......
39 Capital gains treatment of certain timber ....... ....... ......... ......... ......... ......... ......... ......... 90 90 90 100 70 60 80 400
income......................................
40 Expensing of multiperiod timber growing costs 240 250 260 280 290 300 300 1,430 110 120 120 120 120 130 130 620
41 Tax incentives for preservation of historic 270 280 290 310 320 340 360 1,620 80 90 90 90 100 100 110 490
structures..................................
42 Expensing of capital costs with respect to 10 10 10 30 50 30 ......... 120 ......... ......... ......... ......... ......... ......... ......... .........
complying with EPA sulfur regulations.......
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43 Exclusion of gain or loss on sale or exchange ....... ....... 10 20 30 50 40 150 ......... ......... ......... 10 10 20 20 60
of certain brownfield sites.................
Agriculture:
44 Expensing of certain capital outlays......... 20 20 20 20 20 20 30 110 90 110 110 110 120 120 120 580
45 Expensing of certain multiperiod production 10 10 10 10 10 10 20 60 50 60 60 70 70 70 70 340
costs.......................................
46 Treatment of loans forgiven for solvent ....... ....... ......... ......... ......... ......... ......... ......... 10 10 10 10 10 10 10 50
farmers.....................................
47 Capital gains treatment of certain income.... ....... ....... ......... ......... ......... ......... ......... ......... 880 870 900 1,050 750 590 780 4,070
48 Income averaging for farmers................. ....... ....... ......... ......... ......... ......... ......... ......... 40 40 40 40 40 40 50 210
49 Deferral of gain on sale of farm refiners.... 10 10 20 20 20 20 20 100 ......... ......... ......... ......... ......... ......... ......... .........
50 Bio-Diesel and small agri-biodiesel producer ....... ....... ......... ......... ......... ......... ......... ......... 30 90 100 90 40 20 20 270
tax credits.................................
Commerce and housing:
Financial institutions and insurance:
51 Exemption of credit union income............ 1290 1370 1450 1540 1640 1,740 1,850 8,220 ......... ......... ......... ......... ......... ......... ......... .........
52 Excess bad debt reserves of financial 10 10 10 ......... ......... ......... ......... 10 ......... ......... ......... ......... ......... ......... ......... .........
institutions...............................
53 Exclusion of interest on life insurance 1,760 1,830 1,910 2,120 2,400 2,620 2,810 11,860 17,440 18,140 18,860 20,480 23,700 26,370 28,540 117,950
savings....................................
54 Special alternative tax on small property 20 20 20 20 20 20 30 110 ......... ......... ......... ......... ......... ......... ......... .........
and casualty insurance companies...........
55 Tax exemption of certain insurance companies 210 220 230 240 250 260 270 1,250 ......... ......... ......... ......... ......... ......... ......... .........
owned by tax-exempt organizations..........
56 Small life insurance company deduction...... 60 60 60 60 60 60 50 290 ......... ......... ......... ......... ......... ......... ......... .........
57 Exclusion of interest spread of financial ....... ....... ......... ......... ......... ......... ......... ......... 1,450 1,540 1,620 1,710 1,800 1,890 1,990 12,000
institutions...............................
Housing:
58 Exclusion of interest on owner-occupied 200 210 210 220 230 230 240 1,130 730 780 830 920 980 1,010 1,040 4,780
mortgage subsidy bonds......................
59 Exclusion of interest on rental housing bonds 90 90 90 100 100 100 100 490 320 340 360 400 430 440 450 2,080
60 Deductibility of mortgage interest on owner- ....... ....... ......... ......... ......... ......... ......... ......... 62,160 72,060 79,860 87,820 94,490 100,980 108,280 471,430
occupied homes..............................
61 Deductibility of State and local property tax ....... ....... ......... ......... ......... ......... ......... ......... 19,110 15,020 12,810 12,910 12,830 12,720 22,930 74,200
on owner-occupied homes.....................
62 Deferral of income from post 1987 installment 290 290 300 300 310 310 310 1,530 830 840 860 880 890 1,000 1,120 4,750
sales.......................................
63 Capital gains exclusion on home sales........ ....... ....... ......... ......... ......... ......... ......... ......... 35,990 39,750 43,900 48,490 59,900 78,860 87,100 318,250
64 Exclusion of net imputed rental income....... ....... ....... ......... ......... ......... ......... ......... ......... 28,600 29,720 33,210 36,860 40,630 44,785 49,364 204,849
65 Exception from passive loss rules for $25,000 ....... ....... ......... ......... ......... ......... ......... ......... 6470 6370 6230 6060 5880 5700 5510 29,380
of rental loss..............................
66 Credit for low-income housing investments.... 3,300 3,450 3,610 3,790 4,000 4,210 4,440 20,050 580 610 640 670 710 740 780 3,540
67 Accelerated depreciation on rental housing 650 710 760 840 910 960 1,030 4,500 8,960 9,920 10,710 11,820 12,910 13,750 14,890 64,080
(normal tax method).........................
Commerce:
68 Cancellation of indebtedness................. ....... ....... ......... ......... ......... ......... ......... ......... 30 160 110 40 40 40 40 270
69 Exceptions from imputed interest rules....... ....... ....... ......... ......... ......... ......... ......... ......... 50 50 50 50 50 50 50 250
70 Capital gains (except agriculture, timber, ....... ....... ......... ......... ......... ......... ......... ......... 26,170 25,990 26,760 31,280 22,340 17,580 23,410 121,370
iron ore, and coal).........................
71 Capital gains exclusion of small corporation ....... ....... ......... ......... ......... ......... ......... ......... 200 230 260 300 320 350 470 1,700
stock.......................................
72 Step-up basis of capital gains at death...... ....... ....... ......... ......... ......... ......... ......... ......... 26,820 29,510 32,460 35,700 36,480 34,560 38,010 177,210
73 Carryover basis of capital gains on gifts.... ....... ....... ......... ......... ......... ......... ......... ......... 410 540 640 750 790 1,270 6,370 9,820
74 Ordinary income treatment of loss from small ....... ....... ......... ......... ......... ......... ......... ......... 50 50 50 50 50 50 50 250
business corporation stock sale.............
75 Accelerated depreciation of buildings other 220 400 530 720 730 970 1,230 4,180 -1,130 -680 -440 -170 -370 -20 350 -650
than rental housing (normal tax method).....
76 Accelerated depreciation of machinery and 15,850 30,250 39,870 47,870 57,290 63,410 69,170 277,610 4,370 10,270 12,360 14,070 16,190 17,680 19,290 75,990
equipment (normal tax method)...............
77 Expensing of certain small investments 1,710 1,440 1,240 -280 -2 160 310 1,428 3,680 3,280 3,120 630 870 950 1,150 6,720
(normal tax method).........................
78 Graduated corporation income tax rate (normal 3,160 3,450 3,590 3,940 4,180 4,300 4,390 20,400 ......... ......... ......... ......... ......... ......... ......... .........
tax method).................................
79 Exclusion of interest on small issue bonds... 80 90 90 90 100 100 100 480 310 330 350 390 410 430 440 2,020
80 Deduction for US production activities....... 4,870 3,980 8,320 9,770 10,630 16,550 16,880 62,150 1,350 1,170 2,350 2,420 2,480 3,770 5,390 16,410
81 Special rules for certain film and TV 70 90 70 60 -30 -70 -50 -20 20 20 20 10 -10 -20 -10 -10
production..................................
Transportation:
82 Deferral of tax on shipping companies........ 20 20 20 20 20 20 20 100 ......... ......... ......... ......... ......... ......... ......... .........
83 Exclusion of reimbursed employee parking ....... ....... ......... ......... ......... ......... ......... ......... 2,590 2,730 2,880 3,030 3,180 3,330 3,420 15,840
expenses....................................
84 Exclusion for employer-provided transit ....... ....... ......... ......... ......... ......... ......... ......... 480 550 630 710 790 880 960 3,970
passes......................................
85 Tax credit for certain expenditures for 70 140 150 110 50 30 10 350 ......... ......... ......... ......... ......... ......... ......... .........
maintaining railroad tracks.................
86 Exclusion of interest on bonds for Financing ....... 10 15 20 25 25 25 110 ......... 15 35 55 70 70 75 305
of Highway Projects and rail-truck transfer
facilities..................................
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Community and regional development:
87 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)............
88 Exclusion of interest for airport, dock, and 170 180 190 190 200 200 210 990 630 680 720 800 860 880 910 4,170
similar bonds...............................
89 Exemption of certain mutuals' and 60 60 70 70 70 70 70 350 ......... ......... ......... ......... ......... ......... ......... .........
cooperatives' income........................
90 Empowerment zones and renewal communities.... 290 310 340 370 420 190 60 1,380 830 900 1,000 1,110 1,320 940 360 4,730
91 New markets tax credit....................... 110 150 210 220 200 170 130 930 320 460 620 650 590 500 390 2,750
92 Expensing of environmental remediation costs. 60 50 30 ......... -20 -10 -10 -10 10 10 10 ......... ......... ......... ......... 10
93 Credit to holders of Gulf Tax Credit Bonds... ....... ....... ......... ......... ......... ......... ......... ......... ......... ......... 10 10 10 10 10 50
Education, training, employment, and social
services:
Education:
94 Exclusion of scholarship and fellowship ....... ....... ......... ......... ......... ......... ......... ......... 1,380 1,450 1,510 1,580 1,640 1,720 1,790 8,240
income (normal tax method).................
95 HOPE tax credit............................. ....... ....... ......... ......... ......... ......... ......... ......... 3,710 3,650 3,060 3,090 3,220 3,240 3,480 16,090
96 Lifetime Learning tax credit................ ....... ....... ......... ......... ......... ......... ......... ......... 2,330 2,340 2,020 2,030 2,060 2,090 2,220 10,420
97 Education Individual Retirement Accounts.... ....... ....... ......... ......... ......... ......... ......... ......... 70 90 110 140 180 230 280 940
98 Deductibility of student-loan interest...... ....... ....... ......... ......... ......... ......... ......... ......... 780 800 810 820 830 840 780 4,080
99 Deduction for higher education expenses..... ....... ....... ......... ......... ......... ......... ......... ......... 1,830 1,840 ......... ......... ......... ......... ......... .........
100 State prepaid tuition plans................. ....... ....... ......... ......... ......... ......... ......... ......... 430 540 620 710 810 930 1,090 4,160
101 Exclusion of interest on student-loan bonds. 60 60 70 70 70 70 70 350 220 240 250 280 300 310 320 1,460
102 Exclusion of interest on bonds for private 230 240 250 260 260 270 280 1,320 850 920 970 1070 1150 1180 1220 5,590
nonprofit educational facilities...........
103 Credit for holders of zone academy bonds.... 110 130 140 150 150 150 150 740 ......... ......... ......... ......... ......... ......... ......... .........
104 Exclusion of interest on savings bonds ....... ....... ......... ......... ......... ......... ......... ......... 10 20 20 20 20 20 20 100
redeemed to finance educational expenses...
105 Parental personal exemption for students age ....... ....... ......... ......... ......... ......... ......... ......... 3,760 2,500 1,760 1,650 1,510 1,420 2,740 9,080
19 or over.................................
106 Deductibility of charitable contributions 540 560 590 620 660 700 740 3,310 2,880 3,120 3,440 3,640 3,890 4,170 4,470 19,610
(education)................................
107 Exclusion of employer-provided educational ....... ....... ......... ......... ......... ......... ......... ......... 560 590 620 660 690 730 40 2,740
assistance.................................
