[Senate Prints 105-18]
[From the U.S. Government Publishing Office]







105th Congress                                                  S. Prt. 
1st Session                 COMMITTEE PRINT                     105-18
_______________________________________________________________________

                                     

 
 
                    PROGRAM DESCRIPTIONS AND GENERAL
                         BUDGET INFORMATION FOR

                            FISCAL YEAR 1998


                      Prepared by the Staff of the

                          COMMITTEE ON FINANCE
                          UNITED STATES SENATE

                     William V. Roth, Jr., Chairman

                                     

                                     
[GRAPHIC] [TIFF OMITTED] TONGRESS.#13

                                     
                               APRIL 1997

            Printed for the use of the Committee on Finance


                   U.S. GOVERNMENT PRINTING OFFICE
38-606--CC                WASHINGTON : 1997

            For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC 
                                 20402




                          COMMITTEE ON FINANCE

                     WILLIAM V. ROTH, JR., Chairman

JOHN H. CHAFEE, Rhode Island         DANIEL PATRICK MOYNIHAN, New York
CHARLES E. GRASSLEY, Iowa            MAX BAUCUS, Montana
ORRIN G. HATCH, Utah                 JOHN D. ROCKEFELLER IV, West 
ALFONSE M. D'AMATO, New York         Virginia
FRANK H. MURKOWSKI, Alaska           JOHN BREAUX, Louisiana
DON NICKLES, Oklahoma                KENT CONRAD, North Dakota
PHIL GRAMM, Texas                    BOB GRAHAM, Florida
TRENT LOTT, Mississippi              CAROL MOSELEY-BRAUN, Illinois
JAMES M. JEFFORDS, Vermont           RICHARD H. BRYAN, Nevada
CONNIE MACK, Florida                 J. ROBERT KERREY, Nebraska

            Lindy L. Paull, Staff Director and Chief Counsel

      Mark A. Patterson, Minority Staff Director and Chief Counsel




                                PREFACE

    This document contains data and information that will be 
needed by the Committee on Finance for meeting its FY1998 
budget reconciliation instructions. Included are descriptions 
of the budget process and constraints, followed by descriptions 
of each of President Clinton's FY1998 budget proposals that 
falls within the jurisdiction of the Committee on Finance. A 
description of present law precedes the description of each 
proposal. At the end of each section are tables showing the 
estimated budgetary effects of the proposals prepared both by 
the Joint Committee on Taxation (revenues) or the Congressional 
Budget Office (spending), and estimates prepared by the Office 
of Management and Budget are also included.
    The Committee would like to thank the staffs of the Joint 
Committee on Taxation, the Congressional Research Service, and 
the Congressional Budget Office for their assistance in 
preparing this document.


                                     




                            C O N T E N T S

                              ----------                              

                     BUDGET PROCESS AND CONSTRAINTS

                                                                   Page
A. Budget Enforcement Procedures.................................     1

B. The Line-Item Veto............................................     2

                           REVENUE PROVISIONS

Introduction.....................................................     5

  I.  TAX CUT SUNSET..................................................7

 II.  MIDDLE CLASS TAX RELIEF.........................................9

        A. Tax Credit For Families With Children Under Age 13....     9
        B. Tax Incentives For Education and Training.............    10
            1. HOPE scholarship tuition tax credit...............    10
            2. Education and job training tax deduction..........    14
            3. Tax incentives for expansion of student loan 
                forgiveness......................................    19
            4. Extension of exclusion for employer-provided 
                educational assistance...........................    20
            5. Small business tax credit for employer-provided 
                educational assistance...........................    20
        C. Provisions Relating to Individual Retirement Plans....    21
        D. Exclusion of Capital Gains on Sale of Principal 
            Residence............................................    25

III.  DISTRESSED AREAS INITIATIVES...................................27

        A. Expand Empowerment Zones and Enterprise Communities...    27
        B. Expensing of Environmental Remediation Costs 
            (``Brownfields'')....................................    32
        C. Tax Credit For Equity Investments in Community 
            Development Financial Institutions...................    35

 IV.  WELFARE-TO-WORK TAX CREDIT.....................................37

  V.  EXPANSION OF ESTATE TAX EXTENSION PROVISIONS FOR CLOSELY HELD 
      BUSINESSES.....................................................39

 VI.  OTHER TAX INCENTIVES...........................................41

        A. Equitable Tolling of the Statute of Limitations Period 
            For Claiming Tax Refunds for Incapacitated Taxpayers.    41
        B. Extend and Modify Puerto Rico Tax Credit..............    41
        C. Extend Foreign Sales Corporation Benefits to Licenses 
            of Computer Software For Reproduction Abroad.........    42
        D. District of Columbia Tax Incentives...................    43

VII.  EXTENSIONS OF EXPIRING TAX PROVISIONS..........................44

        A. Research Tax Credit...................................    44
        B. Contributions of Stock to Private Foundations.........    47
        C. Work Opportunity tax Credit...........................    48
        D. Orphan Drug Tax Credit................................    51

VIII. CORPORATE REFORMS AND OTHER TAX PROVISIONS.....................52


        A. Provisions Relating to Financial Products.............    52
            1. Deny interest deduction on certain debt 
                instruments......................................    52
            2. Defer interest deduction on certain convertible 
                debt.............................................    53


            3. Limit dividends-received deduction................    54
               a. Reduce dividends-received deduction to 50 
                  percent........................................    54
               b. Modify holding period for dividends-received 
                  deduction......................................    55
               c. Deny dividends-received deduction for preferred 
                  stock with certain nonstock characteristics....    55
            4. Disallowance of interest on indebtedness allocable 
                to tax-exempt obligations........................    56
            5. Basis of substantially identical securities 
                determined on an average basis...................    58
            6. Require recognition of gain on certain appreciated 
                positions in personal property...................    59
            7. Gains and losses from certain terminations with 
                respect to property..............................    62
            8. Determination of original issue discount where 
                pooled debt obligations subject to acceleration..    63
        B. Corporate Tax Provisions..............................    64
            1. Require gain recognition for certain extraordinary 
                dividends........................................    64
            2. Repeal percentage depletion for nonfuel minerals 
                mined on certain Federal lands...................    66
            3. Modify net operating loss carryback and 
                carryforward rules...............................    67
            4. Treat certain preferred stock as ``boot''.........    68
            5. Conversion of large corporations into S 
                corporations treated as complete liquidations....    69
            6. Require gain recognition on certain distributions 
                of controlled corporation stock..................    71
            7. Reform tax treatment of certain corporate stock 
                transfers........................................    72
            8. Modify the extension of section 29 credit for 
                biomass and coal facilities......................    73
        C. Foreign Provisions....................................    74
            1. Expand subpart F provisions regarding income from 
                notional principal contracts and stock lending 
                transactions.....................................    74
            2. Taxation of certain captive insurance companies 
                and their shareholders...........................    75
            3. Modify foreign tax credit carryover rules.........    78
            4. Reform treatment of foreign oil and gas income and 
                dual-capacity taxpayers..........................    78
            5. Replace sales source rules with activity-based 
                rule.............................................    80
        D. Accounting Provisions.................................    81
            1. Termination of suspense accounts for family farm 
                corporations required to use accrual method of 
                accounting.......................................    81
            2. Repeal lower of cost or market inventory 
                accounting method................................    82
            3. Repeal components of cost inventory accounting 
                method...........................................    83
        E. Gain Deferral Provisions..............................    85
            1. Expansion of requirement that involuntarily 
                converted property be replaced with property from 
                an unrelated person..............................    85
            2. Further restrict like-kind exchanges involving 
                foreign personal property........................    85
        F. Administrative Provisions.............................    86
            1. Registration of confidential corporate tax 
                shelters.........................................    86
            2. Information reporting on persons receiving 
                contract payments from certain Federal agencies..    88
            3. Increased information reporting penalties.........    89
            4. Disclosure of tax return information for 
                administration of certain veterans' programs.....    90
            5. Extension of withholding to certain gambling 
                winnings.........................................    91
            6. Reporting of certain payments made to attorneys...    91
            7. Modify the substantial understatement penalty.....    93
            8. Establish IRS continuous levy and improve debt 
                collection.......................................    93
               a. Continuous levy................................    93
               b. Modifications of levy exemptions...............    94
        G. Employment Taxes......................................    95
            1. Extension of Federal unemployment tax.............    95
            2. Deposit requirement for Federal unemployment taxes    95


        H. Excise Taxes..........................................    96
            1. Reinstate Airport and Airway Trust Fund excise 
                taxes............................................    96
            2. Reinstate Leaking Underground Storage Tank Trust 
                Fund excise tax..................................    97
            3. Reinstate Superfund excise taxes and corporate 
                environmental income tax.........................    98
            4. Reinstate Oil Spill Liability Trust Fund excise 
                tax..............................................    98
            5. Kerosene taxed as diesel fuel.....................    98
            6. Exempt Federal vaccine purchases from vaccine 
                excise tax for one year..........................   100

REVENUE TABLES...................................................   101

  Explanation of Estimates.......................................   102
  Estimated Budget Effects of the Revenue Provisions Contained in 
    the President's Fiscal Year 1998 Budget Proposal (Includes 
    Sunset of Certain Provisions)................................   104
  Hypothethical Estimate of the Budget Effects of the Revenue 
    Provisions Contained in the President's Fiscal Year 1998 
    Budget Proposal as if Certain Tax Reduction Provisions 
    Subject to Sunset on December 31, 2000, are Enacted on a 
    Permanent Basis..............................................   110
  Federal Receipts and Collections: Effect of Proposals on 
    Receipts.....................................................   116

                                MEDICARE

Introduction.....................................................   119

PART A...........................................................   121

  Hospitals......................................................   121
    Annual Hospital Payment Updates..............................   121
    Hospital-Capital Payments....................................   121
    Definition of Hospital ``Transfer''..........................   122
    Rural Health Provisions......................................   122
    Graduate Medical Education Payments..........................   122
    Disproportionate Share Hospital (DSH) Payments...............   123
    Payment to Teaching and Disproportionate Share Hospitals From 
      Managed Care Rates.........................................   123
    Other Hospital Proposals.....................................   124
  Skilled Nursing Facilities (SNFs)..............................   124
    Payment Reform...............................................   124
  Part A Premiums................................................   125
    Enrollment...................................................   125
    Working Disabled.............................................   125

PART B...........................................................   126

  Physicians and Other Suppliers.................................   126
    Establish Single Conversion Factor and Reform Method for 
      Updating Physician Fees....................................   126
    Make Single Payment for Surgery..............................   127
    Create Incentives to Control High-Volume Physician Services..   127
    Direct Payment to Physician Assistants, Nurse Practitioners, 
      and Clinical Nurse Specialists.............................   127
    Payment of Acquisition Costs for Drugs.......................   128
    Chiropractic Services........................................   128
  Hospital Outpatient Departments (OPDs).........................   128
    Payment for Hospital Outpatient Departments (OPDs)...........   128
    Formula Driven Overpayment for Hospital Outpatient Department 
      Care.......................................................   129
    Beneficiary Coinsurance for Hospital Outpatient Department 
      Care.......................................................   129
  Other Providers................................................   130
    Ambulatory Surgical Centers (ASCs)...........................   130
    Competitive Bidding for Laboratories, Durable Medical 
      Equipment and Other Items..................................   130
    Payment for Automated Laboratory Tests.......................   130
    Payment for Ambulance Services...............................   131
  Premiums.......................................................   131
    Part B Premiums..............................................   131
    Part B Enrollment and Penalties for Delayed Enrollment.......   131


  Benefits.......................................................   132
    Mammography Services.........................................   132
    Colorectal Screening.........................................   132
    Preventive Injections........................................   132
    Diabetes Self-Management Benefit.............................   133
    Respite Benefit..............................................   133

PARTS A AND B....................................................   133

  Home Health Services...........................................   133
    Payment Reform...............................................   133
    Extend Savings from Home Health Cost Limits Freeze...........   134
    Clarification of the Definition of ``Homebound''.............   135
    Provide Secretarial Authority to Make Payment Denials Based 
      on Normative Service Standards.............................   135
  Reallocate Financing of Part of the Home Health Benefit to Part 
    B............................................................   136
  Medigap........................................................   136
    Medigap Enrollment...........................................   136
  Purchasing Initiatives.........................................   137
    Centers of Excellence........................................   137
    Other Purchasing Initiatives.................................   138
  Coordination of Benefits, Program Integrity and Other
      Management Initiatives.....................................   138
    Medicare Secondary Payer.....................................   138
    Consolidated Billing for SNF Services........................   139
    Home Health Payments Based on Location of Service............   139
    Periodic Interim Payments for Home Health....................   139
    Survey and Certification.....................................   139
  Fraud and Abuse................................................   140
    Advisory Opinions............................................   140
    Managed Care Exception in Anti-Kickback Statute..............   140
    Reasonable Diligence.........................................   141

MEDICARE MANAGED CARE............................................   141

  Payments and Plan Choice.......................................   141
    Payment Changes..............................................   141
    Increased Plan Choice and Consumer Information...............   144
  Additional Proposals...........................................   146
    Permit Enrollment of ESRD Beneficiaries......................   146
    Limits on Charges for Out-of-Network Services................   147
    Coverage of Out-of-Area Dialysis Services....................   147
    Clarification of Coverage for Emergency Services.............   147
    Permit States with Programs Approved by the Secretary to Have 
      Primary Oversight Responsibility...........................   147
    Modify Termination and Sanction Authority....................   148
    Deem Privately Accredited Plans to Meet Internal Quality 
      Assurance Standards........................................   148
    Replace 50/50 Rule with Quality Measurement System...........   148

Tables:
  CBO Estimate of President's Budget Plan for Medicare...........   152
  OMB Estimate of President's Budget Plan for Medicare...........   156

                                MEDICAID

Introduction.....................................................   159

Federal Payments.................................................   161

  Limitations on per capita rate of growth in Federal financial 
    participation................................................   161

Entitlement to Benefits Are Mantained............................   162

  Reduction of disproportionate share payments...................   162
  Medicaid eligibility quality control (MEQC) requirements.......   163
  Nursing home survey and certification..........................   163

Eligibility......................................................   164

  Disabled children who lose SSI benefits........................   164
  State option to permit workers with disabilities to buy into 
    medicaid.....................................................   164
  Extension of coverage to additional individuals................   165


  Elimination of authority for new statewide eligibility 
    expansion demonstrations.....................................   165
  Continuous eligibility for children............................   165
  Upper income limit on ``less restrictive'' eligibility 
    methodologies................................................   166