108 Special deduction for teacher expenses...... ....... ....... ......... ......... ......... ......... ......... ......... 160 150 ......... ......... ......... ......... ......... .........
109 Discharge of student loan indebtedness...... ....... ....... ......... ......... ......... ......... ......... ......... 20 20 20 20 20 20 20 100
Training, employment, and social services:
110 Work opportunity tax credit................. 130 180 150 100 80 50 20 400 30 30 40 30 30 20 10 130
111 Welfare-to-work tax credit.................. 60 70 60 30 10 ......... ......... 100 10 10 10 10 ......... ......... ......... 20
112 Employer provided child care exclusion...... ....... ....... ......... ......... ......... ......... ......... ......... 610 810 920 960 1010 1060 1070 5,020
113 Employer-provided child care credit......... ....... ....... ......... ......... ......... ......... ......... ......... 10 10 10 20 20 20 10 80
114 Assistance for adopted foster children...... ....... ....... ......... ......... ......... ......... ......... ......... 310 320 350 370 400 430 470 2,020
115 Adoption credit and exclusion............... ....... ....... ......... ......... ......... ......... ......... ......... 360 540 560 570 580 600 540 2,850
116 Exclusion of employee meals and lodging ....... ....... ......... ......... ......... ......... ......... ......... 850 890 930 970 1,010 1,060 1,110 5,080
(other than military)......................
117 Child credit \2\............................ ....... ....... ......... ......... ......... ......... ......... ......... 41,790 42,090 42,120 42,070 41,830 41,870 31,730 199,620
118 Credit for child and dependent care expenses ....... ....... ......... ......... ......... ......... ......... ......... 3,060 2,740 1,820 1,750 1,660 1,590 1,540 8,360
119 Credit for disabled access expenditures..... 10 10 10 10 10 10 10 50 20 20 20 30 30 30 30 140
120 Deductibility of charitable contributions, 1,230 1,290 1,360 1,430 1,500 1,570 1640 7,500 28,440 31,260 33,140 35,360 37,910 40,640 43,570 190,620
other than education and health............
121 Exclusion of certain foster care payments... ....... ....... ......... ......... ......... ......... ......... ......... 440 440 450 450 450 460 470 2,280
122 Exclusion of parsonage allowances........... ....... ....... ......... ......... ......... ......... ......... ......... 460 480 510 540 580 610 640 2,880
123 Employee retention credit for employers ....... 40 ......... ......... ......... ......... ......... ......... ......... 100 20 20 ......... ......... ......... 40
affected by Hurricane Katrina, Rita, and
Wilma......................................
Health:
124 Exclusion of employer contributions for ....... ....... ......... ......... ......... ......... ......... ......... 118,420 132,730 146,780 161,120 176,290 191,980 212,820 888,990
medical insurance premiums and medical care.
125 Self-employed medical insurance premiums..... ....... ....... ......... ......... ......... ......... ......... ......... 3,790 4,240 4,630 5,080 5,570 6,050 6,730 28,060
126 Medical Savings Accounts / Health Savings ....... ....... ......... ......... ......... ......... ......... ......... 1,050 1,830 2,650 3,510 3,960 3,910 3,860 17,890
Accounts....................................
127 Deductibility of medical expenses............ ....... ....... ......... ......... ......... ......... ......... ......... 6,110 4,410 5,310 6,490 7,720 9,220 12,260 41,000
128 Exclusion of interest on hospital 410 420 430 440 460 470 490 2,290 1,470 1,590 1,680 1,860 1,990 2,050 2,110 9,690
construction bonds..........................
129 Deductibility of charitable contributions 160 160 170 180 190 200 210 950 3,190 3,510 3,720 3,970 4,260 4,570 4,900 21,420
(health)....................................
130 Tax credit for orphan drug research.......... 210 230 260 290 320 360 410 1,640 ......... ......... ......... ......... ......... ......... ......... .........
131 Special Blue Cross/Blue Shield deduction..... 710 780 850 920 760 830 920 4,280 ......... ......... ......... ......... ......... ......... ......... .........
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132 Tax credit for health insurance purchased by ....... ....... ......... ......... ......... ......... ......... ......... 20 20 30 30 30 30 30 150
certain displaced and retired individuals...
Income security:
133 Exclusion of railroad retirement system ....... ....... ......... ......... ......... ......... ......... ......... 390 390 380 360 370 370 350 1,830
benefits....................................
134 Exclusion of workers' compensation benefits.. ....... ....... ......... ......... ......... ......... ......... ......... 5,770 6,000 6,180 6,390 6,630 6,860 7,090 33,150
135 Exclusion of public assistance benefits ....... ....... ......... ......... ......... ......... ......... ......... 430 450 470 490 510 530 550 2,550
(normal tax method).........................
136 Exclusion of special benefits for disabled ....... ....... ......... ......... ......... ......... ......... ......... 50 50 50 40 40 40 40 210
coal miners.................................
137 Exclusion of military disability pensions.... ....... ....... ......... ......... ......... ......... ......... ......... 100 110 110 120 120 130 130 610
Net exclusion of pension contributions and
earnings:
138 Employer plans............................... ....... ....... ......... ......... ......... ......... ......... ......... 50,630 50,360 52,470 48,100 45,760 44,760 36,910 228,000
139 401(k) plans................................. ....... ....... ......... ......... ......... ......... ......... ......... 37,440 37,330 39,800 43,100 48,810 53,870 47,290 232,870
140 Individual Retirement Accounts............... ....... ....... ......... ......... ......... ......... ......... ......... 3,100 4,230 5,970 7,180 8,300 8,840 8,060 38,350
141 Low and moderate income savers credit........ ....... ....... ......... ......... ......... ......... ......... ......... 1,310 1,380 830 ......... ......... ......... ......... 830
142 Keogh plans.................................. ....... ....... ......... ......... ......... ......... ......... ......... 9,400 9,990 10,670 11,630 12,670 13,800 15,040 63,810
Exclusion of other employee benefits:
143 Premiums on group term life insurance....... ....... ....... ......... ......... ......... ......... ......... ......... 2,020 2,070 2,180 2,250 2,310 2,380 2,490 11,610
144 Premiums on accident and disability ....... ....... ......... ......... ......... ......... ......... ......... 280 290 300 310 320 330 340 1,600
insurance..................................
145 Income of trusts to finance supplementary ....... ....... ......... ......... ......... ......... ......... ......... 20 20 20 20 20 20 20 100
unemployment benefits......................
146 Special ESOP rules.......................... 1310 1410 1520 1640 1780 1940 2100 8,980 340 350 370 390 390 390 390 1,930
147 Additional deduction for the blind.......... ....... ....... ......... ......... ......... ......... ......... ......... 40 30 30 40 40 40 50 200
148 Additional deduction for the elderly........ ....... ....... ......... ......... ......... ......... ......... ......... 1,850 1,740 1,740 1,880 1,930 1,980 2,940 10,470
149 Tax credit for the elderly and disabled..... ....... ....... ......... ......... ......... ......... ......... ......... 20 20 20 10 10 10 10 60
150 Deductibility of casualty losses............ ....... ....... ......... ......... ......... ......... ......... ......... 250 980 640 300 320 330 360 1,950
151 Earned income tax credit \3\................ ....... ....... ......... ......... ......... ......... ......... ......... 4,925 5,050 5,150 5,445 5,640 5,810 6,070 28,115
152 Additional exemption for housing Hurricane ....... ....... ......... ......... ......... ......... ......... ......... ......... 110 20 ......... ......... ......... ......... 20
Katrina displaced individuals..............
Social Security:
Exclusion of social security benefits:
153 Social Security benefits for retired workers ....... ....... ......... ......... ......... ......... ......... ......... 19,110 19,350 19,590 20,250 20,700 21,000 23,330 104,870
154 Social Security benefits for disabled....... ....... ....... ......... ......... ......... ......... ......... ......... 3,600 3,810 4,110 4,330 4,570 4,960 5,530 23,500
155 Social Security benefits for dependents and ....... ....... ......... ......... ......... ......... ......... ......... 3,940 3,980 4,040 4,070 4,100 4,180 4,360 20,750
survivors..................................
Veterans benefits and services:
156 Exclusion of veterans death benefits and ....... ....... ......... ......... ......... ......... ......... ......... 3,320 3,600 3,770 3,900 4,050 4,140 4,350 20,210
disability compensation.....................
157 Exclusion of veterans pensions............... ....... ....... ......... ......... ......... ......... ......... ......... 130 140 140 140 140 150 150 720
158 Exclusion of GI bill benefits................ ....... ....... ......... ......... ......... ......... ......... ......... 150 170 210 240 280 330 400 1,460
159 Exclusion of interest on veterans housing 10 10 10 10 10 10 10 50 30 30 40 40 40 40 40 200
bonds.......................................
General purpose fiscal assistance:
160 Exclusion of interest on public purpose State 5,710 5,880 6,060 6,240 6,430 6,620 6,820 32,170 20,650 22,300 23,580 26,090 27,980 28,820 29,690 136,160
and local bonds.............................
161 Deductibility of nonbusiness state and local ....... ....... ......... ......... ......... ......... ......... ......... 36,460 30,310 27,210 27,730 28,260 29,000 49,510 161,710
taxes other than on owner-occupied homes....
162 Tax credit for corporations receiving income 800 400 40 ......... ......... ......... ......... 40 ......... ......... ......... ......... ......... ......... ......... .........
from doing business in U.S. possessions.....
Interest:
163 Deferral of interest on U.S. savings bonds... ....... ....... ......... ......... ......... ......... ......... ......... 1,350 1,340 1,350 1,360 1,380 1,390 1,440 6,920
Addendum: Aid to State and local governments:
Deductibility of:
Property taxes on owner-occupied homes...... ....... ....... ......... ......... ......... ......... ......... ......... 19,110 15,020 12,810 12,910 12,830 12,720 22,930 74,200
Nonbusiness State and local taxes other than ....... ....... ......... ......... ......... ......... ......... ......... 36,460 30,310 27,210 27,730 28,260 29,000 49,510 161,710
on owner-occupied homes....................
Exclusion of interest on State and local
bonds for:
Public purposes............................. 5,710 5,880 6,060 6,240 6,430 6,620 6,820 32,170 20,650 22,300 23,580 26,090 27,980 28,820 29,690 136,160
Energy facilities........................... 20 20 20 20 20 20 20 100 60 70 70 80 80 90 90 410
Water, sewage, and hazardous waste disposal 100 100 100 110 110 110 120 550 350 380 400 440 470 490 500 2,300
facilities.................................
Small-issues................................ 80 90 90 90 100 100 100 480 310 330 350 390 410 430 440 2,020
Owner-occupied mortgage subsidies........... 200 210 210 220 230 230 240 1,130 730 780 830 920 980 1,010 1,040 4,780
Rental housing.............................. 90 90 90 100 100 100 100 490 320 340 360 400 430 440 450 2,080
Airports, docks, and similar facilities..... 170 180 190 190 200 200 210 990 630 680 720 800 860 880 910 4,170
Student loans............................... 60 60 70 70 70 70 70 350 220 240 250 280 300 310 320 1,460
Private nonprofit educational facilities.... 230 240 250 260 260 270 280 1,320 850 920 970 1,070 1,150 1,180 1,220 5,590
Hospital construction....................... 410 420 430 440 460 470 490 2,290 1,470 1,590 1,680 1,860 1,990 2,050 2,110 9,690
Veterans' housing........................... 10 10 10 10 10 10 10 50 30 30 40 40 40 40 40 200
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Credit for holders of zone academy bonds....... 110 130 140 150 150 150 150 740 ......... ......... ......... ......... ......... ......... ......... .........