Managed Care.....................................................   166

Benefits.........................................................   168

  Home and community-based services..............................   168
  Elimination of requirement to pay for private insurance........   168
  Individuals covered during transition to work..................   168
  Copayments in health maintenance organizations.................   169

Provider Participation and Payment Rates.........................   169

  Methods for establishing provider payment rates................   169
  Physician qualification requirements...........................   170
  Elimination of obstetrical and pediatric payment rate 
    requirements.................................................   170
  Program for all-inclusive care for the elderly (PACE)..........   170

State Plan Administration........................................   170

  Elimination of personnel requirements..........................   170
  Elimination of duplicative inspection of care requirements for 
    ICFs/MR and mental hospitals.................................   171
  Public process for developing state plan amendments............   171
  Alternative sanctions for non-compliant ICFs/MR................   171
  Modification of MMIS requirements..............................   172
  Nurse aide training and competency evaluation programs.........   172
  Elimination of repayment requirement for States imposing 
    alternative remedies on non-compliant nursing facilities.....   172

Miscellaneous Provisions.........................................   173

  Commission on Medicaid.........................................   173
  Effective date.................................................   173
  Increase Federal payment cap for Puerto Rico...................   174
  Increase Federal payment to the District of Columbia...........   174
  Medicaid eligibility for non-citizens..........................   174

Tables:
  CBO Estimates of the Final FY 1998 President's Budget Medicaid 
    Proposals....................................................   178
  OMB Estimates of the FY 1998 President's Budget Medicaid 
    Proposals....................................................   180

                            HEALTH INSURANCE

Introduction.....................................................   181

Initiative To Maintain and Expand Workers' Coverage..............   183

  Temporary premium assistance for families between jobs.........   183

Voluntary Purchasing Cooperatives................................   184

Children's Health Initiative.....................................   185

  Grants to the States...........................................   185
  Investments to expand Medicaid coverage........................   186

Table.--OMB and CBO Estimated Costs of the Health Insurance 
  Provisions in the President's FY1998 Budget....................   188

                  INCOME SECURITY AND SOCIAL SECURITY

Introduction.....................................................   189

A. SSI and Medicaid Benefits for Legal Immigrants................   191

    1. SSI eligibility for legal immigrants......................   191
    2. Medicaid eligibility for legal immigrants.................   191

B. Medicaid Eligibility for Disabled Children....................   192

C. Welfare-to-Work Measures......................................   192

    1. Welfare-to-work jobs challenge............................   192
    2. Work Opportunity Tax Credit...............................   193
    3. Transportation to jobs and other supportive services......   194


D. Unspecified Welfare Reform ``Technical Corrections''..........   194

E. Vocational Rehabilitation Services for SSDI/SSI Beneficiaries.   195

F. Railroad Retirement Benefits..................................   195

G. Unemployment Compensation.....................................   195

    1. Extension of the FUTA Surtax..............................   195

    2. Monthly Payment of Unemployment Taxes.....................   196

Table.--President's Legislative Proposals--Income Security and 
  Social Security................................................   197

                                 TRADE

Introduction.....................................................   199

Administration Proposals.........................................   201

  Generalized System of Preferences..............................   201
  Caribbean Basin Initiative.....................................   201
  OECD Shipbuilding Subsidies Agreement..........................   202
Table.--CBO Reestimate of the Trade Proposals in the 1998 
  President's Budget.............................................   203

                      NET INTEREST AND DEBT LIMIT

Net Interest.....................................................   207

  CBO Baseline Projections of Interest Costs.....................   207
Debt Limit.......................................................   208

  CBO Baseline Projections of Federal Debt.......................   209



                     BUDGET PROCESS AND CONSTRAINTS

                    A. Budget Enforcement Procedures

    The Balanced Budget and Emergency Deficit Control Act of 
1985 (popularly known as Gramm-Rudman-Hollings) set annual 
deficit targets that were intended to lead to a balanced budget 
in 1991. It also established a procedure--known as 
sequestration--to make those goals binding. Under 
sequestration, an across-the-board reduction in spending 
(excepting numerous entitlement programs) would automatically 
occur if the projected deficit exceeded its goal. The deficit 
targets were revised in 1987, and lawmakers designated 1993 as 
the year in which the deficit would be eliminated. Although the 
deficit declined in the fiscal year following enactment of 
Gramm-Rudman-Hollings (and remained virtually at the same level 
for the next 2 years) the fixed deficit target approach failed 
to achieve the desired reductions. (For 1990, the last year for 
which the procedures were fully in effect, the actual deficit 
exceeded the revised target deficit by $121 billion and the 
original target by $185 billion.) Moreover, that approach led 
to rosy economic projections, the use of questionable budgetary 
saving such as timing shifts, and a perception that the process 
put an unfair burden on discretionary appropriations. 
Consequently, the law was amended by the Budget Enforcement Act 
of 1990 (BEA).
    In place of fixed deficit targets, the BEA established 
annual caps on discretionary budget authority and outlays 
provided in appropriation acts. It also instituted a pay-as-
you-go requirement for mandatory spending and revenue 
legislation. Under the BEA, discretionary appropriations in 
excess of the caps trigger a sequestration of only 
discretionary spending. Furthermore, a sequestration of 
mandatory spending is imposed if the net effect of all 
legislation affecting mandatory spending or revenues is to 
increase the deficit. The BEA kept those rules in place through 
fiscal year 1995. The Omnibus Budget Reconciliation Act of 1993 
extended them through fiscal year 1998, with essentially no 
change.
    In general, the BEA procedures have been successful in 
preventing new legislation from increasing the deficit. One 
indication that the pay-as-you-go procedure has been effective 
is that since 1990 proponents of legislation that would 
increase mandatory spending or cut taxes have almost always 
been greeted with, ``How are you going to pay for it?'' That 
may seem an obvious question, but it was one that proponents of 
legislation did not generally have to answer before 1990. In 
addition, there have been no pay-as-you-go sequestrations. 
Since the enactment of the BEA, only two small discretionary 
sequestrations have been ordered. In one case, the 
sequestration offset an overage that the Office of Management 
and Budget estimated at $2.4 million (the Congressional Budget 
Office estimated that appropriations did not exceed the cap), 
which resulted in a sequester reducing each discretionary 
spending account by .0013 percent. In the other instance, 
enacted appropriations exceeded the cap by $395 million because 
of a drafting mistake in an appropriation bill enacted just 
before the Congress adjourned for the year. When the Congress 
reconvened, it enacted legislation that corrected the mistake 
and canceled the sequestration.
    Although the BEA procedures have been successful in 
constraining new budgetary legislation, many Members of 
Congress have expressed concern that those constraints do not 
limit increases in mandatory spending that can occur without 
changes in law and do not require the elimination of deficits. 
With the expiration of the BEA procedures looming, the Congress 
must decide whether to extend those constraints (either in 
essentially the same form or with modifications).

                         B. The Line-Item Veto

    The Line Item Veto Act was enacted last year and went into 
effect on January 1, 1997. The act, which as indicated below 
was subsequently declared unconstitutional by a Federal 
District Court, represents a different kind of constraint on 
the budgetary decisions of the Congress by granting the 
President the authority to cancel certain new spending or tax 
benefits signed into law after that date. The act was to have 
remained in effect for 8 years. Since a final adjudication of 
the act's constitutionality may not be rendered until later in 
1997 or in 1998, a description of the act's provisions follow.
    The Line Item Veto Act is intended to allow the President--
as part of a broader effort to reduce the deficit--to eliminate 
new spending and tax breaks that he deems wasteful or 
unnecessary. Although there is disagreement over whether the 
new law will reduce the deficit, most observers agree that it 
is a significant change in the Federal budget process that is 
likely to shift budgetary power from the Congress to the 
President.
    Under the act, the President may cancel ``any dollar amount 
of discretionary budget authority, any item of new direct 
spending, or any limited tax benefit'' that he signs into law. 
The President must notify the Congress of any cancellations by 
special message and he must do so within 5 days of signing the 
law from which cancellations have been made. Cancellations go 
into effect only when the Congress receives the special 
message.
    A cancellation may only be overturned by the enactment of a 
subsequent law. For each special message, the Congress may 
consider a ``disapproval bill'' under fast-track legislative 
procedures during a 30-day review period (that could extend 
well beyond 30 calendar days because of recesses and 
adjournments). The President may not use his cancellation 
authority on a disapproval bill. Of course, the Congress may 
include provisions overturning cancellations as part of a 
measure that is not a disapproval bill, but such a measure 
would not come under fast-track procedures or be protected from 
the President's cancellation authority.
    Before the Line Item Veto Act, the President could propose 
to cancel amounts of budget authority provided by law, but any 
such rescission that he proposed had to be enacted into law to 
go into effect permanently. Under the act, the President may 
unilaterally cancel certain spending and tax benefits that he 
has signed into law, and any cancellations can only be reversed 
by the enactment of a subsequent law. Because the President 
seems likely to veto any disapproval bill, such a measure will 
probably require the support of two-thirds of the Congress--the 
margin needed to override a veto--to ensure its enactment.
    In certain respects the act is broader, and in others more 
restrictive, than some earlier proposals to expand the 
President's impoundment authority. For example, earlier 
proposals generally would have applied only to discretionary 
appropriations provided in annual appropriations acts. The act 
permits the President to cancel such amounts as well as certain 
new, direct (mandatory) spending and tax benefits. In the case 
of discretionary appropriations, however, the President may 
only cancel entire dollar amounts specified in appropriations 
acts, governing committee reports, or related statutes. He may 
not cancel a portion of such amounts, which would have been 
allowed under some earlier proposals.
    Budget enforcement procedures in effect since 1990 have 
worked to prevent new spending and revenue laws from increasing 
the deficit. It is unclear whether, if sustained by the Supreme 
Court, the President's new authority will lead to further 
reductions in the deficit or will simply empower him to 
substitute his own budgetary priorities for those of the 
Congress. In any event, the act does not address the leading 
cause of recent and projected deficits; namely, mandatory 
spending increases under existing law. To control such 
spending, whether as part of a plan to balance the budget or 
for other purposes, the Congress must enact legislation 
modifying existing laws.
    On January 2, 1997, a lawsuit was filed in the U.S. 
District Court for the District of Columbia challenging the 
constitutionality of the act. The plaintiffs, six Members of 
Congress, including Senators Byrd, Hatfield, Levin, and 
Moynihan, contended that the act violated Art. I, Sec. 7 of the 
Constitution, which requires that any bill making or changing 
Federal law must be passed by both houses of Congress and then 
presented to the President in toto, in which form he must sign 
it (or allow it to become law by the passage of 10 days, 
Sundays excepted) or veto it. The defendants in the case, which 
was captioned Sen. Robert C. Byrd, et al. v. Franklin Raines, 
et al., were the Director of the Office of Management and 
Budget and the Secretary of the Treasury.
    The District Court heard oral argument in Byrd v. Raines on 
March 21, 1997, and on April 10, 1997, the court ordered that 
the Line Item Veto Act was adjudged and declared 
unconstitutional. In an opinion by Judge Thomas Penfield 
Jackson, the court held that the act was unconstitutional 
because it effectively permitted the President to repeal duly 
enacted provisions of Federal law, which is a function reserved 
to the Congress under the Constitution.
    At the time of this writing, it is expected that the 
defendants will appeal the District Court's decision directly 
to the U.S. Supreme Court pursuant to Section 3 of the Line 
Item Veto Act, which provides for expedited judicial review.
      

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


                           REVENUE PROVISIONS

This section,1 prepared by the staff of the Joint 
Committee on Taxation, provides a description of the revenue 
provisions contained in the President's fiscal year 1998 budget 
proposal, as submitted to the Congress on February 6 
1997.2
---------------------------------------------------------------------------
    \1\ This section may be cited as follows: Joint Committee on 
Taxation, Description of Revenue Provisions Contained in the 
President's Fiscal Year 1998 Budget Proposal (JCX-6-97R), February 10, 
1996.
    \2\ See Department of the Treasury, General Explanations of the 
Administration's Revenue Proposals, February 1997. Also, Office of 
Management and Budget, Budget of the United States Government, Fiscal 
Year 1998: Analytical Perspectives, pp. 45-60.

This section does not include a description of certain user 
fees and other proposals contained in the President's fiscal 
year 1998 budget proposal that may or may not be considered to 
be in the jurisdiction of the House Committee on Ways and Means 
or the Senate Committee on Finance.3
---------------------------------------------------------------------------
    \3\ See Office of Management and Budget, Budget of the United 
States Government, Fiscal Year 1998: Analytical Perspectives, pp. 61-
69.

This section contains only a description of present law and 
each of the tax revenue proposals contained in the President's 
budget. The document does not provide any analysis of the 
policy issues raised by the proposals. The Joint Committee 
staff anticipates providing such policy analysis at a later 
date (e.g., in connection with Senate Finance or Ways and Means 
---------------------------------------------------------------------------
Committee hearings on the proposals).

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

                           I. TAX CUT SUNSET

    The President's budget proposal states that a mechanism 
will apply to ensure that the budget is balanced in 2002 under 
both Office of Management and Budget (``OMB'') and 
Congressional Budget Office (``CBO'') economic assumptions. 
Specifically, the President's budget states the following:

        ``The Administration is confident that its own 
        assumptions will continue to prove the more accurate.

        ``Nevertheless, the budget includes a mechanism to 
        ensure that the President's plan reaches balance in 
        2002 under OMB or CBO assumptions. If OMB's assumptions 
        prove correct, as we expect, then the mechanism would 
        not take effect. If, however, CBO proves correct--and 
        the President and Congress cannot agree on how to close 
        the gap through expedited procedures--then most of the 
        President's tax cuts would sunset, and discretionary 
        budget authority and identified entitlement programs 
        would face an across-the-board limit.'' 4

    \4\ Office of Management and Budget, Budget of the United States 
Government, Fiscal Year 1998.
---------------------------------------------------------------------------
    The budget proposal documents published by the 
Administration contain no additional detail with respect to the 
sunset mechanism as relates to the President's tax proposals. A 
draft document provided by OMB to the staff of the Joint 
Committee on Taxation specifies in detail the application of 
the mechanism to spending provisions. However, with respect to 
the tax reduction provisions in the President's budget, the OMB 
document merely states that specified tax cuts sunset at the 
end of calendar year 2000.
    The Treasury Department has indicated in a draft document 
provided to the staff of the Joint Committee on Taxation that 
the sunset mechanism would apply to the following provisions: 
(1) the tax credit for families with young children, (2) the 
HOPE scholarship tuition tax credit, (3) the education and job 
training deduction, (4) the expanded Individual Retirement 
Arrangement (``IRA'') provisions, (5) the expanded empowerment 
zone and enterprise communities provision, and (6) the 
deduction for environmental remediation expenses 
(``Brownfields''). The Treasury Department provided specific 
detail with respect to how the IRA provisions would be sunset 
under the mechanism, but did not provide details with respect 
to the application of the sunset to the other specified tax cut 
provisions.
    Until additional information is known regarding the 
application of the sunset mechanism, the staff of the Joint 
Committee on Taxation is not able to provide an analysis of the 
sunset mechanism nor can the budget effects of the 
Administration's tax proposals be finally estimated. In order 
to provide such analysis and revenue estimates, the following 
information is required: (1) a description of how the sunset 
date identified by the OMB would apply to the specified tax cut 
provisions, other than IRAs, (2) statutory language detailing 
the application of the sunset mechanism, and (3) a CBO analysis 
of the budget proposal and the sunset mechanism. The 
President's budget documents and the OMB description of the 
sunset mechanism appear to assume that CBO economic assumptions 
will trigger the application of the tax cut sunset mechanism. 
However, the estimated budget receipts shown in the President's 
budget proposal do not incorporate the effects of the sunset 
mechanism.
                      II. MIDDLE CLASS TAX RELIEF

         A. Tax Credit for Families with Children Under Age 13

                              Present Law

In general

     Present law does not provide any tax credit specific based 
solely on the taxpayer's number of dependent children. 
Taxpayers with dependent children, however, generally are able 
to claim a personal exemption for each of these dependents. The 
total amount for personal exemptions is subtracted (along with 
certain other items) from adjusted gross income (AGI) in 
arriving at taxable income. The amount of each personal 
exemption is $2,650 for 1997, and is adjusted annually for 
inflation. In 1997, the amount of the personal exemption is 
phased out for taxpayers with AGI in excess of $121,200 for 
single taxpayers, $151,500 for heads of household, and $181,800 
for married couples filing joint returns. These phaseout 
thresholds are adjusted annually for inflation.
     In addition, under present law, taxpayers with children 
may be entitled to (1) a tax credit for child care expenses and 
(2) an exclusion from income for employer-provided dependent 
care assistance. Further, the amount of earned income credit 
(EIC) to which a taxpayer is entitled may be increased 
depending upon the taxpayer's family size.

                        Description of Proposal

    The proposal would provide taxpayers with a nonrefundable 
tax credit of $300 for each qualifying child under the age of 
13 (as of the close of the calendar year in which the 
taxpayer's taxable year begins) for taxable years 1997, 1998 
and 1999. The credit would be calculated before the application 
of the earned income credit (in a manner similar to the 
provision contained in the Balanced Budget Act of 1995 as 
passed by the Congress). The amount of the credit would be 
increased to $500 for each qualifying child for taxable years 
beginning after December 31, 1999.
    The credit would be phased out ratably for taxpayers with 
AGI over $60,000 and would be fully phased out at AGI of 
$75,000. In the case of a taxable year beginning after calendar 
year 2000, the maximum credit and the beginning point of the 
phaseout range would be indexed annually for inflation.

                             Effective Date

    The proposal would be effective for taxable years beginning 
after December 31, 1996. The President's budget proposal 
contains a tax cut sunset provision that, if triggered, would 
sunset the child credit for calendar years after 2000. See the 
description of this sunset mechanism in Part I., above.

              B. Tax Incentives for Education and Training

1. HOPE scholarship tuition tax credit

                              Present Law

    Taxpayers generally may not deduct education and training 
expenses. However, a deduction for education expenses generally 
is allowed under section 162 if the education or training (1) 
maintains or improves a skill required in a trade or business 
currently engaged in by the taxpayer, or (2) meets the express 
requirements of the taxpayer's employer, or requirements of 
applicable law or regulations, imposed as a condition of 
continued employment (Treas. Reg. sec. 1.162-5). Education 
expenses are not deductible if they relate to certain minimum 
educational requirements or to education or training that 
enables a taxpayer to begin working in a new trade or business. 
In the case of an employee, education expenses (if not 
reimbursed by the employer) may be claimed as an itemized 
deduction only if such expenses relate to the employee's 
current job and only to the extent that the expenses, along 
with other miscellaneous deductions, exceed 2 percent of the 
taxpayer's adjusted gross income (AGI).
    Education expenses that are reimbursed by the employer are 
excludable from the employee's gross income as a working 
condition fringe benefit (sec. 132(d)) if the education 
qualifies as work related under section 162. A special rule 
allows an employee to exclude from gross income for income tax 
purposes and from wages for employment tax purposes up to 
$5,250 paid by his or her employer for educational assistance, 
regardless of whether the education maintains or improves a 
skill required by the employee's current position (sec. 127). 
This special rule for employer-provided educational assistance 
expires with respect to courses beginning after June 30, 1997 
5 (and does not apply to graduate level courses 
beginning after June 30, 1996).
---------------------------------------------------------------------------
    \5\ The legislative history of the Small Business Job Protection 
Act of 1996 indicated Congressional intent to extend the exclusion for 
employer-provided educational assistance through May 31, 1997. The 
statute, however, extended the exclusion through June 30, 1997.
---------------------------------------------------------------------------
    Another special rule (sec. 135) provides that interest 
earned on a qualified U.S. Series EE savings bond issued after 
1989 is excludable from gross income if the proceeds of the 
bond upon redemption do not exceed qualified higher education 
expenses paid by the taxpayer during the taxable 
year.6 ``Qualified higher education expenses'' 
include tuition and fees (but not room and board expenses) 
required for the enrollment or attendance of the taxpayer, the 
taxpayer's spouse, or a dependent of the taxpayer at certain 
colleges, universities, or vocational schools. The exclusion 
provided by section 135 is phased out for certain higher-income 
taxpayers, determined by the taxpayer's modified AGI during the 
year the bond is redeemed. For 1996, the exclusion was phased 
out for taxpayers with modified AGI between $49,450 and $64,450 
($74,200 and $104,200 for joint returns). To prevent taxpayers 
from effectively avoiding the income phaseout limitation 
through issuance of bonds directly in the child's name, section 
135(c)(1)(B) provides that the interest exclusion is available 
only with respect to U.S. Series EE savings bonds issued to 
taxpayers who are at least 24 years old.
---------------------------------------------------------------------------
    \6\ If the aggregate redemption amount (i.e., principal plus 
interest) of all Series EE bonds redeemed by the taxpayer during the 
taxable year exceeds the qualified education expenses incurred, then 
the excludable portion of interest income is based on the ratio that 
the education expenses bears to the aggregate redemption amount (sec. 
135(b)).
---------------------------------------------------------------------------
    Section 117 excludes from gross income amounts received as 
a qualified scholarship by an individual who is a candidate for 
a degree and used for tuition and fees required for the 
enrollment or attendance (or for fees, books, supplies, and 
equipment required for courses of instruction) at a primary, 
secondary, or post-secondary educational institution. The tax-
free treatment provided by section 117 does not extend to 
scholarship amounts covering regular living expenses, such as 
room and board. There is, however, no dollar limitation for the 
section 117 exclusion, provided that the scholarship funds are 
used to pay for tuition and required fees. In addition to the 
exclusion for qualified scholarships, section 117 provides an 
exclusion from gross income for qualified tuition reductions 
for education below the graduate level provided to employees of 
certain educational organizations.
    In the case of an individual, section 108(f) provides that 
gross income subject to Federal income tax does not include any 
amount from the forgiveness (in whole or in part) of certain 
student loans, provided that the forgiveness is contingent on 
the student's working for a certain period of time in certain 
professions for any of a broad class of employers (e.g., 
providing health care services to a nonprofit organization). 
Student loans eligible for this special rule must be made to an 
individual to assist the individual in attending an education 
institution that normally maintains a regular faculty and 
curriculum and normally has a regularly enrolled body of 
students in attendance at the place where its education 
activities are regularly carried on. Loan proceeds may be used 
not only for tuition and required fees, but also to cover room 
and board expenses (in contrast to tax-free scholarships under 
section 117, which are limited to tuition and required fees). 
In addition, the loan must be made by (1) the United States (or 
an instrumentality or agency thereof), (2) a State (or any 
political subdivision thereof), (3) certain tax-exempt public 
benefit corporations that control a State, county, or municipal 
hospital and whose employees have been deemed to be public 
employees under State law, or (4) an educational organization 
that originally received the funds from which the loan was made 
from the United States, a State, or a tax-exempt public benefit 
corporation. As with section 117, there is no dollar limitation 
for the section 108(f) exclusion.
    Section 529 (enacted as part of the Small Business Job 
Protection Act of 1996) provides tax-exempt status to 
``qualified State tuition programs,'' meaning certain programs 
established and maintained by a State (or agency or 
instrumentality thereof) under which persons may (1) purchase 
tuition credits or certificates on behalf of a designated 
beneficiary that entitle the beneficiary to a waiver or payment 
of qualified higher education expenses of the beneficiary, or 
(2) make contributions to an account that is established for 
the purpose of meeting qualified higher education expenses of 
the designated beneficiary of the account. ``Qualified higher 
education expenses'' are defined as tuition, fees, books, 
supplies, and equipment required for the enrollment or 
attendance at a college or university (or certain vocational 
schools). Qualified higher education expenses do not include 
room and board expenses. Section 529 also provides that no 
amount shall be included in the gross income of a contributor 
to, or beneficiary of, a qualified State tuition program with 
respect to any distribution from, or earnings under, such 
program, except that (1) amounts distributed or educational 
benefits provided to a beneficiary (e.g., when the beneficiary 
attends college) will be included in the beneficiary's gross 
income (unless excludable under another Code section) to the 
extent such amount or the value of the educational benefits 
exceeds contributions made on behalf of the beneficiary, and 
(2) amounts distributed to a contributor (e.g., when a parent 
receives a refund) will be included in the contributor's gross 
income to the extent such amounts exceeds contributions made by 
that person.

                        Description of Proposal

    Individual taxpayers would be allowed to claim a non-
refundable credit against Federal income taxes up to $1,500 per 
student per year for tuition and required fees (but not room 
and board expenses) for the first two years of the student's 
post-secondary education in a degree or certificate program. 
The education expenses must be incurred on behalf of the 
taxpayer, the taxpayer's spouse, or a dependent. The credit 
would be available with respect to an individual student for 
two taxable years, provided that the student has not completed 
the first two years of post-secondary education. With respect 
to each student, a taxpayer may claim either the credit or the 
proposed above-the-line deduction (described below). If, for 
any taxable year, a taxpayer chooses to claim a credit with 
respect to a particular student, then the proposed above-the-
line deduction will not be available with respect to that 
particular student for that year (although the proposed 
deduction may be available with respect to that student for 
other taxable years, such as after the student completes two 
years of college and no longer is eligible for the credit). For 
one taxable year, a taxpayer may claim the proposed above-the 
line deduction for education expenses with respect to one 
student and also claim the credit with respect to other 
students. An eligible student would not be entitled to claim a 
credit under the proposal if that student is claimed as a 
dependent for tax purposes by another taxpayer. If a parent 
claims a student as a dependent, any education expenses paid by 
the student would be treated as paid by the parent for purposes 
of the proposal.
    With respect to each individual student, a taxpayer is 
limited to a tuition tax credit of the lesser of the qualified 
education expenses incurred during the taxable year with 
respect to that student or the maximum credit amount. The 
maximum credit amount for a taxable year would be $1,500, 
reduced by any Federal educational grants, such as Pell Grants, 
awarded to the student for that year (or for education 
beginning in the first three months of the next year, if 
credits are claimed based on payments for that education). 
Beginning in 1998, the maximum credit amount would be indexed 
for inflation, rounded down to the closest multiple of $50.
    The maximum credit amount would be phased out ratably for 
taxpayers with modified AGI between $50,000 and $70,000 
($80,000 and $100,000 for joint returns). Modified AGI would 
include taxable Social Security benefits and amounts otherwise 
excluded with respect to income earned abroad (or income from 
Puerto Rico or U.S. possessions). Modified AGI for purposes of 
the credit would be determined without regard to the proposed 
above-the-line deduction for higher education expenses 
(described below) in cases where the credit is claimed with 
respect to one student and the deduction is claimed with 
respect to another student in the same taxable year. Beginning 
in 2001, the income phase-out ranges would be indexed for 
inflation, rounded down to the closest multiple of $5,000.
    The credit would be available for ``qualified higher 
education expenses,'' meaning tuition and fees required for the 
enrollment or attendance of an eligible student (e.g., 
registration fees, laboratory fees, and extra charges for 
particular courses) at an eligible institution. Charges and 
fees associated with meals, lodging, student activities, 
athletics, insurance, transportation, books, and similar 
personal, living or family expenses would not be included. The 
expenses of education involving sports, games, or hobbies would 
not be qualified higher education expenses unless this 
education is part of a degree program.
    An eligible student would be one who is enrolled or 
accepted for enrollment in a degree, certificate, or other 
program (including a program of study abroad approved for 
credit by the institution at which such student is enrolled) 
leading to a recognized educational credential at an eligible 
institution of higher education. The student must pursue a 
course of study on at least a half-time basis. In addition, for 
a student's qualified higher education expenses to be eligible 
for the credit, the student must not have been convicted of a 
Federal or State felony consisting of the possession or 
distribution of certain drugs, and generally cannot be a 
nonresident alien. Furthermore, a taxpayer would be entitled to 
the credit for a student in a second taxable year only if the 
student obtained a qualifying grade point average for all 
previous post-secondary education. Generally, this would be an 
average of at least 2.75 on a 4-point scale, or a substantially 
similar measure of achievement.7
---------------------------------------------------------------------------
    \7\ Institutions that do not use a 4-point grading scale would be 
allowed to retain their own system while still allowing their students 
to qualify for the credit; these institutions will determine what 
measure under the system they use reasonably approximates a B-GPA.
---------------------------------------------------------------------------
    Eligible institutions would be defined by reference to 
section 481 of the Higher Education Act of 1965. Such 
institutions generally would be accredited post-secondary 
educational institutions offering credit toward a bachelor's 
degree, an associate's degree, or another recognized post-
secondary credential. Certain proprietary institutions and 
post-secondary vocational institutions also would be eligible 
institutions. The institution must be eligible to participate 
in Department of Education student aid programs.
    Qualified education expenses generally would include only 
out-of-pocket tuition and fees. Qualified education expenses 
would not include expenses covered by educational assistance 
that is not required to be included in the gross income of 
either the student or the taxpayer claiming the credit. Thus, 
total tuition and required fees would be reduced by scholarship 
or fellowship grants excludable from gross income under 
present-law section 117 and any tax-free veteran's educational 
benefits. In addition, qualified education expenses would be 
reduced by the interest from U.S. savings bonds that is 
excludable from gross income under section 135 for the taxable 
year. However, no reduction of qualified education expenses 
would be required for a gift, bequest, devise, or inheritance 
within the meaning of section 102(a). If a student's education 
expenses for a taxable year are deducted under any section of 
the Code (including the proposed above-the-line deduction for 
education expenses), then no credit would be available for such 
expenses.
    The credit would be available in the taxable year the 
expenses are paid, subject to the requirement that the 
education commence or continue during that year or during the 
first three months of the next year. Qualified higher education 
expenses paid with the proceeds of a loan generally would be 
eligible for the credit (rather than repayment of the loan 
itself). The credit would be recaptured in cases where the 
student or taxpayer receives a refund (or reimbursement through 
insurance) of tuition and fees for which a credit has been 
claimed in a prior year.
    The Secretary of the Treasury (in consultation with the 
Secretary of Education) would have authority to issue 
regulations to implement the proposal, including regulations 
providing appropriate rules for recordkeeping and information 
reporting. These regulations would address the information 
reports that educational institutions would file to assist 
students and the IRS in determining whether a student meets the 
eligibility requirements for the credit and calculating the 
amount of the credit potentially available. Where certain terms 
are defined by reference to the Higher Education Act of 1965, 
the Secretary of Education would have authority to issue 
regulations, as well as authority to define other education 
terms as necessary.