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\1\ In addition, the alcohol fuel credit results in a reduction in excise tax receipts (in millions of dollars) as follows: 2005 $1,500; 2006 $2,110; 2007 $2,400; 2008 $2,740; 2009 $3,080; 2010 $3,410 and 2011 $870.
\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: 2005 $14,620; 2006 $14,110; 2007 $13,540; 2008 $12,950; 2009 $12,760
and 2010 $12,330:2011 $12,110.
\3\ The figures in the table indicate the effect of the earned income tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2005 $34,559;2006 $35,098; 2007 $35,645; 2008 $36,955; 2009
$38,048; 2010 $38,823; and 2011 $40,278.
Note: Provisions with estimates denoted normal tax method have no revenue loss under the reference tax law method.
All estimates have been rounded to the nearest $10 million. Provisions with estimates that rounded to zero in each year are not included in the table.
Tax Expenditure Baselines
A tax expenditure is an exception to baseline provisions of the tax
structure that usually results in a reduction in the amount of tax owed.
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 deduction of 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:
Income is taxable only when it is realized in exchange.
Thus, either 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 vary by level of income.
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.\2\ The normal tax baseline also
excludes gifts between individuals from gross income. Under
the normal tax baseline, however, all cash transfer payments
from the Gov
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ernment 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. \3\
---------------------------------------------------------------------------
\2\ Gross income does, however, include transfer payments associated
with past employment, such as Social Security benefits.
\3\ 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.
Table 19-3. INCOME TAX EXPENDITURES RANKED BY TOTAL 2007-2011 PROJECTED REVENUE EFFECT
(in millions of dollars)
----------------------------------------------------------------------------------------------------------------
Provision 2007 2007-11
----------------------------------------------------------------------------------------------------------------
Exclusion of employer contributions for medical insurance premiums and medical 146,780 888,990
Deductibility of mortgage interest on owner-occupied homes.................... 79,860 471,430
Accelerated depreciation of machinery and equipment (normal tax method)....... 52,230 357,200
Capital gains exclusion on home sales......................................... 43,900 318,250
401(k) plans.................................................................. 39,800 232,870
Employer plans................................................................ 52,470 228,000
Exclusion of net imputed rental income........................................ 33,210 204,849
Child credit.................................................................. 42,120 199,620
Deductibility of charitable contributions, other than education and health.... 34,430 198,120
Step-up basis of capital gains at death....................................... 32,460 177,210
Exclusion of interest on public purpose State and local bonds................. 29,640 168,330
Deductibility of nonbusiness state and local taxes other than on owner- 27,210 161,710
occupied homes...............................................................
Exclusion of interest on life insurance savings............................... 20,770 129,810
Capital gains (except agriculture, timber, iron ore, and coal)................ 26,760 121,370
Social Security benefits for retired workers.................................. 19,590 104,870
Deduction for US production activities........................................ 10,670 78,560
Deductibility of State and local property tax on owner-occupied homes......... 12,810 74,200
Deferral of income from controlled foreign corporations (normal tax method)... 11,940 68,580
Keogh plans................................................................... 10,670 63,810
Deductibility of medical expenses............................................. 5,310 41,000
Individual Retirement Accounts................................................ 5,970 38,350
Exclusion of workers' compensation benefits................................... 6,180 33,150
Exception from passive loss rules for $25,000 of rental loss.................. 6,230 29,380
Expensing of research and experimentation expenditures (normal tax method).... 6,990 28,250
Earned income tax credit...................................................... 5,147 28,104
Self-employed medical insurance premiums...................................... 4,630 28,060
Credit for low-income housing investments..................................... 4,250 23,590
Social Security benefits for disabled......................................... 4,110 23,500
Deductibility of charitable contributions (education)......................... 4,030 22,920
Deductibility of charitable contributions (health)............................ 3,890 22,370
Social Security benefits for dependents and survivors......................... 4,040 20,750
Graduated corporation income tax rate (normal tax method)..................... 3,590 20,400
Exclusion of veterans death benefits and disability compensation.............. 3,770 20,210
Medical Savings Accounts/Health Savings Accounts.............................. 2,650 17,890
Exclusion of income earned abroad by U.S. citizens............................ 2,940 16,400
HOPE tax credit............................................................... 3,060 16,090
Exclusion of reimbursed employee parking expenses............................. 2,880 15,840
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Exclusion of benefits and allowances to armed forces personnel................ 3,050 15,390
Exclusion of interest spread of financial institutions........................ 1,620 12,000
Exclusion of interest on hospital construction bonds.......................... 2,110 11,980
Premiums on group term life insurance......................................... 2,180 11,610
Inventory property sales source rules exception............................... 1,840 11,030
Special ESOP rules............................................................ 1,890 10,910
Additional deduction for the elderly.......................................... 1,740 10,470
Lifetime Learning tax credit.................................................. 2,020 10,420
Carryover basis of capital gains on gifts..................................... 640 9,820
Parental personal exemption for students age 19 or over....................... 1,760 9,080
Credit for child and dependent care expenses.................................. 1,820 8,360
Exclusion of scholarship and fellowship income (normal tax method)............ 1,510 8,240
Exemption of credit union income.............................................. 1,450 8,220
Expensing of certain small investments (normal tax method).................... 4,360 8,148
Deferral of interest on U.S. savings bonds.................................... 1,350 6,920
Exclusion of interest on bonds for private nonprofit educational facilities... 1,220 6,910
Deferral of income from post 1987 installment sales........................... 1,160 6,280
Empowerment zones, Enterprise communities, and Renewal communities............ 1,340 6,110
Exclusion of interest on owner-occupied mortgage subsidy bonds................ 1,040 5,910
Exclusion of certain allowances for Federal employees abroad.................. 1,000 5,540
Exclusion of interest for airport, dock, and similar bonds.................... 910 5,160
Exclusion of employee meals and lodging (other than military)................. 930 5,080
Employer provided child care exclusion........................................ 920 5,020
Special Blue Cross/Blue Shield deduction...................................... 850 4,280
State prepaid tuition plans................................................... 620 4,160
Deductibility of student-loan interest........................................ 810 4,080
Capital gains treatment of certain income..................................... 900 4,070
New technology credit......................................................... 690 4,060
Exclusion for employer-provided transit passes................................ 630 3,970
New markets tax credit........................................................ 830 3,680
Accelerated depreciation of buildings other than rental housing (normal tax 90 3,530
method)......................................................................
Alternative fuel production credit............................................ 2,460 3,450
Excess of percentage over cost depletion, fuels............................... 690 3,230
Expensing of exploration and development costs, fuels......................... 870 3,230
Exclusion of parsonage allowances............................................. 510 2,880
Exclusion of interest on bonds for water, sewage, and hazardous waste 500 2,850
facilities...................................................................
Adoption credit and exclusion................................................. 560 2,850
Exclusion of employer-provided educational assistance......................... 620 2,740
Exclusion of interest on rental housing bonds................................. 450 2,570
Exclusion of public assistance benefits (normal tax method)................... 470 2,550
Exclusion of interest on small issue bonds.................................... 440 2,500
Extraterritorial income exclusion............................................. 1,960 2,350
Exclusion of certain foster care payments..................................... 450 2,280
Tax incentives for preservation of historic structures........................ 380 2,110
Expensing of multiperiod timber growing costs................................. 380 2,050
Assistance for adopted foster children........................................ 350 2,020
Deductibility of casualty losses.............................................. 640 1,950
Exclusion of railroad retirement system benefits.............................. 380 1,830
Exclusion of interest on student-loan bonds................................... 320 1,810
Capital gains exclusion of small corporation stock............................ 260 1,700
Tax credit for orphan drug research........................................... 260 1,640
Premiums on accident and disability insurance................................. 300 1,600
Excess of percentage over cost depletion, nonfuel minerals.................... 300 1,590
Credit for increasing research activities..................................... 920 1,540
Exclusion of GI bill benefits................................................. 210 1,460
Tax exemption of certain insurance companies owned by tax-exempt organizations 230 1,250
Deferred taxes for financial firms on certain income earned overseas.......... 960 960
Education Individual Retirement Accounts...................................... 110 940
Low and moderate income savers credit......................................... 830 830
Temporary 50% expensing for equipment used in the refining of liquid fuels.... 30 830
Credit for investment in clean coal facilities................................ 50 780
Credit for holders of zone academy bonds...................................... 140 740
Exclusion of veterans pensions................................................ 140 720
Expensing of certain capital outlays.......................................... 130 690
Amortize all geological and geophysical expenditures over 2 years............. 150 630
Exclusion of military disability pensions..................................... 110 610
Natural gas distribution pipelines treated as 15-year property................ 50 560
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Work opportunity tax credit................................................... 190 530
Credit for energy efficiency improvements to existing homes................... 380 530
Exclusion of interest on energy facility bonds................................ 90 510
Tax credit and deduction for clean-fuel burning vehicles...................... 200 420
Exclusion of interest on bonds for Financing of Highway Projects and rail- 50 415
truck transfer facilities....................................................
Capital gains treatment of royalties on coal.................................. 90 400
Capital gains treatment of certain timber income.............................. 90 400
Expensing of certain multiperiod production costs............................. 70 400
Exclusion of utility conservation subsidies................................... 80 380
Tax credit for certain expenditures for maintaining railroad tracks........... 150 350
Exemption of certain mutuals' and cooperatives' income........................ 70 350
Allowance of deduction for certain energy efficient commercial building 190 340
property.....................................................................
Small life insurance company deduction........................................ 60 290
Cancellation of indebtedness.................................................. 110 270
Bio-Diesel tax credit......................................................... 100 270
Exclusion of interest on veterans housing bonds............................... 50 250
Exceptions from imputed interest rules........................................ 50 250
Ordinary income treatment of loss from small business corporation stock sale.. 50 250
Alcohol fuel credits.......................................................... 40 230
Exclusion of special benefits for disabled coal miners........................ 50 210
Income averaging for farmers.................................................. 40 210
Exclusion of gain or loss on sale or exchange of certain brownfield sites..... 10 210
Investment credit for rehabilitation of structures (other than historic)...... 40 200
Additional deduction for the blind............................................ 30 200
Exception from passive loss limitation for working interests in oil and gas 40 200
properties...................................................................
Credit for disabled access expenditures....................................... 30 190
Credit for holding clean renewable energy bonds............................... 10 180
Tax credit for health insurance purchased by certain displaced and retired 30 150
individuals..................................................................
Credit for business installation of qualified fuel cells and stationary 130 150
microturbine power plants....................................................
Welfare-to-work tax credit.................................................... 70 120
Expensing of capital costs with respect to complying with EPA sulfur 11 113
regulations..................................................................
Special alternative tax on small property and casualty insurance companies.... 20 110
Deferral of tax on shipping companies......................................... 20 100
Exclusion of interest on savings bonds redeemed to finance educational 20 100
expenses.....................................................................
Discharge of student loan indebtedness........................................ 20 100
Income of trusts to finance supplementary unemployment benefits............... 20 100
Deferral of gain on sale of farm refiners..................................... 20 100
Employer-provided child care credit........................................... 10 80
Credit for energy efficient appliances........................................ 80 80
Tax credit for the elderly and disabled....................................... 20 60
Treatment of loans forgiven for solvent farmers............................... 10 50
Credit to holders of Gulf Tax Credit Bonds.................................... 10 50
Tax credit for corporations receiving income from doing business in U.S. 40 40
possessions..................................................................