                             Effective Date

    The proposal would be effective for payments made on or 
after January 1, 1997, for education commencing on or after 
July 1, 1997. The President's budget proposal contains a tax 
cut sunset provision that, if triggered, would sunset the HOPE 
scholarship tuition tax credit for calendar years after 2000. 
See the description of this sunset mechanism in Part I., above.

2. Education and job training tax deduction

                              Present Law

    Taxpayers generally may not deduct education and training 
expenses. However, a deduction for education expenses generally 
is allowed under section 162 if the education or training (1) 
maintains or improves a skill required in a trade or business 
currently engaged in by the taxpayer, or (2) meets the express 
requirements of the taxpayer's employer, or requirements of 
applicable law or regulations, imposed as a condition of 
continued employment (Treas. Reg. sec. 1.162-5). Education 
expenses are not deductible if they relate to certain minimum 
educational requirements or to education or training that 
enables a taxpayer to begin working in a new trade or business. 
In the case of an employee, education expenses (if not 
reimbursed by the employer) may be claimed as an itemized 
deduction only if such expenses relate to the employee's 
current job and only to the extent that the expenses, along 
with other miscellaneous deductions, exceed 2 percent of the 
taxpayer's adjusted gross income (AGI).
    Education expenses that are reimbursed by the employer are 
excludable from the employee's gross income as a working 
condition fringe benefit (sec. 132(d)) if the education 
qualifies as work related under section 162. A special rule 
allows an employee to exclude from gross income for income tax 
purposes and from wages for employment tax purposes up to 
$5,250 paid by his or her employer for educational assistance, 
regardless of whether the education maintains or improves a 
skill required by the employee's current position (sec. 127). 
This special rule for employer-provided educational assistance 
expires with respect to courses beginning after June 30, 1997 
8 (and does not apply to graduate level courses 
beginning after June 30, 1996).
---------------------------------------------------------------------------
    \8\ The legislative history of the Small Business Job Protection 
Act of 1996 indicated Congressional intent to extend the exclusion for 
employer-provided educational assistance through May 31, 1997. The 
statute, however, extended the exclusion through June 30, 1997.
---------------------------------------------------------------------------
    Another special rule (sec. 135) provides that interest 
earned on a qualified U.S. Series EE savings bond issued after 
1989 is excludable from gross income if the proceeds of the 
bond upon redemption do not exceed qualified higher education 
expenses paid by the taxpayer during the taxable 
year.9 ``Qualified higher education expenses'' 
include tuition and fees (but not room and board expenses) 
required for the enrollment or attendance of the taxpayer, the 
taxpayer's spouse, or a dependent of the taxpayer at certain 
colleges, universities, or vocational schools. The exclusion 
provided by section 135 is phased out for certain higher-income 
taxpayers, determined by the taxpayer's modified AGI during the 
year the bond is redeemed. For 1996, the exclusion was phased 
out for taxpayers with modified AGI between $49,450 and $64,450 
($74,200 and $104,200 for joint returns). To prevent taxpayers 
from effectively avoiding the income phaseout limitation 
through issuance of bonds directly in the child's name, section 
135(c)(1)(B) provides that the interest exclusion is available 
only with respect to U.S. Series EE savings bonds issued to 
taxpayers who are at least 24 years old.
---------------------------------------------------------------------------
    \9\ If the aggregate redemption amount (i.e., principal plus 
interest) of all Series EE bonds redeemed by the taxpayer during the 
taxable year exceeds the qualified education expenses incurred, then 
the excludable portion of interest income is based on the ratio that 
the education expenses bears to the aggregate redemption amount (sec. 
135(b)).
---------------------------------------------------------------------------
    Section 117 excludes from gross income amounts received as 
a qualified scholarship by an individual who is a candidate for 
a degree and used for tuition and fees required for the 
enrollment or attendance (or for fees, books, supplies, and 
equipment required for courses of instruction) at a primary, 
secondary, or post-secondary educational institution. The tax-
free treatment provided by section 117 does not extend to 
scholarship amounts covering regular living expenses, such as 
room and board. There is, however, no dollar limitation for the 
section 117 exclusion, provided that the scholarship funds are 
used to pay for tuition and required fees. In addition to the 
exclusion for qualified scholarships, section 117 provides an 
exclusion from gross income for qualified tuition reductions 
for education below the graduate level provided to employees of 
certain educational organizations.
    In the case of an individual, section 108(f) provides that 
gross income subject to Federal income tax does not include any 
amount from the forgiveness (in whole or in part) of certain 
student loans, provided that the forgiveness is contingent on 
the student's working for a certain period of time in certain 
professions for any of a broad class of employers (e.g., 
providing health care services to a nonprofit organization). 
Student loans eligible for this special rule must be made to an 
individual to assist the individual in attending an education 
institution that normally maintains a regular faculty and 
curriculum and normally has a regularly enrolled body of 
students in attendance at the place where its education 
activities are regularly carried on. Loan proceeds may be used 
not only for tuition and required fees, but also to cover room 
and board expenses (in contrast to tax-free scholarships under 
section 117, which are limited to tuition and required fees). 
In addition, the loan must be made by (1) the United States (or 
an instrumentality or agency thereof), (2) a State (or any 
political subdivision thereof), (3) certain tax-exempt public 
benefit corporations that control a State, county, or municipal 
hospital and whose employees have been deemed to be public 
employees under State law, or (4) an educational organization 
that originally received the funds from which the loan was made 
from the United States, a State, or a tax-exempt public benefit 
corporation. As with section 117, there is no dollar limitation 
for the section 108(f) exclusion.
    Section 529 (enacted as part of the Small Business Job 
Protection Act of 1996) provides tax-exempt status to 
``qualified State tuition programs,'' meaning certain programs 
established and maintained by a State (or agency or 
instrumentality thereof) under which persons may (1) purchase 
tuition credits or certificates on behalf of a designated 
beneficiary that entitle the beneficiary to a waiver or payment 
of qualified higher education expenses of the beneficiary, or 
(2) make contributions to an account that is established for 
the purpose of meeting qualified higher education expenses of 
the designated beneficiary of the account. ``Qualified higher 
education expenses'' are defined as tuition, fees, books, 
supplies, and equipment required for the enrollment or 
attendance at a college or university (or certain vocational 
schools). Qualified higher education expenses do not include 
room and board expenses. Section 529 also provides that no 
amount shall be included in the gross income of a contributor 
to, or beneficiary of, a qualified State tuition program with 
respect to any distribution from, or earnings under, such 
program, except that (1) amounts distributed or educational 
benefits provided to a beneficiary (e.g., when the beneficiary 
attends college) will be included in the beneficiary's gross 
income (unless excludable under another Code section) to the 
extent such amount or the value of the educational benefits 
exceeds contributions made on behalf of the beneficiary, and 
(2) amounts distributed to a contributor (e.g., when a parent 
receives a refund) will be included in the contributor's gross 
income to the extent such amounts exceeds contributions made by 
that person.

                        Description of Proposal

    Individual taxpayers would be allowed an above-the-line 
deduction for qualified higher education expenses paid during 
the taxable year for the education or training of the taxpayer, 
the taxpayer's spouse, or the taxpayer's dependents at an 
institution of higher education. The deduction would be allowed 
in computing a taxpayer's AGI and could be claimed regardless 
of whether the taxpayer itemizes deductions. In 1997 and 1998, 
the maximum deduction allowed per taxpayer return would be 
$5,000. After 1998, the maximum deduction would increase to 
$10,000. The maximum deduction would not vary with the number 
of students in a taxpayer's family. A taxpayer may claim the 
deduction for a taxable year with respect to one or more 
students, even though the taxpayer also claims a proposed Hope 
Scholarship tuition tax credit (discussed previously) for that 
same year with respect to other students. With respect to each 
student, a taxpayer must choose between claiming the proposed 
credit or the deduction. If, for any taxable year, a taxpayer 
chooses to claim the proposed credit with respect to a 
particular student, then the deduction will not be available 
with respect to that particular student for that year (although 
the deduction may be available with respect to that student for 
other taxable years, such as after the student completes two 
years of college and no longer is eligible for the credit). A 
student would not be eligible to claim a deduction under the 
proposal if that student is claimed as a dependent for tax 
purposes by another taxpayer. If a parent claims a student as a 
dependent, any education expenses paid by the student would be 
treated as paid by the parent for purposes of the proposal. In 
contrast to the proposed Hope Scholarship tuition tax credit, 
there would be no limit on the number of taxable years for 
which the proposed deduction for qualified higher education 
expenses could be claimed with respect to a particular student.
    The maximum deduction would be phased out ratably for 
taxpayers with modified AGI between $50,000 and $70,000 
($80,000 and $100,000 for joint returns). Modified AGI would 
include taxable Social Security benefits and amounts otherwise 
excluded with respect to income earned abroad (or income from 
Puerto Rico or U.S. possessions) and would be determined 
without regard to the deduction allowed by the proposal. 
Beginning in 2001, the income phase-out ranges would be indexed 
for inflation, rounded down to the closest multiple of $5,000.
    The deduction would be available for ``qualified higher 
education expenses,'' meaning tuition and fees required for the 
enrollment or attendance of an eligible student (e.g., 
registration fees, laboratory fees, and extra charges for 
particular courses) at an eligible institution. Charges and 
fees associated with meals, lodging, student activities, 
athletics, insurance, transportation, books, and similar 
personal, living or family expenses would not be deductible. 
The expenses of education involving sports, games, or hobbies 
would not be qualified higher education expenses unless this 
education is part of a degree program (or lead to improvement 
or acquisition of job skills).
    An ``eligible student'' generally would be one who is 
enrolled or accepted for enrollment in a degree, certificate, 
or other program (including a program of study abroad approved 
for credit by the institution at which such student is 
enrolled) leading to a recognized educational credential at an 
institution of higher education. The student must pursue a 
course of study on at least a half-time basis. However, a 
student taking a course to improve or acquire job skills also 
would be an eligible student for purposes of the deduction. In 
contrast to the proposed Hope Scholarship tuition tax credit 
(described previously), there are no requirements for purposes 
of the deduction that the student maintain any grade point 
average or be free of felony drug convictions. An eligible 
student generally could not be a nonresident alien.
    Eligible institutions would be defined by reference to 
section 481 of the Higher Education Act of 1965. Such 
institutions generally would be accredited post-secondary 
educational institutions offering credit toward a bachelor's 
degree, an associate's degree, or another recognized post-
secondary credential. Certain proprietary institutions and 
post-secondary vocational institutions also would be eligible 
institutions. The institution must be eligible to participate 
in Department of Education student aid programs.
    Qualified education expenses generally would include only 
out-of-pocket tuition and fees. Qualified education expenses 
would not include expenses covered by educational assistance 
that is not required to be included in the gross income of 
either the student or the taxpayer claiming the deduction. 
Thus, total tuition and required fees would be reduced (prior 
to the application of the $5,000 or $10,000 deduction 
limitation) by scholarship or fellowship grants excludable from 
gross income under present-law section 117 and any tax-free 
veteran's educational benefits.10 In addition, 
qualified education expenses would be reduced by the interest 
from U.S. savings bonds that is excludable from gross income 
under section 135 for the taxable year. However, no reduction 
of qualified education expenses would be required for a gift, 
bequest, devise, or inheritance within the meaning of section 
102(a). If a student's education expenses for a taxable year 
are deducted under any other section of the Code, then such 
expenses would not be deductible under the proposal.
---------------------------------------------------------------------------
    \10\ For example, if during a taxable year, a taxpayer pays $8,500 
for college tuition, but receives a $4,000 tax-free scholarship to 
cover some of those same tuition expenses, then the taxpayer would be 
deemed to have paid $4,500 of qualified higher education expenses under 
the proposal.
---------------------------------------------------------------------------
    The deduction would be available in the taxable year the 
expenses are paid, subject to the requirement that the 
education commence or continue during that year or during the 
first three months of the next year. Qualified higher education 
expenses paid with the proceeds of a loan generally would be 
eligible for the deductible (rather than repayment of the loan 
itself). Normal tax benefit rules would apply to refunds (and 
reimbursement through insurance) of previously deducted tuition 
and fees, making such refunds includable in income in the year 
received.
    The Secretary of the Treasury would be granted authority to 
issue regulations to implement the proposal, including rules 
requiring record keeping and information reporting.

                             Effective Date

    The proposal would be effective for payments made on or 
after January 1, 1997, for education commencing on or after 
July 1, 1997. The President's budget proposal contains a tax 
cut sunset provision that, if triggered, would sunset the 
education and job training tax deduction for calendar years 
after 2000. See the description of this sunset mechanism in 
Part I., above.

3. Tax incentives for expansion of student loan forgiveness

                               Present Law

    In the case of an individual, gross income subject to 
Federal income tax does not include any amount from the 
forgiveness (in whole or in part) of certain student loans, 
provided that the forgiveness is contingent on the student's 
working for a certain period of time in certain professions for 
any of a broad class of employers (sec. 108(f)).
    Student loans eligible for this special rule must be made 
to an individual to assist the individual in attending an 
educational institution that normally maintains a regular 
faculty and curriculum and normally has a regularly enrolled 
body of students in attendance at the place where its education 
activities are regularly carried on. Loan proceeds may be used 
not only for tuition and required fees, but also to cover room 
and board expenses (in contrast to tax free scholarships under 
section 117, which are limited to tuition and required fees). 
In addition, the loan must be made by (1) the United States (or 
an instrumentality or agency thereof), (2) a State (or any 
political subdivision thereof), (3) certain tax-exempt public 
benefit corporations that control a State, county, or municipal 
hospital and whose employees have been deemed to be public 
employees under State law, or (4) an educational organization 
that originally received the funds from which the loan was made 
from the United States, a State, or a tax-exempt public benefit 
corporation. Thus, loans made with private, nongovernmental 
funds are not qualifying student loans for purposes of the 
section 108(f) exclusion.

                        Description of Proposal

    The proposal would expand section 108(f) so that an 
individual's gross income does not include forgiveness of loans 
made by tax-exempt charitable organizations (e.g., educational 
organizations or private foundations) if the proceeds of such 
loans are used to pay costs of attendance at an educational 
institution or to refinance outstanding student loans and the 
student is not employed by the lender organization. As under 
present law, the section 108(f) exclusion would apply only if 
the forgiveness is contingent on the student's working for a 
certain period of time in certain professions for any of a 
broad class of employers.
    The exclusion would also be expanded to cover forgiveness 
of direct student loans made through the William D. Ford 
Federal Direct Loan Program where loan repayment and 
forgiveness are contingent on the borrower's income level.

                             Effective Date

    The proposal would be effective with respect to amounts 
otherwise includible in income after the date of enactment.

4. Extension of exclusion for employer-provided educational assistance

                               Present Law

    Under present law, an employee's gross income and wages do 
not include amounts paid or incurred by the employer for 
educational assistance provided to the employee if such amounts 
were paid or incurred pursuant to an educational assistance 
program that meets certain requirements. The exclusion is 
limited to $5,250 of educational assistance with respect to an 
individual during a calendar year. The exclusion applies 
whether or not the education is job related. Under present law, 
in the absence of this exclusion, educational assistance is 
excludable from income only if it is related to an employee's 
current job.
    The exclusion for employer-provided educational assistance 
expires with respect to courses beginning after June 30, 
1997.11 The exclusion is not available for graduate 
level courses beginning after June 30, 1996. Graduate courses 
are defined as any graduate level course of a kind normally 
taken by an individual pursuing a program leading to a law, 
business, marketing or other advanced academic or professional 
degree.
---------------------------------------------------------------------------
    \11\ The legislative history of the Small Business Job Protection 
Act of 1996 indicated Congressional intent to extend the exclusion for 
employer-provided educational assistance through May 31, 1997. The 
statute, however, extended the exclusion through June 30, 1997.
---------------------------------------------------------------------------

                        Description of Proposal

    Under the proposal, the exclusion for employer-provided 
educational assistance would be extended through December 31, 
2000, and the provision limiting the exclusion to undergraduate 
courses would be retroactively repealed.

                             Effective Date

    The extension of the exclusion would be effective for 
taxable years beginning after December 31, 1996. The repeal of 
the limitation on the exclusion to undergraduate education 
would be effective for graduate level courses beginning after 
June 30, 1996.

5. Small business tax credit for employer-provided educational 
        assistance

                               Present Law

    Under present law, an employer may deduct certain job-
related training and education expenses, as well as amounts 
paid or incurred for educational assistance provided to 
employees pursuant to an educational assistance program that 
meets certain requirements. Employer payments for job-related 
training and amounts paid under a qualified educational 
assistance program up to $5,250 annually are excluded from the 
gross income and wages of the employee. The exclusion for 
employer-provided educational assistance expires after June 
30,1997.12 Under present law, not more than 5 
percent of the amounts paid or incurred by the employer during 
the year for educational assistance under a qualified 
educational assistance program can be provided for the class of 
individuals consisting of more than 5-percent owners of the 
employer and the spouses or dependents of such more than 5-
percent owners.
---------------------------------------------------------------------------
    \12\ The legislative history of the Small Business Job Protection 
Act of 1996 indicated Congressional intent to extend the exclusion for 
employer-provided educational assistance through May 31, 1997. The 
statute, however, extended the exclusion through June 30, 1997.
---------------------------------------------------------------------------

                        Description of Proposal

    The proposal would provide a temporary 10-percent income 
tax credit for small businesses with respect to expenses 
incurred for education of employees by third parties under a 
qualified employer-provided educational assistance program. The 
credit would be available to employers (including self-employed 
individuals) where the business has average annual gross 
receipts of $10 million or less for the prior three years.

                             Effective Date

    The proposal would be effective for payments made in 
taxable years beginning after December 31, 1997 and before 
January 1, 2001 with respect to expenses incurred during those 
years.

         C. Provisions Relating to Individual Retirement Plans

                               Present Law

In general

    Under certain circumstances, an individual is allowed a 
deduction for contributions to an individual retirement account 
or an individual retirement annuity (an ``IRA''). An individual 
generally is not subject to income tax on amounts held in an 
IRA, including earnings on contributions, until the amounts are 
withdrawn from the IRA. No deduction is permitted with respect 
to contributions made to an IRA for a taxable year after the 
IRA owner attains age 70\1/2\.
    Under present law, the maximum deductible contribution that 
can be made to an IRA generally is the lesser of $2,000 or 100 
percent of an individual's compensation (earned income in the 
case of self-employed individuals). A married taxpayer filing a 
joint return is permitted to make the maximum deductible IRA 
contribution of up to $2,000 for each spouse (including, for 
example, a homemaker who does not work outside the home) if the 
combined compensation of both spouses is at least equal to the 
contributed amount. A single taxpayer is permitted to make the 
maximum deductible IRA contribution for a year if the 
individual is not an active participant in an employer-
sponsored retirement plan for the year or the individual has 
adjusted gross income (``AGI'') of less than $25,000. A married 
taxpayer filing a joint return is permitted to make the maximum 
deductible IRA contribution for a year if neither spouse is an 
active participant in an employer-sponsored plan or the couple 
has combined AGI of less than $40,000.
    If a single taxpayer or either spouse (in the case of a 
married couple) is an active participant in an employer-
sponsored retirement plan, the maximum IRA deduction is phased 
out over certain AGI levels. For single taxpayers, the maximum 
IRA deduction is phased out between $25,000 and $35,000 of AGI. 
For married taxpayers, the maximum deduction is phased out 
between $40,000 and $50,000 of AGI.

Nondeductible IRA contributions

    Individuals may make nondeductible IRA contributions to the 
extent deductible contributions are not allowed because of the 
AGI phaseout and active participant rules. A taxpayer may also 
elect to make nondeductible contributions in lieu of deductible 
contributions. Thus, any individual may make nondeductible 
contributions up to the excess of (1) the lesser of $2,000 or 
100 percent of compensation over (2) the IRA deduction claimed 
by the individual. As is the case with earnings on deductible 
IRA contributions, earnings on nondeductible contributions are 
not subject to income tax until withdrawn.

Taxation of withdrawals

    Amounts withdrawn from IRAs (other than amounts that 
represent a return of nondeductible contributions) are 
includible in income when withdrawn.
    In addition, a 10-percent additional tax applies to 
withdrawals from IRAs made before age 59\1/2\, unless the 
withdrawal is made (1) on account of a death or disability, (2) 
in the form of annuity payments, (3) for medical expenses that 
exceed 7.5 percent of adjusted gross income (``AGI'') or (4) 
for medical insurance (without regard to the 7.5 percent of AGI 
floor) if the individual has received unemployment compensation 
for at least 12 weeks, and the withdrawal is made in the year 
such unemployment compensation is received or the following 
year. If a self-employed individual is not eligible for 
unemployment compensation under applicable law, then, to the 
extent provided in regulations, a self-employed individual is 
treated as having received unemployment compensation for at 
least 12 weeks if the individual would have received 
unemployment compensation but for the fact that the individual 
was self-employed. The exception to the additional tax ceases 
to apply if the individual has been reemployed for at least 60 
days.

Elective deferrals

    Under a qualified cash or deferred arrangement, an 
individual can elect to have compensation paid in cash or 
contributed to a tax-qualified retirement plan. Amounts 
contributed at the election of the employee are referred to as 
elective deferrals. Elective deferrals are not includible in 
income until withdrawn from the plan. Qualified cash or 
deferred arrangements are subject to the same rules applicable 
to qualified plans generally, and are also subject to 
additional requirements. One of these additional requirements 
is that the maximum amount of elective deferrals that can be 
made in a year by an individual is limited to $9,500 in 1997. 
This dollar limit is indexed for inflation in $500 increments. 
A similar limit applies to elective deferrals under similar 
arrangements (e.g., tax-sheltered annuities).

                        Description of Proposal

In general

    In general, the proposal would (1) increase the present-law 
income limits (in two steps) on deductible IRA contributions 
and increase the income phase-out range to $20,000 (so that, 
for married taxpayers in 1997, 1998, and 1999, the income 
phase-out range would be $70,000 to $90,000 of AGI, and $80,000 
to $100,000 thereafter; and for single taxpayers in 1997, 1998, 
and 1999, the income phase-out range would be $45,000 to 
$65,000 of AGI, and $50,000 to $70,000 thereafter); (2) index 
the $2,000 IRA contribution limit and the income limits; (3) 
coordinate the IRA contribution limit with the elective 
deferral limit; (4) create nondeductible tax-free IRAs called 
``Special IRAs;'' and (5) provide an exception from the 10-
percent early withdrawal tax for IRA distributions used for 
higher education expenses, first-time home buyer expenses, 
medical expenses (in excess of 7.5 percent of AGI) of the 
individual's child, grandchild, parent or grandparent, and 
distributions to individuals who have been receiving 
unemployment compensation for at least 12 weeks. The proposal 
would also provide that IRA assets can be invested in qualified 
State tuition program instruments.

Deductible IRA contributions

    The proposal would increase the income limits at which the 
maximum IRA deduction is phased out for active participants in 
employer-sponsored retirement plans in two steps. For married 
taxpayers in 1997, 1998, and 1999, the income phase-out range 
would be $70,000 to $90,000 of AGI, and $80,000 to $100,000 
thereafter. For single taxpayers in 1997, 1998, and 1999, the 
income phase-out range would be $45,000 to $65,000 of AGI, and 
$50,000 to $70,000 thereafter. The income thresholds would be 
indexed for inflation, beginning after 2000.
    The IRA deduction limit would be coordinated with the limit 
on elective deferrals so that the maximum allowable IRA 
deduction for a year could not exceed the excess of the 
elective deferral limit over the amount of elective deferrals 
made by the individual.
    The proposal would provide that the exception to the early 
withdrawal tax for distributions after age 59\1/2\ does not 
apply to amounts that have been held in an IRA for less than 5 
years.

Inflation adjustment for IRA contribution limit

    The $2,000 IRA deduction limit would be indexed for 
inflation for taxable years beginning after 1997.

Nondeductible tax-free IRAs

    Under the proposal, individuals who are eligible to make 
deductible IRA contributions also would be eligible to make 
nondeductible contributions to a Special IRA. Special IRAs 
generally would be treated the same as IRAs, but also would be 
subject to special rules. The IRA deduction limit and the limit 
on contributions to Special IRAs would be coordinated. Thus, 
the maximum contribution that could be made in a year to a 
Special IRA would be the excess of the IRA deduction limit 
applicable to the individual over the amount of the 
individual's deductible IRA contributions. Distributions from 
Special IRAs would not be includible in income to the extent 
attributable to contributions that had been in the Special IRA 
for at least five years. Withdrawals of earnings from Special 
IRAs during the 5-year period after contribution would be 
subject to income tax, and also would be subject to the 10-
percent tax on early withdrawals unless used for one of the 
special purposes described below (or unless a present-law 
exception to the tax, other than the exception for 
distributions after age 59\1/2\, applies).
    An individual whose AGI for a year does not exceed $100,000 
for married taxpayers and $70,000 for single taxpayers could 
convert an existing IRA into a Special IRA without being 
subject to the 10-percent tax on early withdrawals. The amount 
transferred from the deductible IRA to the Special IRA 
generally would be includible in the individual's income in the 
year of the transfer.13 However, if a transfer is 
made before 1999, the amount to be included in the individual's 
income with respect to the transfer would be spread evenly over 
four taxable years.14
---------------------------------------------------------------------------
    \13\ The amount transferred would not be included in the taxpayer's 
AGI for purposes of applying the income limits on IRA contributions to 
the taxpayer for the year of transfer.
    \14\ In the case of such a transfer before 1999, the amount of such 
transfer would also be taken into account for purposes of the 15-
percent excise tax on excess distributions ratably over a four-year 
period.
---------------------------------------------------------------------------

Special purpose withdrawals

    The proposal would provide exceptions to the 10-percent 
early withdrawal tax for distributions from IRAs or Special 
IRAs used for certain special purposes. Penalty-free 
withdrawals would be withdrawals (1) for qualified higher 
education expenses of the taxpayer, the taxpayer's spouse, or 
the taxpayer's child or grandchild (whether or not a 
dependent), (2) for acquisition of a principal residence for a 
first-time home buyer who is the taxpayer, the taxpayer's 
spouse, or the taxpayer's child or grandchild, (3) for medical 
expenses (in excess of 7.5 percent of AGI) of the individual's 
child, grandchild, parent or grandparent, whether or not that 
person otherwise qualifies as the individual's dependent, and 
(4) made by individuals who have been receiving unemployment 
compensation for at least 12 consecutive weeks.

Investment in qualified State prepaid tuition program instruments

    The proposal would provide that any IRA assets can be 
invested in qualified State tuition program instruments. To the 
extent the instrument is converted into tuition and fees, the 
account holder would be treated as receiving a distribution 
equal to the cost of such tuition and fees as of the time of 
the conversion. Further, such a deemed distribution would be 
treated as a special purpose withdrawal for qualified higher 
education expenses, and thus would not be subject to the 10-
percent additional tax on early withdrawals. The tax treatment 
of the deemed distribution would depend on whether the 
instrument is held by an IRA or a Special IRA.