Credit for construction of new energy efficient homes......................... 20 40
Employee retention credit for employers affected by Hurricane Katrina, Rita, 20 40
and Wilma....................................................................
Enhanced oil recovery credit.................................................. ............... 20
30% credit for residential purchases/installations of solar and fuel cells.... 10 20
Additional exemption for housing Hurricane Katrina displaced individuals...... 20 20
Excess bad debt reserves of financial institutions............................ 10 10
Deduction for higher education expenses....................................... ............... ...............
Expensing of exploration and development costs, nonfuel minerals.............. ............... ...............
Special deduction for teacher expenses........................................ ............... ...............
Expensing of environmental remediation costs.................................. 40 ...............
Alternative Fuel and Fuel Mixture tax credit.................................. ............... ...............
Credit for production from advanced nuclear power facilities.................. ............... ...............
Special rules for certain film and TV production.............................. 90 -30
Pass through low sulfur diesel expensing to cooperative owners................ -10 -30
Deferral of gain from dispositions of transmission property to implement FERC 530 -210
restructuring policy.........................................................
----------------------------------------------------------------------------------------------------------------
[[Page 299]]
Table 19-4. PRESENT VALUE OF SELECTED TAX EXPENDITURES FOR ACTIVITY IN CALENDAR YEAR 2005
(in millions of dollars)
----------------------------------------------------------------------------------------------------------------
2005 Present
Provision Value of
Revenue Loss
----------------------------------------------------------------------------------------------------------------
1 Deferral of income from controlled foreign corporations (normal tax method)......... 10,020
2 Deferred taxes for financial firms on income earned overseas........................ 2,270
3 Expensing of research and experimentation expenditures (normal tax method).......... 2,390
4 Expensing of exploration and development costs--fuels............................... 180
5 Expensing of exploration and development costs--nonfuels............................ 10
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.......................... 19,640
10 Accelerated depreciation on rental housing.......................................... 16,088
11 Accelerated depreciation of buildings other than rental............................. 15,980
12 Accelerated depreciation of machinery and equipment................................. 64,330
13 Expensing of certain small investments (normal tax method).......................... 1,100
14 Deferral of tax on shipping companies............................................... 20
15 Credit for holders of zone academy bonds............................................ 210
16 Credit for low-income housing investments........................................... 3,970
17 Deferral for state prepaid tuition plans............................................ 1,190
18 Exclusion of pension contributions--employer plans.................................. 81,160
19 Exclusion of 401(k) contributions................................................... 102,640
20 Exclusion of IRA contributions and earnings......................................... 4,460
21 Exclusion of contributions and earnings for Keogh plans............................. 3,190
22 Exclusion of interest on public-purpose bonds....................................... 19,830
23 Exclusion of interest on non-public purpose bonds................................... 6,700
24 Deferral of interest on U.S. savings bonds.......................................... 410
25 Exclusion of Roth earnings and distributions........................................ 8,170
26 Exclusion of non-deductible IRA earnings............................................ 370
----------------------------------------------------------------------------------------------------------------
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 a 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 \4\ 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.
---------------------------------------------------------------------------
\4\ 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.
[[Page 300]]
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.\5\ 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 of policy instruments means that tax expenditures
can be flexible and can have very different economic effects.
---------------------------------------------------------------------------
\5\ Although this chapter 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.
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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, personal exemptions, deductions, credits
and phase-outs 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.
Outlay programs have advantages where direct Government service
provision is particularly warranted such as equipping and providing the
armed forces or administering the system of justice. Outlay programs may
also be specifically designed to meet the needs of low-income families
who would not otherwise be subject to income taxes or need to file a tax
return. Outlay programs may also receive more year-to-year oversight and
fine tuning through the legislative and executive budget process. In
addition, many different types of spending programs including direct
Government provision; credit programs; and payments to State and local
governments, the private sector, or individuals in the form of grants or
contracts provide flexibility for policy design. On the other hand,
certain outlay programs such as direct Government service provision may
rely less directly on economic incentives and private-market provision
than tax incentives, which may reduce the relative efficiency of
spending programs for some goals. Spending programs also require
resources to be raised via taxes, user charges, or Government borrowing,
which can impose further costs by diverting resources from their most
efficient uses. Finally, spending programs, particularly on the
discretionary side, may respond less readily to changing activity levels
and economic conditions than tax expenditures.
Regulations have more direct and immediate effects than outlay and
tax-expenditure programs because regulations apply directly and
immediately to the regulated party (i.e., the intended actor) generally
in the private sector. Regulations can also be fine-tuned more quickly
than tax expenditures because they can often be changed as needed by the
Executive Branch without legislation. Like tax expenditures, regulations
often rely largely on 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 in
[[Page 301]]
tended objectives (e.g., a provision intended to promote an activity or
raise certain incomes may have positive or negative effects on tax
neutrality).
Performance measurement is generally concerned with inputs, outputs,
and outcomes. In the case of tax expenditures, the principal input is
usually the revenue effect. Outputs are quantitative or qualitative
measures of goods and services, or changes in income and investment,
directly produced by these inputs. Outcomes, in turn, represent the
changes in the economy, society, or environment that are the ultimate
goals of programs.
Thus, for a provision that reduces taxes on certain investment
activity, an increase in the amount of investment would likely be a key
output. The resulting production from that investment, and, in turn, the
associated improvements in national income, welfare, or security, could
be the outcomes of interest. For other provisions, such as those
designed to address a potential inequity or unintended consequence in
the tax code, an important performance measure might be how they change
effective tax rates (the discounted present-value of taxes owed on new
investments or incremental earnings) or excess burden (an economic
measure of the distortions caused by taxes). Effects on the incomes of
members of particular groups may be an important measure for certain
provisions.
An overview of evaluation issues by budget function. The discussion
below considers the types of measures that might be useful for some
major programmatic groups of tax expenditures. The discussion is
intended to be illustrative and not all encompassing. However, it is
premised on the assumption that the data needed to perform the analysis
are available or can be developed. In practice, data availability is
likely to be a major challenge, and data constraints may limit the
assessment of the effectiveness of many provisions. In addition, such
assessments can raise significant challenges in economic modeling.
National defense. Some tax expenditures are intended to assist
governmental activities. For example, tax preferences for military
benefits reflect, among other things, the view that benefits such as
housing, subsistence, and moving expenses are intrinsic aspects of
military service, and are provided, in part, for the benefit of the
employer, the U.S. Government. Tax benefits for combat service are
intended to reduce tax burdens on military personnel undertaking
hazardous service for the Nation. A portion of the tax expenditure
associated with foreign earnings is targeted to benefit U.S. Government
civilian personnel working abroad by offsetting the living costs that
can be higher than those in the United States. These tax expenditures
should be considered together with direct agency budget costs in making
programmatic decisions.
International affairs. Tax expenditures are also aimed at goals such
as tax neutrality. These include the exclusion for income earned abroad
by nongovernmental employees and exclusions for income of U.S.-
controlled foreign corporations. Measuring the effectiveness of these
provisions raises challenging issues.
General science, space and technology; energy; natural resources and
the environment; agriculture; and commerce and housing. A series of tax
expenditures reduces the cost of investment, both in specific activities
such as research and experimentation, extractive industries, and certain
financial activities and more generally, through accelerated
depreciation for plant and equipment. These provisions can be evaluated
along a number of dimensions. For example, it could be useful to
consider the strength of the incentives by measuring their effects on
the cost of capital (the interest rate which investments must yield to
cover their costs) and effective tax rates. The impact of these
provisions on the amounts of corresponding forms of investment (e.g.,
research spending, exploration activity, equipment) might also be
estimated. In some cases, such as research, there is evidence that the
investment can provide significant positive externalities that is,
economic benefits that are not reflected in the market transactions
between private parties. It could be useful to quantify these
externalities and compare them with the size of tax expenditures.
Measures could also indicate the effects on production from these
investments such as numbers or values of patents, energy production and
reserves, and industrial production. Issues to be considered include the
extent to which the preferences increase production (as opposed to
benefiting 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 com
[[Page 302]]
pared with alternative programs that address housing supply and demand.
Transportation. Employer-provided parking is a fringe benefit that,
for the most part, is excluded from taxation. The tax expenditure
estimates reflect the cost of parking that is leased by employers for
employees; an estimate is not currently available for the value of
parking owned by employers and provided to their employees. The
exclusion for employer-provided transit passes is intended to promote
use of this mode of transportation, which has environmental and
congestion benefits. The tax treatments of these different benefits
could be compared with alternative transportation policies.
Community and regional development. A series of tax expenditures is
intended to promote community and regional development by reducing the
costs of financing specialized infrastructure, such as airports, docks,
and stadiums. Empowerment zone and enterprise community provisions are
designed to promote activity in disadvantaged areas. These provisions
can be compared with grants and other policies designed to spur economic
development.
Education, training, employment, and social services. Major
provisions in this function are intended to promote post-secondary
education, to offset costs of raising children, and to promote a variety
of charitable activities. The education incentives can be compared with
loans, grants, and other programs designed to promote higher education
and training. The child credits are intended to adjust the tax system
for the costs of raising children; as such, they could be compared to
other Federal tax and spending policies, including related features of
the tax system, such as personal exemptions (which are not defined as a
tax expenditure). Evaluation of charitable activities requires
consideration of the beneficiaries of these activities, who are
generally not the parties receiving the tax reduction.
Health. Individuals also benefit from favorable treatment of
employer-provided health insurance. Measures of these benefits could
include increased coverage and pooling of risks. The effects of
insurance coverage on final outcome measures of actual health (e.g.,
infant mortality, days of work lost due to illness, or life expectancy)
or intermediate outcomes (e.g., use of preventive health care or health
care costs) could also be investigated.
Income security, Social Security, and veterans benefits and services.
Major tax expenditures in the income security function benefit
retirement savings, through employer-provided pensions, individual
retirement accounts, and Keogh plans. These provisions might be
evaluated in terms of their effects on boosting retirement incomes,
private savings, and national savings (which would include the effect on
private savings as well as public savings or deficits). Interactions
with other programs, including Social Security, also may merit analysis.
As in the case of employer-provided health insurance, analysis of
employer-provided pension programs requires imputing the value of
benefits funded at the firm level to individuals.
Other provisions principally affect the incomes of members of certain
groups, rather than affecting incentives. For example, tax-favored
treatment of Social Security benefits, certain veterans' benefits, and
deductions for the blind and elderly provide increased incomes to
eligible parties. The earned-income tax credit, in contrast, should be
evaluated for its effects on labor force participation as well as the
income it provides lower-income workers.
General purpose fiscal assistance and interest. The tax-exemption for
public purpose State and local bonds reduces the costs of borrowing for
a variety of purposes (borrowing for non-public purposes is reflected
under other budget functions). The deductibility of certain State and
local taxes reflected under this function primarily relates to personal
income taxes (property tax deductibility is reflected under the commerce
and housing function). Tax preferences for Puerto Rico and other U.S.
possessions are also included here. These provisions can be compared
with other tax and spending policies as means of benefiting 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 on in this chapter follow. These descriptions relate to current
law as of December 31, 2005, and do not reflect proposals made elsewhere
in the Budget. Legislation enacted in 2005, such as the Safe,
Accountable, Flexible, Efficient Transportation Equity Act: A Legacy For
Users, The Energy Tax Incentives Act of 2005, The Katrina Emergency Tax
Relief Act of 2005, and the Gulf Opportunity Zone Act of 2005, expanded
the scope of existing tax expenditures and introduced several new
provisions. These include: (1) Exclusion of interest on clean renewable
energy bonds; (2) Deferral of gain from dispositions of transmission
property to implement FERC restructuring policy; (3) Credit for
production from advanced nuclear power facilities; (4) Credit for
investment in clean coal facilities; (5) Temporary 50 percent expensing
for equip
[[Page 303]]
ment used in the refining of liquid fuels; (6) Pass-through low-sulfur
diesel expensing to cooperative owners; (7) Natural gas distribution
pipelines treated as 15-year property; (8) Amortize all geological and
geophysical expenditures over 2 years; (9) Allowance of deduction for
certain energy efficient commercial building property; (10) Credit for
construction of new energy efficient homes; (11) Credit for energy
efficiency improvements to existing homes; (12) Credit for energy
efficient appliances; (13) 30 percent credit for residential purchases/
installations of solar and fuel cells; (14) Credit for business
installation of qualified fuel cells and stationary microturbine power
plants; (15) Business solar investment tax credit; (16) Alternative
motor vehicle credit; (17) Credit for installation of alternative
fueling stations; (18) Small agri-biodiesel producer credit; (19)
Alternative fuel and fuel mixture tax credit; (20) Exclusion of interest
spread of financial institutions; (21) Exclusion of interest on bonds
for financing of highway projects and rail-truck transfer facilities;
and (22) expanded and extended scope of a number of existing benefits to
taxpayers in areas affected by hurricanes Katrina, Rita, and Wilma.
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 ($76,193 in 2005).
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.\6\--The exclusion for
extraterritorial income was repealed by the American Jobs Creation Act
of 2004. Under the transition rules, taxpayers retain 80% of ETI
benefits for 2005, 60% of ETI benefits for 2006, and no ETI benefits
thereafter. The exclusion for extraterritorial income remains in effect
for certain transactions which occur pursuant to a binding contract
entered into on or before September 17, 2003.
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\6\ 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.
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5. Sales source rule exceptions.--The worldwide income of U.S. persons
is taxable by the United States and a credit for foreign taxes paid is
allowed. The amount of foreign taxes that can be credited is limited to
the pre-credit U.S. tax on the foreign source income. The sales source
rules for inventory property allow U.S. exporters to use more foreign
tax credits by allowing the exporters to attribute a larger portion of
their earnings abroad than would be the case if the allocation of
earnings was based on actual economic activity.
6. Income of U.S.-controlled foreign corporations.--The income of
foreign corporations controlled by U.S. shareholders is not subject to
U.S. taxation. The income becomes taxable only when the controlling U.S.
shareholders receive dividends or other distributions from their foreign
stockholding. Under the normal tax method, the currently attributable
foreign source pre-tax income from such a controlling interest is
considered to be subject to U.S. taxation, whether or not distributed.
Thus, the normal tax method considers the amount of controlled foreign
corporation income not yet distributed to a U.S. shareholder as tax-
deferred income.
7. Exceptions under subpart F for active financing income.--Financial
firms can defer taxes on income earned overseas in an active business.
Taxes on income earned through December 31, 2006 can be deferred.
General Science, Space, and Technology
8. Expensing R&E expenditures.--Research and experimentation (R&E)
projects can be viewed as investments because, if successful, their
benefits accrue for several years. It is often difficult, however, to
identify whether a specific R&E project is successful and, if
successful, what its expected life will be. Under the normal tax method,
the expensing of R&E expenditures is viewed as a tax expenditure. The
baseline assumed for the normal tax method is that all R&E expenditures
are successful and have an expected life of five years.
9. R&E credit.--The research and experimentation (R&E) credit is 20
percent of qualified research expenditures in excess of a base amount.
The base amount is generally determined by multiplying a ``fixed-base
percentage'' by the average amount of the company's gross receipts for
the prior four years. The taxpayer's fixed base percentage generally is
the ratio of its research expenses to gross receipts for 1984 through
1988. Taxpayers may also elect an alternative credit regime. Under the
alternative credit regime the taxpayer is assigned a three-tiered fixed-
base percentage that is lower than the fixed-base percentage that would
otherwise apply, and the credit rate is reduced (the rates range from
2.65 percent to 3.75 percent). A 20-percent credit with a separate
threshold is provided
[[Page 304]]
for a taxpayer's payments to universities for basic research. A 20-
percent ``flat'' credit with no threshold base amount is available for
energy research expenditures paid to certain research consortia. 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 credit of $3 per oil-
equivalent barrel of production (in 1979 dollars) is provided for gas
produced from biomass and liquid, gaseous, or solid synthetic fuels
produced from coal. The credit is generally available if the price of
oil stays below $29.50 (in 1979 dollars). The credit applies only to
fuel (1) produced at a facility placed in service before July 1, 1998,
and (2) sold before January 1, 2008.
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. Eligible costs include the cost of constructing a gas
treatment plant to prepare Alaska natural gas for pipeline
transportation and any of the following costs with respect to a
qualified EOR project: (1) the cost of depreciable or amortizable
tangible property that is an integral part of the project; (2)
intangible drilling costs (IDCs) that the taxpayer can elect to deduct;
and (3) deductible tertiary injectant costs. The credit rate is reduced
in taxable years following calendar years during which the annual
average unregulated wellhead price per barrel of domestic crude oil
exceeds an inflation adjusted threshold of $28 (adjusted for inflation).
17. New technology, refined coal, Indian coal and coke and coke gas
credits.--A credit is provided equal to 10 percent of the basis of solar
property (30 percent for purchases beginning in 2006 through 2007) and
10 percent of the basis of geothermal property placed in service during
the taxable year. Equipment that uses fiber-optic distributed sunlight
to illuminate the inside of a structure is solar energy property
eligible for a 30 percent credit in 2006 and 2007. A credit is also
available for certain electricity produced from wind energy, biomass,
poultry waste, geothermal energy, solar energy, small irrigation power,
municipal solid waste, or qualified hydropower and sold to an unrelated
party. The credit rate in 2005 is 1.9 cents per kilowatt hour (0.9 cents
per kilowatt hour for open-loop biomass, small irrigation power,
municipal solid waste and qualified hydropower) and the rate is indexed
in subsequent years. To qualify for the credit the electricity must be
produced at a facility placed in service after a specified date
(December 31, 1992, in the case of a closed-loop biomass facility,
December 31, 1993, in the case of a wind energy facility, December 31,
1999, in the case of a poultry waste facility, August 8, 2005 in the
case of qualified hydropower and October 22, 2004, in all other cases)
and before January 1, 2006 for solar facilities and January 1, 2008 for
all other qualifying facilities with the exception of hydropower
facilities. To qualify for the credit, qualifying hydropower facilities
must be placed in service before January 1, 2009. In addition, the
electricity must be produced during the 10-year period after the
facility is originally placed in service. A credit is available for
refined coal produced at facilities placed in service during the period
from October 22, 2004, through December 31, 2008, and sold during the
10-year period beginning on the date the facility was placed in service.
The credit rate in 2005 is $5.481 per ton and the rate is indexed in
subsequent years. A credit is available for Indian coal. The taxpayer
may claim a credit for sales of coal to an unrelated third party from a
quali
[[Page 305]]
fied facility for the seven-year period beginning on January 1, 2006,
and ending after December 31, 2012. The value of the credit is $1.50 per
ton for the first four years of the seven-year production period and
$2.00 per ton for the last three years of the seven-year period. The
credit amounts are indexed for inflation. A credit is available for the
production of coke or coke gas from a qualified facility. Qualified
facilities must have been placed in service before January 1, 1993, or
after June 30, 1998, and before January 1, 2010.
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 51 cents per gallon through 2010. In lieu of the alcohol
mixture credit, the taxpayer may claim a refundable excise 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 and
alternative motor vehicle credits.--A tax credit of 10 percent (not to
exceed $4,000) is provided for purchasers of electric vehicles. The
credit is reduced by 75 percent for vehicles placed in service in 2006
and is not available for vehicles placed in service after December 31,
2006. Purchasers of other clean-fuel burning vehicles and owners of
clean-fuel refueling property may deduct part of their expenditures. No
deduction is available to taxpayers for vehicles placed in service after
December 31, 2005. The deduction for clean-fuel property is available
for costs incurred before January 1, 2007. A taxpayer may claim a 30
percent credit for the cost of installing clean-fuel vehicle refueling
property for property placed in service after December 31, 2005 and
before January 1, 2008. The taxpayer may not claim deductions with
respect to property for which the credit is claimed. A tax credit is
also available for the purchase of hybrid vehicles, fuel cell vehicles,
alternative fuel vehicles and advanced lean burn vehicles. The provision
applies to vehicles placed in service after December 31, 2005, in the
case of qualified fuel cell motor vehicles, before January 1, 2015; in
the case of qualified hybrid motor vehicles that are automobiles and
light trucks and in the case of advanced lean-burn technology vehicles,
before January 1, 2011; in the case of qualified hybrid motor vehicles
that are medium and heavy trucks, before January 1, 2010; and in the
case of qualified alternative fuel motor vehicles, before January 1,
2011. A tax credit is available for the purchase of hybrid vehicles,
fuel cell vehicles, alternative fuel vehicles and advanced lean burn
vehicles. The provision applies to vehicles placed in service after
December 31, 2005, in the case of qualified fuel cell motor vehicles,
before January 1, 2015; in the case of qualified hybrid motor vehicles
that are automobiles and light trucks and in the case of advanced lean-
burn technology vehicles, before January 1, 2011; in the case of
qualified hybrid motor vehicles that are medium and heavy trucks, before
January 1, 2010; and in the case of qualified alternative fuel motor
vehicles, before January 1, 2011.
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.
21. Credit to holders of clean renewable energy bonds.--The Energy Tax
Incentives Act of 2005 introduced this provision which provides for up
to $800 million in aggregate issuance of Clean Renewable Energy Bonds
(CREBs) through December 31, 2007. Taxpayers holding CREBs on a credit
allowance date are entitled to a tax credit.
22. Deferral of gain from dispositions of transmission property to
implement FERC restructuring policy.--Utilities that sell their
transmission assets to a FERC-approved independent transmission company
are allowed a longer recognition period for their gains from sale.
Rather than paying tax on any gain from the sale in the year that the
sale is completed, utilities will have 8 years to pay the tax on any
gain from the sale. The rule expires at the end of 2007.
23. Credit for production from advanced nuclear power facilities.--
This provision was introduced by the Energy Tax Incentives Act of 2005.
A taxpayer producing electricity at a qualifying advanced nuclear power
facility may claim a credit equal to 1.8 cents per kilowatt-hour of
electricity produced for the eight-year period starting when the
facility is placed in service, limited no more than $125 million in tax
credits per 1,000 megawatts of allocated capacity in any one year.
24. Credit for investment in clean coal facilities.--This provision
was introduced by the Energy Tax Incentives Act of 2005. Three
investment tax credits for clean coal facilities are available: a 15
percent and 20 percent investment tax credit for clean coal facilities
producing electricity; and a 20 percent credit for industrial
gasification projects. Integrated gasification combined cycle (IGCC)
projects get a 20 percent investment tax credit and other advanced coal-
based projects that produce electricity get a 15 percent credit. The
Secretary of the Treasury may allocate up to $800 million for IGCC
projects and up to $500 million for other advanced coal-based
technologies and up to $350 million for industrial gasification.