                             Effective Date

    The proposal would generally be effective on January 1, 
1997. The President's budget proposal contains a tax cut sunset 
provision that, if triggered, would sunset some of the expanded 
IRA provisions for calendar years after 2000. See the 
description of this sunset mechanism in Part I., above. A 
document provided by the Treasury Department indicates that the 
sunset would apply to (1) the increased income limits, (2) the 
increased IRA deduction limit, (3) contributions to Special 
IRAs, and (4) rollovers from deductible IRAs to Special IRAs.

      D. Exclusion of Capital Gains on Sale of Principal Residence

                               Present Law

Rollover of gain

    No gain is recognized on the sale of a principal residence 
if a new residence at least equal in cost to the sales price of 
the old residence is purchased and used by the taxpayer as his 
or her principal residence within a specified period of time 
(sec. 1034). This replacement period generally begins two years 
before and ends two years after the date of sale of the old 
residence. The basis of the replacement residence is reduced by 
the amount of any gain not recognized on the sale of the old 
residence by reason of this gain rollover rule.

One-time exclusion

    In general, an individual, on a one-time basis, may exclude 
from gross income up to $125,000 of gain from the sale or 
exchange of a principal residence if the taxpayer (1) has 
attained age 55 before the sale, and (2) has owned the property 
and used it as a principal residence for three or more of the 
five years preceding the sale (sec. 121).

                        Description of Proposal

    A taxpayer generally would be able to exclude up to 
$250,000 ($500,000 if married filing a joint return) of capital 
gain realized on the sale or exchange of a principal residence. 
The exclusion would be allowed each time a taxpayer selling or 
exchanging a principal residence meets the eligibility 
requirements, but generally no more frequently than once every 
two years. The proposal provides that gain would be recognized 
to the extent of any depreciation allowable with respect to the 
rental or business use of such principal residence for periods 
after December 31, 1996.
    To be eligible for the exclusion, a taxpayer must have 
owned a residence and occupied it as a principal residence for 
at least two of the five years prior to the sale or exchange of 
the residence. A taxpayer who is forced to sell without meeting 
these requirements (e.g., because of a change of place of 
employment or medical reasons) would be able to exclude the 
fraction of the $250,000 ($500,000 if married filing a joint 
return) equal to the fraction of two years that these 
requirements are met.
    In the case of joint filers not sharing a principal 
residence, an exclusion of $250,000 would be available on a 
qualifying sale or exchange of the principal residence of one 
of the spouses. Similarly, if a single taxpayer who is 
otherwise eligible for an exclusion marries someone who has 
used the exclusion within the two years prior to the marriage, 
the proposal would allow the newly married taxpayer a maximum 
exclusion of $250,000. Once both spouses satisfy the 
eligibility rules and two years have passed since the last 
exclusion was allowed to either of them, the taxpayers may 
exclude $500,000 of gain on their joint return.

                             Effective Date

    The proposal would be available for all sales or exchanges 
of a principal residence occurring on or after January 1, 1997, 
and would replace the present-law rollover and one-time 
exclusion provisions applicable to principal residences. In the 
case of sales or exchanges occurring between January 1, 1997 
and the date of enactment, taxpayers could elect whether to 
apply the new exclusion or prior law. For a taxpayer who 
acquired his or her current principal residence in a rollover 
transaction within the five years prior to the date of 
enactment, the residency requirement of the proposal would be 
applied by taking into account the period of the taxpayer's 
residence in the previous principal residence.
                   III. DISTRESSED AREAS INITIATIVES

         A. Expand Empowerment Zones and Enterprise Communities

                               Present Law

In general

    Pursuant to the Omnibus Budget Reconciliation Act of 1993 
(OBRA 1993), the Secretaries of the Department of Housing and 
Urban Development (HUD) and the Department of Agriculture 
designated a total of nine empowerment zones and 95 enterprise 
communities on December 21, 1994. As required by law, six 
empowerment zones are located in urban areas (with aggregate 
population for the six designated urban empowerment zones 
limited to 750,000) and three empowerment zones are located in 
rural areas.15 Of the enterprise communities, 65 are 
located in urban areas and 30 are located in rural areas (sec. 
1391). Designated empowerment zones and enterprise communities 
were required to satisfy certain eligibility criteria, 
including specified poverty rates and population and geographic 
size limitations (sec. 1392).
---------------------------------------------------------------------------
    \15\ The six designated urban empowerment zones are located in New 
York City, Chicago, Atlanta, Detroit, Baltimore, and Philadelphia-
Camden (New Jersey). The three designated rural empowerment zones are 
located in Kentucky Highlands (Clinton, Jackson, and Wayne counties, 
Kentucky), Mid-Delta Mississippi (Bolivar, Holmes, Humphreys, Leflore 
counties, Mississippi), and Rio Grande Valley Texas (Cameron, Hidalgo, 
Starr, and Willacy counties, Texas).
---------------------------------------------------------------------------
    The following tax incentives are available for certain 
businesses located in empowerment zones: (1) a 20-percent wage 
credit for the first $15,000 of wages paid to a zone resident 
who works in the zone; (2) an additional $20,000 of section 179 
expensing for ``qualified zone property'' placed in service by 
an ``enterprise zone business'' (accordingly, certain 
businesses operating in empowerment zones are allowed up to 
$38,000 of expensing for 1997); and (3) special tax-exempt 
financing for certain zone facilities (described in more detail 
below).
    The 95 enterprise communities are eligible for the special 
tax-exempt financing benefits but not the other tax incentives 
available in the nine empowerment zones. In addition to these 
tax incentives, OBRA 1993 provided that Federal grants would be 
made to designated empowerment zones and enterprise 
communities.
    The tax incentives for empowerment zones and enterprise 
communities generally will be available during the period that 
the designation remains in effect, i.e., a 10-year period.

Definition of ``qualified zone property''

    Present-law section 1397C defines ``qualified zone 
property'' as depreciable tangible property (including 
buildings), provided that: (1) the property is acquired by the 
taxpayer (from an unrelated party) after the zone or community 
designation took effect; (2) the original use of the property 
in the zone or community commences with the taxpayer; and (3) 
substantially all of the use of the property is in the zone or 
community in the active conduct of a trade or business by the 
taxpayer in the zone or community. In the case of property 
which is substantially renovated by the taxpayer, however, the 
property need not be acquired by the taxpayer after zone or 
community designation or originally used by the taxpayer within 
the zone or community if, during any 24-month period after zone 
or community designation, the additions to the taxpayer's basis 
in the property exceed 100 percent of the taxpayer's basis in 
the property at the beginning of the period, or $5,000 
(whichever is greater).

Definition of ``enterprise zone business''

    Present-law section 1397B defines the term ``enterprise 
zone business'' as a corporation or partnership (or 
proprietorship) if for the taxable year: (1) the sole trade or 
business of the corporation or partnership is the active 
conduct of a qualified business within an empowerment zone or 
enterprise community; (2) at least 80 percent of the total 
gross income is derived from the active conduct of a 
``qualified business'' within a zone or community; (3) 
substantially all of the business's tangible property is used 
within a zone or community; (4) substantially all of the 
business's intangible property is used in, and exclusively 
related to, the active conduct of such business; (5) 
substantially all of the services performed by employees are 
performed within a zone or community; (6) at least 35 percent 
of the employees are residents of the zone or community; and 
(7) no more than 5 percent of the average of the aggregate 
unadjusted bases of the property owned by the business is 
attributable to (a) certain financial property, or (b) 
collectibles not held primarily for sale to customers in the 
ordinary course of an active trade or business.
    A ``qualified business'' is defined as any trade or 
business other than a trade or business that consists 
predominantly of the development or holding of intangibles for 
sale or license.16In addition, the leasing of real 
property that is located within the empowerment zone or 
community to others is treated as a qualified business only if 
(1) the leased property is not residential property, and (2) at 
least 50 percent of the gross rental income from the real 
property is from enterprise zone businesses. The rental of 
tangible personal property to others is not a qualified 
business unless substantially all of the rental of such 
property is by enterprise zone businesses or by residents of an 
empowerment zone or enterprise community.
---------------------------------------------------------------------------
    \16\ Also, a qualified business does not include certain facilities 
described in section 144(c)(6)(B)(e.g., massage parlor, hot tub 
facility, or liquor store) or certain large farms.
---------------------------------------------------------------------------

Tax-exempt financing rules

    Tax-exempt private activity bonds may be issued to finance 
certain facilities in empowerment zones and enterprise 
communities. These bonds, along with most private activity 
bonds, are subject to an annual private activity bond State 
volume cap equal to $50 per resident of each State, or (if 
greater) $150 million per State.
    Qualified enterprise zone facility bonds are bonds 95 
percent or more of the net proceeds of which are used to 
finance (1) ``qualified zone property'' (as defined above) the 
principal user of which is an ``enterprise zone business'' 
(also defined above 17), or (2) functionally related 
and subordinate land located in the empowerment zone or 
enterprise community. These bonds may only be issued while an 
empowerment zone or enterprise community designation is in 
effect.
---------------------------------------------------------------------------
    \17\ For purposes of the tax-exempt financing rules, an 
``enterprise zone business'' also includes a business located in a zone 
or community which would qualify as an enterprise zone business if it 
were separately incorporated.
---------------------------------------------------------------------------
    The aggregate face amount of all qualified enterprise zone 
bonds for each qualified enterprise zone business may not 
exceed $3 million per zone or community. In addition, total 
qualified enterprise zone bond financing for each principal 
user of these bonds may not exceed $20 million for all zones 
and communities.

                        Description of Proposal

To amend the Internal Revenue Code of 1986 Two additional empowerment 
        zones with same tax incentives as previously designated 
        empowerment zones

    The Secretary of HUD would be authorized to designate two 
additional empowerment zones located in urban areas (thereby 
increasing to eight the total number of empowerment zones 
located in urban areas) with respect to which would apply the 
same tax incentives (i.e., the wage credit, additional 
expensing, and special tax-exempt financing) as are available 
within the empowerment zones authorized by OBRA 1993. The two 
additional empowerment zones would be subject to the same 
eligibility criteria under present-law section 1392 that 
applied to the original six urban empowerment zones. In order 
to permit designation of these two additional empowerment 
zones, the proposal would increase the present-law 750,000 
aggregate population cap applicable to empowerment zones 
located in urban areas to a cap of one million aggregate 
population for the eight urban empowerment zones. No additional 
Federal grants would be authorized.
    The two empowerment zones would be required to be 
designated within 180 days after enactment, and the 
designations generally would remain in effect for 10 years.

Designation of additional empowerment zones and enterprise communities

    In addition, the proposal would authorize the Secretaries 
of HUD and Agriculture to designate an additional 20 
empowerment zones (no more than 15 in urban areas and no more 
than five in rural areas) and an additional 80 enterprise 
communities (no more than 50 in urban areas and no more than 30 
in rural areas).18 With respect to these additional 
empowerment zones and enterprise communities, the present-law 
eligibility criteria would be expanded slightly. First, the 
square mileage limitations of present law (i.e., 20 square 
miles for urban areas and 1,000 for rural areas) would be 
expanded to allow the empowerment zones to include an 
additional 2,000 acres and enterprise communities to include an 
additional 1,000 acres. This additional acreage, which could be 
developed for commercial or industrial purposes, would not be 
subject to the poverty rate criteria and could be divided among 
up to three noncontiguous parcels. In addition, the present-law 
requirement that at least half of the nominated area consist of 
census tracts with poverty rates of 35 percent or more would 
not be applicable. Thus, under present-law section 1392(a)(4), 
at least 90 percent of the census tracts within a nominated 
area must have a poverty rate of 25 percent or more, and the 
remaining census tracts must have a poverty rate of 20 percent 
or more.19 For this purpose, census tracts with 
populations under 2,000 would be treated as satisfying the 25-
percent poverty rate criteria if (1) at least 75 percent of the 
tract was zoned for commercial or industrial use and (2) the 
tract was contiguous to one or more other tracts that actually 
have a poverty rate of 25 percent or more.
---------------------------------------------------------------------------
    \18\ Under the proposal, areas located within Indian reservations 
would be eligible for designation as empowerment zones or enterprise 
communities.
    \19\ In lieu of the poverty criteria, outmigration may be taken 
into account in designating one rural empowerment zone and up to five 
rural enterprise communities.
---------------------------------------------------------------------------
    Within the 20 additional empowerment zones, qualified 
``enterprise zone businesses'' would be eligible to receive up 
to $20,000 of additional section 179 expensing 20 
and to utilize special tax-exempt financing benefits. The 
Administration's proposed ``brownfields'' tax incentive 
(described elsewhere) also would be available within all 
designated empowerment zones. Businesses within the 20 
additional empowerment zones would not, however, be eligible to 
receive the present-law wage credit available within the 11 
other designated empowerment zones (i.e., the wage credit would 
be available only in the nine present-law zones and two urban 
zones designated under the first part of the proposal).
---------------------------------------------------------------------------
    \20\ However, the additional section 179 expensing would not be 
available within the additional 2,000 acres allowed to be included 
under the proposal within an empowerment zone.
---------------------------------------------------------------------------
    Within the 80 additional enterprise communities, qualified 
``enterprise zone businesses'' would (as within the present-law 
enterprise communities) be eligible to utilize special tax-
exempt financing benefits, as well as the ``brownfields'' tax 
incentives that applies to all designated zones and 
communities.
    The 20 additional empowerment zones and 80 additional 
enterprise communities would be required to be designated 
before 1999, and the designations generally would remain in 
effect for 10 years.

Modification of definition of enterprise zone business

    The proposal would modify the present-law requirement of 
section 1397B that an entity may qualify as an ``enterprise 
zone business'' only if (in addition to the other present-law 
criteria) at least 80 percent of the total gross income of such 
entity is derived from the active conduct of a qualified 
business within an empowerment zone or enterprise community. 
The proposal would liberalize this present-law requirement by 
reducing the percentage threshold so that an entity could 
qualify as an enterprise zone business if at least 50 percent 
of the total gross income of such entity is derived from the 
active conduct of a qualified business within an empowerment 
zone or enterprise community (assuming that the other criteria 
of section 1397B are satisfied).
    In addition, section 1397B would be modified so that rather 
than requiring that ``substantially all'' tangible and 
intangible property (and employee services) of an enterprise 
zone business be used (and performed) within a designated zone 
or community, a ``substantial portion'' of tangible and 
intangible property (and employee services) of an enterprise 
zone business would be required to be used (and performed)) 
within a designated zone or community. Moreover, the proposal 
would further amend the section 1397B rule governing intangible 
assets so that a substantial portion of an entity's intangible 
property must be used in the active conduct of a qualified 
business within a zone or community, but there will be no need 
(as under present law) to determine whether the use of such 
assets is ``exclusively related to'' such business. However, 
the present-law rule of section 1397B(d)(4) would continue to 
apply, such that a ``qualified business'' would not include any 
trade or business consisting predominantly of the development 
or holding or intangibles for sale or license. The proposal 
also would clarify that an enterprise zone business that leases 
to others commercial property within a zone or community may 
rely on a lessee's certification that the lessee is an 
enterprise zone business. Finally, the proposal would provide 
that the rental to others of tangible personal property shall 
be treated as a qualified business if and only if at least 50 
percent of the rental of such property is by enterprise zone 
businesses or by residents of a zone or community (rather than 
the present-law requirement that ``substantially all'' tangible 
personal property rentals of an enterprise zone business 
satisfy this test).
    This modified ``enterprise zone business'' definition would 
apply to all previously designated and newly designated 
empowerment zones and enterprise communities.