25. Temporary 50 percent expensing for equipment used in the refining
of liquid fuels.--This provision was introduced by the Energy Tax
Incentives Act of 2005. Taxpayers may expense 50 percent of the cost of
refinery investments which increase the capacity of an existing refinery
by at least 5 percent or increase the throughput of qualified fuels by
at least 25 percent. Qualified fuels include oil from shale and tar
sands. Investments must be placed in service before January 1, 2012.
26. Pass through low sulfur diesel expensing to cooperative owners.--
This provision was introduced by the Energy Tax Incentives Act of 2005.
Taxpayers may expense certain costs for investments to comply with EPA
low sulfur diesel regulations. The deduction
[[Page 306]]
may be passed-through to members of a cooperative if the cooperative
makes an election on their tax return.
27. Natural gas distribution pipelines treated as 15-year property.--
This provision was introduced by the Energy Tax Incentives Act of 2005.
The depreciation period is shortened to 15 years for any gas
distribution lines the original use of which occurred after April 11,
2004 and before January 1, 2011. The provision does not apply to any
property which the taxpayer or a related party had entered into a
binding contract for the construction thereof or self-constructed on or
before April 11, 2005.
28. Amortize all geological and geophysical expenditures over 2
years.--This provision was introduced by the Energy Tax Incentives Act
of 2005. Geological and geophysical amounts incurred in connection with
oil and gas exploration in the United States may be amortized over two
years. In the case of abandoned property, any remaining basis may no
longer be recovered in the year of abandonment of a property as all
basis is recovered over the two-year amortization period.
29. Allowance of deduction for certain energy efficient commercial
building property.--This provision was introduced by the Energy Tax
Incentives Act of 2005. A deduction for energy efficient commercial
buildings that reduce annual energy and power consumption by 50 percent
compared to the American Society of Heating, Refrigerating, and Air
Conditioning Engineers (ASHRAE) standard is allowed. The provision is
effective for property placed in service after December 31, 2005 and
prior to January 1, 2008.
30. Credit for construction of new energy efficient homes.--This
provision was introduced by the Energy Tax Incentives Act of 2005. A
credit is available to eligible contractors for construction of a
qualified new energy-efficient home. The credit applies to homes whose
construction is substantially completed after December 31, 2005 and
which are purchased after December 31, 2005 and prior to January 1,
2008.
31. Credit for energy efficiency improvements to existing homes.--This
provision was introduced by the Energy Tax Incentives Act of 2005. A 10
percent investment tax credit for expenditures with respect to
improvements to building envelope is available. Credits for purchases of
advanced main air circulating fans, natural gas, propane, or oil
furnaces or hot water boilers, and other qualified energy efficient
property are also available. Credit applies to property placed in
service after December 31, 2005 and prior to January 1, 2008.
32. Credit for energy efficient appliances.--This provision was
introduced by the Energy Tax Incentives Act of 2005. Tax credits for the
manufacture of efficient dishwashers, clothes washers, and refrigerators
are available. Credits vary depending on the efficiency of the unit. The
provision is effective for appliances manufactured in 2006 and 2007.
33. Credit for residential purchases/installations of solar and fuel
cells.--This provision was introduced by the Energy Tax Incentives Act
of 2005. A credit, equal to 30 percent of qualifying expenditures, for
purchase for qualified photovoltaic property and solar water heating
property is available. A 30 percent credit for the purchase of qualified
fuel cell power plants is also allowed and applies to property placed in
service after December 31, 2005 and prior to January 1, 2008.
34. Credit for business installation of qualified fuel cells and
stationary microturbine power plants.--This provision was introduced by
the Energy Tax Incentives Act of 2005. A 30 percent business energy
credit for purchase of qualified fuel cell power plants for businesses
and a 10 percent credit for purchase of qualifying stationary
microturbine power plants are allowed.
35. Alternative fuel and fuel mixture tax credit.--This provision was
introduced in the Safe, Accountable, Flexible, Efficient Transportation
Equity Act of 2005. A tax credit is available against the excise tax
imposed on the retail sale or use of alternative fuels or mixture of
alternative fuel and other taxable fuel. The credit is 50 cents per
gallon of alternative fuel.
Natural Resources and Environment
36. 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.
37. 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.
38. 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.
39. Capital gains treatment of certain timber.--Certain timber sales
can be treated as a capital gain rather than ordinary income.
40. 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.
41. 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.
42. 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.
[[Page 307]]
43. Exclusion of gain or loss on sale or exchange of certain
brownfield sites.--In general, an organization that is otherwise exempt
from federal income tax is taxed on income from any trade or business
regularly carried on by the organization that is not substantially
related to the organization's exempt purpose. The AJCA of 2004 created a
special exclusion from unrelated business taxable income of the gain or
loss from the sale or exchange of certain qualifying brownfield
properties. The exclusion applies regardless of whether the property is
debt-financed. In order to qualify, a minimum amount of remediation
expenditures must be incurred by the organization.
Agriculture
44. 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.
45. 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.
46. 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.
47. Capital gains treatment of certain income.--Certain agricultural
income, such as unharvested crops, can be treated as capital gains
rather than ordinary income.
48. 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.
49. 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.
50. 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. The Energy Tax Incentives Act of 2005 extends the
income tax credit, excise tax credit, and payment provisions through
December 31, 2008 and adds a credit for small agri-biodiesel producers.
The conference agreement also creates a similar income tax credit,
excise tax credit and payment system for renewable diesel, however there
is no credit for small producers of renewable diesel. Renewable diesel
means diesel fuel derived form biomass using thermal depolymerization
process.
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.
51. Credit union income.--The earnings of credit unions not
distributed to members as interest or dividends are exempt from income
tax.
52. 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.
53. 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.
54. 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
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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.
55. 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.
56. 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.
57. Exclusion of interest spread of financial institutions.--Consumers
and non-profit organizations pay for some deposit-linked services, such
as check cashing, by accepting a below-market interest rate on their
demand deposits. If they received a market rate of interest on those
deposits and paid explicit fees for the associated services, they would
pay taxes on the full market rate and (unlike businesses) could not
deduct the fees. The government thus foregoes tax on the difference
between the risk-free market interest rate and below-market interest
rates on demand deposits, which under competitive conditions should
equal the value added of deposit services.
58. 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.
59. 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.
60. 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.
61. 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.
62. 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.
63. 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.
64. 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.
65. 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.
66. 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
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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.
67. 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.
68. 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.
69. 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.
70. 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.
71. 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.
72. 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.
73. Carryover basis of capital gains on gifts.--When a gift is made,
the donor's basis in the transferred property (the cost that was
incurred when the transferred property was first acquired) carries-over
to the donee. The carryover of the donor's basis allows a continued
deferral of unrealized capital gains. Even though the estate tax is
repealed for 2010 under EGTRRA, the gift tax is retained with a lifetime
exemption of $1 million.
74. 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.
75. 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.
76. 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.
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77. 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.
78. 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.
79. 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.
80. 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.
81. 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
82. 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.
83. 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 2005, the maximum
amount of the parking exclusion is $200 (indexed) per month. The tax
expenditure estimate does not include parking at facilities owned by the
employer.
84. 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.
85. 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.
86. Exclusion of interest on bonds for Financing of Highway Projects
and Rail-Truck Transfer Facilities.--This provision provides for $15
billion of tax-exempt bond authority to finance qualified highway or
surface freight transfer facilities. It was introduced by the Safe,
Accountable, Flexible, Efficient Transportation Equity Act: A Legacy For
Users enacted in 2005. The authority to issue these bonds expires on
December 31, 2015.
Community and Regional Development
87. 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.
88. 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.
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89. 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.
90. Empowerment zones 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. Empowerment zone and renewal community
designations expire at the end of 2009. 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.
The Gulf Opportunity Zone Act of 2005 added several provisions
targeted to encourage the redevelopment of areas affected by hurricanes
Katrina, Rita and Wilma, including some provisions that have already
been listed elsewhere in this table. Gulf Opportunity Zone Act
provisions not listed elsewhere include additional tax-exempt bond
financing authority, accelerated depreciation of investment in both
structures and equipment, partial expensing for certain demolition and
clean-up costs, increased carryback of certain net operating losses,
increased authority to allocate low-income housing tax credits and new
markets tax credits within the affected areas and other provisions.
91. New markets tax credit.--Taxpayers who make qualified equity
investments in a community development entity (CDE), which then makes
qualified investments in low-income communities, are eligible for a tax
credit received over 7 years. 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 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. Credit
authority is allocated to CDEs through a competitive application
process.
92. Expensing of environmental remediation costs.--Taxpayers who clean
up certain hazardous substances at a qualified site may expense the
clean-up 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.
The Gulf Opportunity Zone Act of 2005 extends this provision through
December 31, 2007 for sites located in the Gulf Opportunity Zone and
expands the allowable costs to include petroleum product remediation.
93. Credit to holders of Gulf Tax Credit Bonds.--Taxpayers that own
Gulf Tax Credit 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. The maximum amount that can be issued is $200 million
in the case of Louisiana, $100 million in the case of Mississippi, and
$50 million in the case of Alabama.
Education, Training, Employment, and Social Services
94. 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).
95. 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 2005, the credit is phased out
ratably for taxpayers with modified AGI between $87,000 and $107,000
($43,000 and $53,000 for singles), indexed.
96. 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, up to a maximum credit per return is $2,000.
The credit is phased out ratably for taxpayers with modified AGI between
$87,000 and $107,000 ($43,000 and $53,000 for singles) (indexed
beginning in 2002). The credit applies to both undergraduate and
graduate students.
97. Deduction for Higher Education Expenses.--The maximum annual
deduction for qualified higher education expenses is $4,000 in 2005 for
taxpayers with 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.
98. 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
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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 2005
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).
99. 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 2005, the maximum deduction is phased down
ratably for taxpayers with modified AGI between $105,000 and $135,000
($50,000 and $65,000 for singles), indexed.
100. 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.
101. 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.
102. 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.
103. 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.
104. 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
$91,850 and $121.850 ($61,200 and $76,200 for singles) in 2005.
105. Dependent students age 19 or older.--Taxpayers may claim personal
exemptions for dependent children who are over the age of 18 or under
the age of 24 and who (1) reside with the taxpayer for over half the
year (with exceptions for temporary absences from home, such as for
school attendance), (2) are full-time students, and (3) do not claim a
personal exemption on their own tax returns.
106. 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.
107. 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).
108. 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).
109. 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.
110. 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. The Katrina Emergency Tax Relief Act of 2005
expanded WOTC eligibility to Hurricane Katrina Employees, defined as
persons whose principal places of abode on August 28, 2005 were in the
core disaster area and who beginning on such date and through August 28,
2007, are hired for a position principally located in the core disaster
area; and beginning on such date and through December 31, 2005, are
hired for a position regardless of its location. The usual certification
process rules are waived for Hurricane Katrina employees.
111. 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.
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112. 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 employer's costs for the child care are a deductible
business expense.
113. 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.
114. 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.
115. Adoption credit and exclusion.--Taxpayers can receive a
nonrefundable tax credit for qualified adoption expenses. The maximum
credit is $10,630 per child for 2005, and is phased-out ratably for
taxpayers with modified AGI between $159,450 and $199,450. 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.
116. 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.
117. Child credit.--Taxpayers with children under age 17 can qualify
for a $1,000 partially 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).
118. 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.
119. 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.
120. 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.
121. 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.
122. 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.