Tax-exempt financing rules

    Exceptions to volume cap

    The proposal would allow ``new empowerment zone facility 
bonds'' to be issued for qualified enterprise zone businesses 
in the 20 additional empowerment zones authorized to be 
designated under the proposal. These bonds would not be subject 
to the State private activity bond volume caps or the special 
limits on issue size applicable to qualified enterprise zone 
facility bonds under present law. The maximum amount of these 
bonds that could be issued would be limited to $60 million per 
rural zone, $130 million per urban zone with a population of 
less than 100,000, and $230 million per urban zone with a 
population of 100,000 or more.

    Changes to certain rules applicable to both empowerment zone 
        facility bonds and qualified enterprise community facility 
        bonds

    Qualified enterprise zone businesses located in newly 
designated empowerment zones and enterprise communities, as 
well as those located in previously designated empowerment 
zones and enterprise communities, would be eligible for special 
tax-exempt bond financing under present-law rules, subject to 
the modifications described below (and the exception to the 
volume cap described above for newly designated empowerment 
zones).
    The proposal would waive until the end of a ``startup 
period'' the requirement that 95 percent or more of the 
proceeds of bond issue be used by a qualified enterprise zone 
business. With respect to each property the startup period 
would end at the beginning of the first taxable year beginning 
more than two years after the later of (1) the date of the bond 
issue financing such property, or (2) the date the property was 
placed in service (but in no event more than three years after 
the date of bond issuance). This waiver would only be available 
if at the beginning of the startup period there is a reasonable 
expectation that the use by a qualified enterprise zone 
business would be satisfied at the end of the startup period 
and the business makes bona fide efforts to satisfy the 
enterprise zone business definition.
    The proposal also would waive the requirements of an 
enterprise zone business (other than the requirement that at 
least 35 percent of the business' employees be residents of the 
zone or community) for all years after a prescribed testing 
period equal to first three taxable years after the startup 
period.
    Finally, the proposal would relax the rehabilitation 
requirement for financing existing property with qualified 
enterprise zone facility bonds. In the case of property which 
is substantially renovated by the taxpayer, the property would 
not need to be acquired by the taxpayer after zone or community 
designation or originally used by the taxpayer within the zone 
if, during any 24-month period after zone or community 
designation, the additions to the taxpayer's basis in the 
property exceeded 15 percent of the taxpayer's basis at the 
beginning of the period, or $5,000 (whichever is greater).

                             Effective Date

    The proposed two additional urban empowerment zones (within 
which would be available the same tax incentives as are 
available in the empowerment zones designated pursuant to OBRA 
1993) would be designated within 180 days after enactment. The 
proposed 20 additional empowerment zones (within which the wage 
credit would not be available) and the 80 additional enterprise 
communities would be designated after enactment but prior to 
January 1, 1999. For purposes of the additional section 179 
expensing available within empowerment zones, the modifications 
to the definition of ``enterprise zone business'' would be 
effective for taxable years beginning on or after the date of 
enactment.
    The proposed changes to the tax-exempt financing rules 
would be effective for qualified enterprise zone facility bonds 
and the new empowerment zone facility bonds issued after the 
date of enactment. The President's budget proposal contains a 
tax cut sunset provision that, if triggered, would sunset the 
expanded empowerment zones and enterprise communities for 
calendar years after 2000. See the description of this sunset 
mechanism in Part I., above.

   B. Expensing of Environmental Remediation Costs (``Brownfields'')

                               Present Law

    Code section 162 allows a deduction for ordinary and 
necessary expenses paid or incurred in carrying on any trade or 
business. Treasury Regulations provide that the cost of 
incidental repairs which neither materially add to the value of 
property nor appreciably prolong its life, but keep it in an 
ordinarily efficient operating condition, may be deducted 
currently as a business expense. Section 263(a)(1) limits the 
scope of section 162 by prohibiting a current deduction for 
certain capital expenditures. Treasury Regulations define 
``capital expenditures'' as amounts paid or incurred to 
materially add to the value, or substantially prolong the 
useful life, of property owned by the taxpayer, or to adapt 
property to a new or different use. Amounts paid for repairs 
and maintenance do not constitute capital expenditures. The 
determination of whether an expense is deductible or 
capitalizable is based on the facts and circumstances of each 
case.
    Treasury regulations provide that capital expenditures 
include the costs of acquiring or substantially improving 
buildings, machinery, equipment, furniture, fixtures and 
similar property having a useful life substantially beyond the 
current year. In INDOPCO, Inc. v. Commissioner, 112 S. Ct. 1039 
(1992), the Supreme Court required the capitalization of legal 
fees incurred by a taxpayer in connection with a friendly 
takeover by one of its customers on the grounds that the merger 
would produce significant economic benefits to the taxpayer 
extending beyond the current year; capitalization of the costs 
thus would match the expenditures with the income produced. 
Similarly, the amount paid for the construction of a filtration 
plant, with a life extending beyond the year of completion, and 
as a permanent addition to the taxpayer's mill property, was a 
capital expenditure rather than an ordinary and necessary 
current business expense. Woolrich Woolen Mills v. United 
States, 289 F.2d 444 (3d Cir. 1961) .
    Although Treasury regulations provide that expenditures 
that materially increase the value of property must be 
capitalized, they do not set forth a method of determining how 
and when value has been increased. In Plainfield-Union Water 
Co. v. Commissioner, 39 T.C. 333 (1962), nonacq., 1964-2 C.B. 
8, the U.S. Tax Court held that increased value was determined 
by comparing the value of an asset after the expenditure with 
its value before the condition necessitating the expenditure. 
The Tax Court stated that ``an expenditure which returns 
property to the State it was in before the situation prompting 
the expenditure arose, and which does not make the relevant 
property more valuable, more useful, or longer-lived, is 
usually deemed a deductible repair.''
    In several Technical Advice Memoranda (TAM), the Internal 
Revenue Service (IRS) declined to apply the Plainfield Union 
valuation analysis, indicating that the analysis represents 
just one of several alternative methods of determining 
increases in the value of an asset. In TAM 9240004 (June 29, 
1992), the IRS required certain asbestos removal costs to be 
capitalized rather than expensed. In that instance, the 
taxpayer owned equipment that was manufactured with insulation 
containing asbestos; the taxpayer replaced the asbestos 
insulation with less thermally efficient, non-asbestos 
insulation. The IRS concluded that the expenditures resulted in 
a material increase in the value of the equipment because the 
asbestos removal eliminated human health risks, reduced the 
risk of liability to employees resulting from the 
contamination, and made the property more marketable. 
Similarly, in TAM 9411002 (November 19, 1993), the IRS required 
the capitalization of expenditures to remove and replace 
asbestos in connection with the conversion of a boiler room to 
garage and office space. However, the IRS permitted deduction 
of costs of encapsulating exposed asbestos in an adjacent 
warehouse.
    In 1994, the IRS issued Rev. Rul. 94-38, 1994-1 C.B. 35, 
holding that soil remediation expenditures and ongoing water 
treatment expenditures incurred to clean up land and water that 
a taxpayer contaminated with hazardous waste are deductible. In 
this ruling, the IRS explicitly accepted the Plainfield Union 
valuation analysis.21 However, the IRS also held 
that costs allocable to constructing a groundwater treatment 
facility are capital expenditures.
---------------------------------------------------------------------------
    \21\ Rev. Rul. 94-38 generally rendered moot the holding in TAM 
9315004 (December 17, 1992) requiring a taxpayer to capitalize certain 
costs associated with the remediation of soil contaminated with 
polychlorinated biphenyls (PCBs).
---------------------------------------------------------------------------
    In 1995, the IRS issued TAM 9541005 (October 13, 1995) 
requiring a taxpayer to capitalize certain environmental study 
costs, as well as associated consulting and legal fees. The 
taxpayer acquired the land and conducted activities causing 
hazardous waste contamination. After the contamination, but 
before it was discovered, the company donated the land to the 
county to be developed into a recreational park. After the 
county discovered the contamination, it reconveyed the land to 
the company for $1. The company incurred the costs in 
developing a remediation strategy. The IRS held that the costs 
were not deductible under section 162 because the company 
acquired the land in a contaminated state when it purchased the 
land from the county. In January, 1996, the IRS revoked and 
superseded TAM 9541005 (PLR 9627002). Noting that the company's 
contamination of the land and liability for remediation were 
unchanged during the break in ownership by the county, the IRS 
concluded that the break in ownership should not, in and of 
itself, operate to disallow a deduction under section 162.

                        Description of Proposal

    The proposal would provide that taxpayers could elect to 
treat certain environmental remediation expenditures that would 
otherwise be chargeable to capital account as deductible in the 
year paid or incurred. The deduction would apply for both 
regular and alternative minimum tax purposes. The expenditure 
must be incurred in connection with the abatement or control of 
hazardous substances at a qualified contaminated site. In 
general, any expenditure for the acquisition of depreciable 
property used in connection with the abatement or control of 
hazardous substances at a qualified contaminated site would not 
constitute a qualified environmental remediation expenditure. 
However, depreciation deductions allowable for such property 
which would otherwise be allocated to the site under the 
principles set forth in Comm'r v. Idaho Power Co.22 
and section 263A would be treated as qualified environmental 
remediation expenditures.
---------------------------------------------------------------------------
    \22\ Comm'r v. Idaho Power Co., 418 U.S. 1 (1974) (holding that 
equipment depreciation allocable to the taxpayer's construction of 
capital facilities must be capitalized under section 263(a)(1)).
---------------------------------------------------------------------------
    A ``qualified contaminated site'' generally would be any 
property that (1) is held for use in a trade or business, for 
the production of income, or as inventory; (2) is certified by 
the appropriate State environmental agency to be located within 
a targeted area; and (3) contains (or potentially contains) a 
hazardous substance (so-called ``brownfields''). Targeted areas 
generally would include (1) empowerment zones and enterprise 
communities (as designated under present law and to be 
designated under the proposal); (2) sites announced before 
February, 1997, as being subject to one of the 76 Environmental 
Protection Agency (EPA) Brownfields Pilots; (3) any population 
census tract with a poverty rate of 20 percent or more; and (4) 
certain industrial and commercial areas that are adjacent to 
tracts described in (3) above.
    Both urban and rural sites would qualify. However, sites 
that are identified on the national priorities list under the 
Comprehensive Environmental Response, Compensation, and 
Liability Act of 1980 (CERCLA) could not be targeted areas. 
Appropriate State environmental agencies would be designated by 
the EPA; if no State agency is designated, the EPA would be 
responsible for providing the certification. Hazardous 
substances generally would be defined by reference to sections 
101(14) and 102 of CERCLA, subject to additional limitations 
applicable to asbestos and similar substances within buildings, 
certain naturally occurring substances such as radon, and 
certain other substances released into drinking water supplies 
due to deterioration through ordinary use.
    The proposal further would provide that, in the case of 
property to which a qualified environmental remediation 
expenditure otherwise would have be capitalized, any deduction 
allowed under the proposal would be treated as a depreciation 
deduction and the property would be treated as subject to 
section 1245. Thus, deductions for qualified environmental 
remediation expenditures would be subject to recapture as 
ordinary income upon sale or other disposition of the property.

                             Effective Date

    The proposal would apply to eligible expenditures incurred 
after the date of enactment. The President's budget proposal 
contains a tax cut sunset provision that, if triggered, would 
sunset the expensing of environmental remediation costs for 
calendar years after 2000. See the description of this sunset 
mechanism in Part I., above.

C. Tax Credit for Equity Investments in Community Development Financial 
                              Institutions

                               Present Law

    The Community Development Financial Institutions Fund (the 
``CDFI Fund'') was created by the Community Development Banking 
and Financial Institutions Act of 1994. Administered by the 
Department of the Treasury, the CDFI Fund provides equity 
investments, grants, loans, and technical assistance to 
qualifying community development financial institutions 
(``CDFIs''). Qualifying CDFIs are organizations that have 
community development as their primary mission and that develop 
a range of programs and methods to accomplish that mission. 
CDFIs and their investors are not eligible for any special tax 
incentives under present law.

                        Description of Proposal

    The proposal would provide $100 million in nonrefundable 
general business tax credits for qualifying equity investments 
in CDFIs between 1997 and 2006. The credits would be allocated 
among equity investors by the CDFI Fund through a competitive 
bidding process. The maximum credit allocable to a particular 
investment would be 25 percent of the amount invested, although 
the CDFI Fund could negotiate a lower percentage.
    The credit would be available in the taxable year in which 
the qualifying investment is made. Unused credits could be 
carried forward for 15 years and back three years, but no 
credit could be carried back to taxable years beginning prior 
to the date of enactment. The credit could be used to offset up 
to 25 percent of a taxpayer's alternative minimum tax 
liability. An investor's basis in its equity interest would be 
reduced by the amount of credit claimed. The credit would be 
subject to recapture in the event of a sale or other 
disposition of the equity interest within five years after the 
date of acquisition.