123. Provide an employee retention credit to employers affected by
hurricane Katrina, Rita, and Wilma.--Businesses located within the Gulf
Opportunity (GO) Zone on August 28, 2005 are eligible for a 40 percent
tax credit on the first $6,000 in qualified wages paid to qualified
employees employed within the GO Zone. Qualified wages are those paid by
an eligible employer to an eligible employee on any day after August 28,
2005 and before January 1, 2006 during the period beginning on the date
on which the trade or business first became inoperable at the principal
place of employment of the employee by reason of hurricane Katrina and
ending on the date on which such trade or business resumed significant
operations at such principal place of employment. Similar rules apply to
the Rita GO Zone and the Wilma GO Zone with initial effective dates of
September 23, 2005, and October 23, 2005, respectively.
Health
124. 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.
125. 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 deduct
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ible percentage is 60 percent in 2001, 70 percent in 2002, and 100
percent in 2003 and thereafter.
126. 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, 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.
127. 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.
128. Hospital construction bonds.--Interest earned on State and local
government debt issued to finance hospital construction is excluded from
income subject to tax.
129. 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.
130. 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.
131. 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.
132. 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
133. 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.
134. Workers' compensation benefits.--Workers compensation provides
payments to disabled workers. These benefits, although income to the
recipients, are not subject to the income tax.
135. 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.
136. 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.
137. Military disability pensions.--Most of the military pension
income received by current disabled retired veterans is excluded from
their income subject to tax.
138. 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.
139. 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 $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.
140. 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 $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 $80,000 ($60,000 for non-joint filers) in
2005 can claim a deduction for IRA contributions. The IRA deduction is
phased out for taxpayers with AGI between $70,000 and $80,000 ($50,000
and $60,000 for non-joint). The phase-out range in
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creases annually until it reaches $80,000 to $100,000 in 2007. 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.
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.
141. 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.
142. 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 $42,000 in 2005. 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.
143. 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.
144. 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.
145. 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.
146. 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.
147. Additional deduction for the blind.--Taxpayers who are blind may
take an additional $1,200 standard deduction if single, or $1,000 if
married in 2005.
148. Additional deduction for the elderly.--Taxpayers who are 65 years
or older may take an additional $1,200 standard deduction if single, or
$1,000 if married in 2005.
149. 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.
150. 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.
151. 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 $7,830 of earned income in 2005. The credit is 40
percent of the first $11,000 of income for a family with two or more
qualifying children. The credit is phased out beginning when the
taxpayer's income exceeds $14,370 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 $31,030 ($35,263 if two or more qualifying children are
present), $33,030 (or $37,263) for those married.
The credit may also be claimed by workers who do not have children
living with them. Qualifying workers
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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 2005, the credit is 7.65 percent of the first $5,220 of earned
income. When the taxpayer's income exceeds $6,530 (8,530 if married),
the credit is phased out at the rate of 7.65 percent. It is completely
phased out at $11,750 ($13,750 for married) of modified adjusted gross
income.
For workers with or without children, the income levels at which the
credit begins to phase-out and the maximum amounts of income on which
the credit can be taken are adjusted for inflation. For married
taxpayers filing a joint return, the base amount for the phase-out
increases by $2,000 in 2005 through 2007, and $3,000 in 2008 (indexed
thereafter).
Earned income tax credits in excess of tax liabilities owed through
the individual income tax system are 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.
152. Additional exemption for housing Hurricane Katrina displaced
individuals.--This provision, introduced by the Katrina Emergency Tax
Relief Act of 2005, provides an additional exemption of $500 for each
Hurricane Katrina displaced individual for whom the taxpayer is
providing shelter in his or her home, for a maximum additional exemption
amount is $2,000.
Social Security
153. 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.
154. 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.
155. 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
156. Veterans death benefits and disability compensation.--All
compensation due to death or disability paid by the Veterans
Administration is excluded from taxable income.
157. Veterans pension payments.--Pension payments made by the Veterans
Administration are excluded from gross income.
158. G.I. Bill benefits.--G.I. Bill benefits paid by the Veterans
Administration are excluded from gross income.
159. 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
160. 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.
161. 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.
162. 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
163. 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).
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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.
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.\7\ 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.
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\7\ 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..
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Furthermore, comprehensive income does not necessarily represent an
ideal tax base; efficiency or equity would be improved by deviating from
comprehensive income as a tax base, e.g., by reducing the tax on capital
income in order to spur economic growth further or by subsidizing
certain types of activities 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 fourteen of the thirty items as tax expenditures under a
comprehensive tax base (those in panel A). Most of these give
preferential tax treatment to the return on certain types of savings or
investment. They are a result of the explicitly hybrid nature of the
existing tax system and arise out of policy decisions that reflect
discomfort with the high tax rate on capital income that would otherwise
arise under the current
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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). A similar line of reasoning could be used to
argue that in the case of corporations, expensing \8\ of R&E or
accelerated depreciation are not a tax expenditures because they serve
to offset the corporate tax penalty.
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\8\ 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.
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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).\9\ 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.
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\9\ 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.
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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.
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\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 minus(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).
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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\ The difficulty is that this presumes that
one's consumption of State and local services relates directly to the
amount of State and local taxes paid. Such a presumption is difficult to
sustain when taxes are levied inconsistently across taxpayers.
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\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.
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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 (roughly measured) tax expenditure
relative to a comprehensive income baseline.\14\
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\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.
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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
[[Page 319]]
baseline. Nonetheless, there are ambiguities. Under a comprehensive
income baseline, all real inflation adjusted gains would be taxed as
accrued, so there would be no deferred unrealized gains on assets held
at death.
The lack of full taxation of Social Security benefits also is listed
in panel B. Consider first Social Security retirement benefits. To the
extent that Social Security is viewed as a pension, a comprehensive
income tax would include in income all contributions to Social Security
retirement funds (payroll taxes) and tax accretions to value as they
arise (inside build-up).\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.
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\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.
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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. 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-earning 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.
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\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.
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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\
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\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 chari
[[Page 320]]
table contributions are a consumption item for the giver, then they are
properly included in his taxable income; a deduction for contributions
would then be a tax expenditure relative to a comprehensive income tax
baseline. In contrast, charitable contributions could represent a
transfer of purchasing power from the giver to the receiver. As such,
they would represent a reduction in the giver's net worth, not an item
of consumption, and so properly would be deductible, implying that
current law's treatment is not a tax expenditure. At the same time,
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 to the extent the recipient has net taxable
income.\21\
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\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..
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Medical expenditures may or may not be an element of income (or
consumption). Some argue that medical expenditures do not represent
discretionary spending, and so are not really consumption. Instead,
these expenditures are a reduction of net worth and should be excluded
from the tax base. In contrast, others argue that there is no way to
distinguish logically 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.
From either perspective, 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, an
equivalent treatment would allow the taxpayer to include the premium
(i.e., tax) and exclude the benefit. The deviation between either of
these treatments 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 one-half of the
premium might suggest that one-half of the payout should be taxed, so
that the current tax rules impose a greater tax burden than that implied
by a comprehensive income tax, i.e., a negative tax expenditure.
The 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.\22\
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\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.
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 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.
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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 ex
[[Page 321]]
penditures, some of which also might be viewed as negative tax
expenditures under an expanded interpretation of the normal or reference
law baseline. Among the more important negative tax expenditures is the
corporation income tax, or more generally the double tax on corporate
profits, which would be eliminated under a comprehensive income tax. The
Jobs and Growth Tax Relief and Reconciliation Act of 2003 (JGTRRA)
reduced the tax rate on dividends and capital gains to 15 percent, thus
reducing the double tax compared to prior law. Nonetheless, as discussed
later in the Appendix, current law still imposes a substantial double
tax on corporate profits. The passive loss rules, restrictions on the
deductibility of capital losses, and net operating loss (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 measure income properly, 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.
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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\
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\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.
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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 in
[[Page 322]]
clude borrowing and lending in the tax base by requiring the borrower to
add the proceeds from loans in his tax base, allowing the lender to
deduct loans from his tax base, allowing the borrower to deduct payments
of principal and interest, and requiring the lender to include receipt
of principal and interest payments. In present value terms, the two
approaches are equivalent for both the borrower and the lender; in
particular both allow the tax base to measure consumption and both
impose a zero effective tax rate on interest income. But which approach
is taken obviously has different implications (at least on an annual
flow basis) for the treatment of many important items of income and
expense, such as the home mortgage interest deduction. The
classification below suggests that the deduction for home mortgage
interest could well be a tax expenditure, but takes note of alternative
views.
Some exclusions of income are equivalent in many respects to
consumption tax treatment that immediately deducts the cost of an
investment while taxing the future cash flow. For example, exempting
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 normal 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.
In addition, provisions can interact even once an appropriate
treatment is determined. For example, suppose that it is determined that
financial flows should be excluded from 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 mortgage interest 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, as with an income tax, trying to
compute the current tax's deviations from ``the'' base of a consumption
tax is very difficult because deviations cannot be uniquely determined,
making it problematic to do a consistent 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 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. One 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.
Exclusion of workers' compensation benefits allows an exclusion from
income that is unrelated to investment, and so should be included in the
base of a comprehensive consumption tax.
The deductibility of home mortgage interest is a strong candidate for
inclusion as a tax expenditure. A consumption tax would seek to tax the
entire value of the flow of services from housing, and so would not
allow a deduction for home mortgage interest. This would be the case
regardless of whether the tax base included the annual flow of housing
services, or instead
[[Page 323]]
used a tax-prepayment or yield exemption approach (discussed more
completely below) to taxing housing services. A deduction for interest
would be allowed under a consumption tax applied to both real and
financial cash flows, but current law does not require the homeowner to
take into income the proceeds of a home loan, nor does it allow him a
deduction for principle repayments.
Nonetheless, an ambiguity about the treatment if home mortgage
interest arises as a result of current law's taxation of interest
income. Under a consumption tax, interest income generally would not be
taxed (at least in present value terms). In a sense, the homeowner's
mortgage interest deduction could be viewed as counterbalancing the
lender's inclusion, eliminating interest flows from the tax base, as
would be appropriate under many types of consumption taxes.\27\
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\27\ 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..
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The deductibility of property taxes on owner-occupied housing also is
a strong candidate for inclusion as a tax expenditure under a
consumption tax baseline, although there is a bit of ambiguity. Property
taxes would be deducted under a consumption tax under which the base
allowed expensing of the cost of the house and included the rental value
of the house in the annual tax base. But, as discussed above in the
income tax section, this deduction nonetheless is a strong candidate for
inclusion as a tax expenditure because the current tax system does not
impute the consumption value of housing services to the homeowner's tax
base.
Under a consumption tax that applied the yield exemption or tax
prepayment approach to housing, property taxes would not be deducted by
the homeowner because the cash flows (positive and negative) related to
the investment are simply ignored for tax purposes--they are outside the
tax base. Their deduction under current law would represent a clear case
of a tax expenditure. As discussed below, current law's taxation of
housing approximates a yield exemption approach; no deduction of the
purchase price of the house, no tax on the house's service flow.
Consequently, the deduction for property taxes probably should be a tax
expenditure relative to a consumption base--there is not even the
slightest ambiguity here.
With respect to the household sector's deduction of state and local
income taxes, some ambiguity arises because these taxes, when considered
separately from the value of any consumption type government services
they might fund, should be excluded from the base of a consumption tax
because they represent a reduction in net worth. Under a consumed income
tax collected from the household, they would need to be deducted to
properly measure consumption.
But state and local income taxes are used to fund government services,
many of which would be included in the base of a consumption tax if paid
for privately. The value of these services probably should be included
in the base of a broad consumption tax. The value of such services is
generally not imputed to the household under current tax law. One rough
proxy for their value is the tax payments made to support them.\28\
Stated another way, the payment of state and local income taxes might
not represent a reduction in net worth (or a real net cost to the
household) to the extent that the payment is accompanied by the
provision of services of equal value.
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\28\ The failure to impute the value of government provided services
casts doubt on the appropriateness of deducting property taxes on owner-
occupied housing even under a consumption tax that allowed the homeowner
to deduct the cost of the house from his taxable consumption and imputed
to his tax base the house's annual consumption flow. .
---------------------------------------------------------------------------
The analysis of state and local sales taxes on consumption items would
seem to parallel that of income taxes. When these taxes are considered
in isolation from government services they might fund, they should be
excluded from the base of a federal consumption tax. But to the extent
sales taxes represent a user charges for government provided consumption
goods, their deduction might be inappropriate because current federal
tax law fails to impute to income the value of the state and local
services funded by sales tax payments.
Property taxes on assets other than housing would seem to be best
thought of using the model discussed above for housing. These taxes
typically are paid on assets, such as automobiles and boats, that yield
a stream of services that current federal tax law fails to impute to
income.
The official tax expenditures for Social Security benefits reflects
exceptions for low-income taxpayers from the general rule that 85
percent of Social Security benefits are included in the recipient's tax
base. The 85 percent inclusion is intended as a simplified mechanism for
taxing Social Security benefits as if the Social Security program were a
private pension with employee contributions made from after-tax income.
Under these tax rules, income earned on contributions made by both
employers and employees benefits from tax deferral, but employer
contributions also benefit because the employee may exclude them from
his taxable income, while the employee's own contributions are included
in his taxable income. These tax rules give the equivalent of
consumption tax treatment, a zero effective tax rate on the return, to
the extent that the original pension contributions are made by the
employer, but give less generous treatment to the extent that the
original contributions are made by the employee. Income earned on
employee contributions is taxed at a low, but positive, effective tax
rate. Based on historical calculations, the 85 percent inclusion
reflects roughly the outcome of applying these tax rules to a lower-
income earner when one-half of the contributions are from the employer
and one-half from the employee.
The current tax expenditure measures a tax benefit relative to a
baseline that is somewhere between a comprehensive income tax and a
consumption tax. The properly measured tax expenditure relative to a
consumption tax baseline would include only those Social Security
benefits that are accorded treatment more favorable than that implied by
a consumption tax, which
[[Page 324]]
would correspond to including 50 percent of Social Security benefits in
the recipient's tax base. Thus, the existing tax expenditure is correct
conceptually, but is not measured properly relative to a comprehensive
income tax. 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 panel 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 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.
Current law does not tax the annual rental value of owner-occupied
housing. In contrast, the annual rental value of the housing would be
taxed under a consumption tax. Hence, from one perspective, the
exclusion of the net annual rental value of owner-occupied housing would
be a tax expenditure relative to a consumption tax baseline.
However, a consumption tax that included in its base the annual rental
value of housing also would allow the homeowner a deduction for the
price of the house in the year it was purchased; the investment in
housing would be expensed. Current law fails to allow such a deduction,
raising doubt about classifying as a tax expenditure the exclusion of
net rental income from owner-occupied housing. Indeed, it is possible to
interpret current law as applying the tax pre-payment or yield exemption
method to housing, in which the purchase price of an investment, rather
than the annual cash flow generated by the investment, is taxed. In the
textbook case, the tax pre-payment approach is equivalent in expected
present value terms to taxing directly the annual consumption value of
the house. So it is not clear whether the failure to tax the rental
income from housing represents a tax expenditure.
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.
[[Page 325]]
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
possibly include 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 gross 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
corporate income tax, or more generally a measure of the double tax on
corporate profits, also would be a negative tax expenditure.
Depreciation allowances, even if accelerated, would be a negative tax
expenditure since consumption tax treatment generally would require
expensing. Depending on the treatment of loans, the borrower's inability
to deduct payments of principal and the lender's inability to deduct
loans might be a negative tax expenditure. The passive loss rules 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.\29\ 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.\30\
The estimates are shown in tables in the body of the main text, e.g.,
Table 19-1.
---------------------------------------------------------------------------
\29\ See Barbara Fraumeni, ``The Measurement of Depreciation in the
U.S. National Income and Product Accounts,'' in Survey of Current
Business 77 No. 7 (Washington, D.C.: Department of Commerce, Bureau of
Economic Analysis, July, 1997), pp. 7-42, and the National Income and
Product Accounts of the United States, Table 7.6, ``Chain-type Quantity
and Price Indexes for Private Fixed Investment by Type,'' U.S.
Department of Commerce, Bureau of Economic Analysis.
\30\ The temporary provision allows 30 percent of the cost of a
qualifying investment to be deducted immediately rather than capitalized
and depreciated over time. It is generally effective for qualifying
investments made after September 10, 2001 and before September 11, 2004.
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.
---------------------------------------------------------------------------
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 com
[[Page 326]]
prehensive 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 deduction
for property taxes and for home mortgage interest.\31\
---------------------------------------------------------------------------
\31\ 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 tax expenditures 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 beginning in the 2006 budget,
which now includes an item for the exclusion of net rental income of
homeowners.\32\
---------------------------------------------------------------------------
\32\ 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., Tables 19-1 and 19-2, 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.\33\
---------------------------------------------------------------------------
\33\ 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 $34
billion in the years 2007 through in 2011. 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 327]]
Appendix Table 1. COMPARISON OF CURRENT TAX EXPENDITURES WITH THOSE IMPLIED BY A COMPREHENSIVE INCOME TAX \1\
--------------------------------------------------------------------------------------------------------------------------------------------------------
Revenue Effect
Description 2007
--------------------------------------------------------------------------------------------------------------------------------------------------------
A. Tax Expenditure Under a Comprehensive Income Tax
Net exclusion of pension contributions and earnings: Employer plans.................................................................. 52,470
Accelerated depreciation of machinery and equipment (normal tax method).............................................................. 52,230
Net exclusion of pension contributions and earnings: 401(k) plans.................................................................... 39,800
Capital gains exclusion on home sales................................................................................................ 43,900
Exclusion of net imputed rental income on owner-occupied housing..................................................................... 33,210
Capital gains (except agriculture, timber, iron ore, and coal)....................................................................... 26,760
Exclusion of interest on public purpose State and local bonds........................................................................ 29,640
Exclusion of interest on life insurance savings...................................................................................... 20,770
Net exclusion of pension contributions and earnings: Keogh plans..................................................................... 10,670
Expensing of research and experimentation expenditures (normal tax method)........................................................... 6,990
Deferral of income from controlled foreign corporations (normal tax method).......................................................... 11,940
Net exclusion of pension contributions and earnings: Individual Retirement Accounts.................................................. 5,970
Exclusion of workers' compensation benefits.......................................................................................... 6,180
Credit for low-income housing investments............................................................................................ 4,250
B. Possibly a Tax Expenditure Under a Comprehensive Income Tax, But With Some Qualifications
Deductibility of mortgage interest on owner-occupied homes........................................................................... 79,860
Child credit......................................................................................................................... 42,120
Step-up basis of capital gains at death.............................................................................................. 32,460
Deductibility of nonbusiness state and local taxes other than on owner-occupied homes................................................ 27,210
Exclusion of Social Security benefits for retired workers............................................................................ 19,590
Deductibility of State and local property tax on owner-occupied homes................................................................ 12,810
Deduction for U.S. production activities............................................................................................. 10,670
Earned income tax credit............................................................................................................. 5,150
Exclusion of Social security benefits of dependents and survivors.................................................................... 4,040
C. Uncertain
Exclusion of employer contributions for medical insurance premiums and medical care.................................................. 146,780
Deductibility of charitable contributions, other than education and health........................................................... 34,500
Deductibility of medical expenses.................................................................................................... 5,310
Deductibility of self-employed medical insurance premiums............................................................................ 4,630
Social security benefits for the disabled............................................................................................ 4,110
Deductibility of charitable contributions, education................................................................................. 4,030
D. Probably Not a Tax Expenditure Under a Comprehensive Income Tax
Exception from passive loss rules for $25,000 of rental loss......................................................................... 6,230
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\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 328]]
Appendix Table 2. COMPARISON OF CURRENT TAX EXPENDITURES WITH THOSE IMPLIED BY A COMPREHENSIVE CONSUMPTION TAX \1\
--------------------------------------------------------------------------------------------------------------------------------------------------------
Revenue Effect
Description 2007
--------------------------------------------------------------------------------------------------------------------------------------------------------
A. Tax Expenditure Under a Consumption Base
Exclusion of workers' compensation benefits.......................................................................................... 6,180
B. Probably a Tax Expenditure Under a Consumption Base
Deductibility of mortgage interest on owner-occupied homes........................................................................... 79,860
Child credit......................................................................................................................... 42,120
Deductibility of nonbusiness state and local taxes other than on owner-occupied homes................................................ 27,210
Exclusion of Social Security benefits for retired workers............................................................................ 19,590
Deductibility of State and local property tax on owner-occupied homes................................................................ 12,810
Earned income tax credit............................................................................................................. 5,150
Exclusion of Social Security benefits of dependents and survivors.................................................................... 4,040
C. Uncertain
Exclusion of employer contributions for medical insurance premiums and medical care.................................................. 146,780
Deductibility of charitable contributions, other than education and health........................................................... 34,500
Exclusion of net imputed rental income on owner-occupied housing..................................................................... 33,210
Deductibility of medical expenses.................................................................................................... 5,310
Deductibility of self-employed medical insurance premiums............................................................................ 4,630
Credit for low-income housing investments............................................................................................ 4,250
Social Security benefits for disabled................................................................................................ 4,110
Deductibility of charitable contributions, education................................................................................. 3,440
D. Not a Tax Expenditure Under a Consumption Base
Net exclusion of pension contributions and earnings: Employer plans.................................................................. 52,470
Accelerated depreciation of machinery and equipment (normal tax method).............................................................. 52,230
Capital gains exclusion on home sales................................................................................................ 43,900
Net exclusion of pension contributions and earnings: 401(k) plans.................................................................... 39,800
Step-up basis of capital gains at death.............................................................................................. 32,460
Exclusion of interest on public purpose State and local bonds........................................................................ 29,640
Capital gains (except agriculture, timber, iron ore, and coal)....................................................................... 26,760
Exclusion of interest on life insurance savings...................................................................................... 20,770
Deferral of income from controlled foreign corporations (normal tax method).......................................................... 11,940
Net exclusion of pension contributions and earnings: Keogh plans..................................................................... 10,670
Deduction for U.S. production activities............................................................................................. 10,670
Expensing of research and experimentation expenditures (normal tax method)........................................................... 6,990
Exception from passive loss rules for $25,000 of rental loss......................................................................... 6,230
Net exclusion of pension contributions and earnings: Individual Retirement Accounts.................................................. 5,970
--------------------------------------------------------------------------------------------------------------------------------------------------------
\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 ---------------------------------------------------------------------
2005 2006 2007 2008 2009 2010 2011
----------------------------------------------------------------------------------------------------------------
Imputed Rent On Owner-Occupied Housing.... 28,600 29,720 33,210 36,860 40,630 44,785 49,364
Double Tax on corporate profit \2\........ -33,940 -33,320 -34,660 -35,900 -37,040 -38,216 -39,430
----------------------------------------------------------------------------------------------------------------
\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.