                             Effective Date

    The credit would be available for qualifying investments 
made in taxable years beginning after December 31, 1996.
                     IV. WELFARE-TO-WORK TAX CREDIT

                               Present Law

    The work opportunity tax credit is available on an elective 
basis for employers hiring individuals from one or more of 
seven targeted groups. The credit generally is equal to 35 
percent of qualified wages. Qualified wages consist of wages 
attributable to service rendered by a member of a targeted 
group during the one-year period beginning with the day the 
individual begins work for the employer. For a vocational 
rehabilitation referral, however, the period will begin on the 
day the individual begins work for the employer on or after the 
beginning of the individual's vocational rehabilitation plan as 
under prior law.
    For purposes of the work opportunity tax credit, the 
targeted groups for which the credit is available include (1) 
families receiving Aid to Families with Dependent Children 
(AFDC), (2) qualified ex-felons, (3) high-risk youth, (4) 
vocational rehabilitation referrals, (5) qualified summer youth 
employees, (6) qualified veterans, and (7) families receiving 
food stamps.
    Generally, no more than $6,000 of wages during the first 
year of employment is permitted to be taken into account with 
respect to any individual. Thus, the maximum credit per 
individual is $2,100. With respect to qualified summer youth 
employees, the maximum credit is 35 percent of up to $3,000 of 
qualified first-year wages, for a maximum credit of $1,050.
    The deduction for wages is reduced by the amount of the 
credit.
    The work opportunity tax credit is effective for wages paid 
or incurred to a qualified individual who begins work for an 
employer after September 30, 1996, and before October 1, 
1997.23
---------------------------------------------------------------------------
    \23\ See the proposal described below to extend and expand the work 
opportunity tax credit.
---------------------------------------------------------------------------

                        Description of Proposal

    The proposal provides to employers a 50-percent credit on 
the first $10,000 of eligible wages paid to qualified long-term 
family assistance (AFDC or its successor program) recipients 
for both the first and second years of employment. The maximum 
credit each year would be $5,000 per qualified employee.
    Qualified long-term family assistance recipients would 
include: (1) members of a family that has received family 
assistance for at least 18 consecutive months ending on the 
hiring date; (2) members of a family that has received family 
assistance for a total of at least 18 months (whether or not 
consecutive) after the date of enactment of this credit if they 
are hired within 2 years after the date that the 18-month total 
is reached; and (3) members of a family who are no longer 
eligible for family assistance because of either Federal or 
State time limits, if they are hired within 2 years after the 
Federal or State time limits made the family ineligible for 
family assistance.
    Eligible wages would include amounts paid by the employer 
for the following: (1) educational assistance excludable under 
a section 127 program (or that would be excludable but for the 
expiration of section 127); (2) health plan coverage for the 
employee, but not more than the applicable premium defined 
under section 4980B(f)(4); and (3) dependent care assistance 
excludable under section 129.

                             Effective Date

    The proposal would be effective for wages paid or incurred 
to a qualified individual who begins work for an employer on or 
after the date of enactment and before October 1, 2000.
   V. EXPANSION OF ESTATE TAX EXTENSION PROVISIONS FOR CLOSELY HELD 
                               BUSINESSES

                               Present Law

    In general, the estate tax is due within nine months of a 
decedent's death. Under Code section 6166, an executor 
generally may elect to pay the Federal estate tax attributable 
to an interest in a closely held business in installments over, 
at most, a 14-year period. If the election is made, the estate 
pays only interest for the first four years, followed by up to 
10 annual installments of principal and interest. Interest is 
generally imposed at the rate applicable to underpayments of 
tax under section 6621 (i.e., the Federal short-term rate plus 
3 percentage points). Under section 6601(j), however, a special 
4-percent interest rate applies to the amount of deferred 
estate tax attributable to the first $1,000,000 in value of the 
closely-held business. All interest paid on the deferred estate 
tax is allowed as a deduction against either the estate tax or 
the estate's income tax obligation. If the deduction is taken 
against the estate tax, supplemental returns must be filed each 
year to recompute the value of the taxable estate.
    To qualify for the installment payment election, the 
business must be an active trade or business and the value of 
the decedent's interest in the closely held business must 
exceed 35 percent of the decedent's adjusted gross estate. An 
interest in a closely held business includes: (1) any interest 
as a proprietor in a business carried on as a proprietorship; 
(2) any interest in a partnership carrying on a trade or 
business if the partnership has 15 or fewer partners, or if at 
least 20 percent of the partnership's assets are included in 
determining the decedent's gross estate; or (3) stock in a 
corporation if the corporation has 15 or fewer shareholders, or 
if at least 20 percent of the value of the voting stock is 
included in determining the decedent's gross estate. In 
general, the installment payment election is available only if 
the estate directly owns an interest in a closely held active 
trade or business. Under a special rule, however, an executor 
may elect to look through certain non-publicly traded holding 
companies that own stock in a closely held active trade or 
business, but if the election is made, neither the five-year 
deferral (i.e., the provision that requires no principal 
payments until the fifth year) nor the special 4-percent rate 
applies.
    If the installment payment election is made, a special 
estate tax lien applies to any property on which tax is 
deferred for the installment payment period.

                        Description of Proposal

    The proposal would increase the amount of value in a 
closely held business that would be eligible for the special 
low interest rate, from $1,000,000 to $2,500,000. Interest paid 
on the deferred estate tax would not be deductible for estate 
or income tax purposes, but the 4-percent rate would be reduced 
to 2 percent, and the deferred estate tax on any value of a 
closely held business in excess of $2,500,000 would be subject 
to interest at a rate equal to 45 percent of the usual rate 
applicable to tax underpayments.
    The proposal also would expand the availability and 
benefits of the holding company exception to include 
partnerships that function as holding companies, and would 
clarify and expand the non-readily tradeable stock requirement 
to include non-publicly traded partnerships. In addition, an 
estate using the holding company exception (as modified by the 
proposal) would be able to take advantage of the five-year 
deferral and special 2-percent rate, thus providing the same 
relief to closely held businesses whether owned directly or 
through holding companies.
    Finally, the proposal would authorize the Secretary of the 
Treasury to accept security arrangements in lieu of the special 
estate tax lien.

                             Effective Date

    The proposal would apply to the estates of decedents dying 
after December 31, 1997. Estates that are deferring estate tax 
under current law could make a one-time election to use the 
lower interest rates and forgo the interest deduction.
                        VI. OTHER TAX INCENTIVES

A. Equitable Tolling of the Statute of Limitations Period for Claiming 
                Tax Refunds for Incapacitated Taxpayers

                               Present Law

    In general, a taxpayer must file a refund claim within 
three years of the filing of the return or within two years of 
the payment of the tax, whichever period expires later (if no 
return is filed, the two-year limit applies) (sec. 6511(a)). A 
refund claim that is not filed within these time periods is 
rejected as untimely.
    There is no explicit statutory rule providing for equitable 
tolling of the statute of limitations. Several courts have 
considered whether equitable tolling implicitly exists. The 
First, Third, Fourth, and Eleventh Circuits have rejected 
equitable tolling with respect to tax refund claims. The Ninth 
Circuit, however, has permitted equitable tolling.

                        Description of Proposal

    The proposal would permit equitable tolling of the statute 
of limitations for refund claims for the period of time during 
which an individual taxpayer is under a sufficient medically 
determined physical or mental disability as to be unable to 
manage his or her financial affairs. Tolling would not apply 
during periods in which the taxpayer's spouse or another person 
is authorized to act on the taxpayer's behalf in financial 
matters.

                             Effective Date

    The proposal would apply with respect to tax years ending 
after the date of enactment.

              B. Extend and Modify Puerto Rico Tax Credit

                               Present Law

     The Small Business Job Protection Act of 1996 generally 
repealed the Puerto Rico and possession tax credit. However, 
certain domestic corporations that had active business 
operations in Puerto Rico or another U.S. possession on October 
13, 1995 may continue to claim credits under section 936 or 
section 30A for a ten-year transition period. Such credits 
apply to possession business income, which is derived from the 
active conduct of a trade or business within a U.S. possession 
or from the sale or exchange of substantially all of the assets 
that were used in such a trade or business. In contrast to the 
foreign tax credit, the Puerto Rico and possession tax credit 
is granted whether or not the corporation pays income tax to 
the possession.
    One of two alternative limitations is applicable to the 
amount of the credit attributable to possession business 
income. Under the economic activity limit, the amount of the 
credit with respect to such income cannot exceed the sum of a 
portion of the taxpayer's wage and fringe benefit expenses and 
depreciation allowances (plus, in certain cases, possession 
income taxes); beginning in 2002, the income eligible for the 
credit computed under this limit generally is subject to a cap 
based on the corporation's pre-1996 possession business income. 
Under the alternative limit, the amount of the credit is 
limited to the applicable percentage (45 percent for 1997 and 
40 percent for 1998 and thereafter) of the credit that would 
otherwise be allowable with respect to possession business 
income; beginning in 1998, the income eligible for the credit 
computed under this limit generally is subject to a cap based 
on the corporations's pre-1996 possession business income. 
Special rules apply in computing the credit with respect to 
operations in Guam, American Samoa, and the Commonwealth of the 
Northern Mariana Islands. The credit is eliminated for taxable 
years beginning after December 31, 2005.

                        Description of Proposal

    The proposal would modify the credit computed under the 
economic activity limit with respect to operations in Puerto 
Rico only. First, the proposal would eliminate the December 31, 
2005 termination date with respect to such credit. Second, the 
proposal would eliminate the income cap with respect to such 
credit. Third, the proposal would eliminate the limitation 
applying the credit only to certain corporations with pre-
existing operations in Puerto Rico with respect to such credit. 
The proposal would not modify the credit computed under the 
economic activity limit with respect to operations in 
possessions other than Puerto Rico. The proposal also would not 
modify the credit computed under the alternative limit.

                             Effective Date

    The proposal would apply to taxable years beginning after 
December 31, 1997.

 C. Extend Foreign Sales Corporation Benefits to Licenses of Computer 
                    Software for Reproduction Abroad

                              Present Law

    Under special tax provisions that provide an export 
incentive, a portion of the foreign trade income of an eligible 
foreign sales corporation (``FSC'') is exempt from Federal 
income tax. Foreign trade income is defined as the gross income 
of a FSC that is attributable to foreign trading gross 
receipts. The term ``foreign trading gross receipts'' includes 
the gross receipts of a FSC from the sale, lease, or rental of 
export property and from services related and subsidiary to 
such sales, leases, or rentals.
    For purposes of the FSC rules, export property is defined 
as property (1) which is manufactured, produced, grown, or 
extracted in the United States by a person other than a FSC; 
(2) which is held primarily for sale, lease, or rental in the 
ordinary conduct of a trade or business by or to a FSC for 
direct use, consumption, or disposition outside the United 
States; and (3) not more than 50 percent of the fair market 
value of which is attributable to articles imported into the 
United States. Intangible property generally is excluded from 
the definition of export property for purposes of the FSC 
rules; this exclusion applies to copyrights other than films, 
tapes, records, or similar reproductions for commercial or home 
use. The temporary Treasury regulations provide that a license 
of a master recording tape for reproduction outside the United 
States is not excluded from the definition of export property 
(Treas. Reg. sec. 1.927(a)-1T(f)(3)). The statutory exclusion 
for intangible property does not contain any specific reference 
to computer software. However, the temporary Treasury 
regulations provide that a copyright on computer software does 
not constitute export property, and that standardized, mass 
marketed computer software constitutes export property if such 
software is not accompanied by a right to reproduce for 
external use (Treas. Reg. sec. 1.927(a)-1T(f)(3)).

                        Description of Proposal

    The proposal would provide that computer software licensed 
for reproduction abroad would not be excluded from the 
definition of export property for purposes of the FSC 
provisions.

                             Effective Date

    The proposal would apply to software licenses granted after 
the date of enactment.

                 D. District of Columbia Tax Incentives

                               Present Law

    Under present law, residents of and businesses, employees, 
and owners of property located in the District of Columbia are 
not eligible for any special Federal tax treatment by virtue of 
their District of Columbia nexus.

                        Description of Proposal

    The proposal would provide tax incentives intended, 
according to the Department of Treasury, ``to encourage 
employment of disadvantaged residents and to revitalize those 
areas of the District of Columbia where development has been 
inadequate.'' 24 The proposal does not identify any 
specific measures in this regard.
---------------------------------------------------------------------------
    \24\ Department of the Treasury, General Explanations of the 
Administration's Revenue Proposals, February 1997, p. 31.
               VII. EXTENSIONS OF EXPIRING TAX PROVISIONS

                         A. Research Tax Credit

                               Present Law

General rule

    Section 41 provides for a research tax credit equal to 20 
percent of the amount by which a taxpayer's qualified research 
expenditures for a taxable year exceeded its base amount for 
that year. The research tax credit is scheduled to expire and 
generally will not apply to amounts paid or incurred after May 
31, 1997.25
---------------------------------------------------------------------------
    \25\ When originally enacted, the research tax credit applied to 
qualified expenses incurred after June 30, 1981. The credit was 
modified several times and was extended through June 30, 1995. The 
credit later was extended for the period July 1, 1996, through May 31, 
1997 (with a special 11-month extension for taxpayers that elect to be 
subject to the alternative incremental research credit regime).
---------------------------------------------------------------------------
    A 20-percent research tax credit also applied to the excess 
of (1) 100 percent of corporate cash expenditures (including 
grants or contributions) paid for basic research conducted by 
universities (and certain nonprofit scientific research 
organizations) over (2) the sum of (a) the greater of two 
minimum basic research floors plus (b) an amount reflecting any 
decrease in nonresearch giving to universities by the 
corporation as compared to such giving during a fixed-base 
period, as adjusted for inflation. This separate credit 
computation is commonly referred to as the ``university basic 
research credit'' (see sec. 41(e)).

Computation of allowable credit

    Except for certain university basic research payments made 
by corporations, the research tax credit applies only to the 
extent that the taxpayer's qualified research expenditures for 
the current taxable year exceed its base amount. The base 
amount for the current year generally is computed by 
multiplying the taxpayer's ``fixed-base percentage'' by the 
average amount of the taxpayer's gross receipts for the four 
preceding years. If a taxpayer both incurred qualified research 
expenditures and had gross receipts during each of at least 
three years from 1984 through 1988, then its ``fixed-base 
percentage'' is the ratio that its total qualified research 
expenditures for the 1984-1988 period bears to its total gross 
receipts for that period (subject to a maximum ratio of .16). 
All other taxpayers (so-called ``start-up firms'') are assigned 
a fixed-base percentage of 3 percent.26
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    \26\ The Small Business Job Protection Act of 1996 expanded the 
definition of ``start-up firms'' under section 41(c)(3)(B)(I) to 
include any firm if the first taxable year in which such firm had both 
gross receipts and qualified research expenses began after 1983.
     A special rule (enacted in 1993) is designed to gradually 
recompute a start-up firm's fixed-base percentage based on its actual 
research experience. Under this special rule, a start-up firm will be 
assigned a fixed-base percentage of 3 percent for each of its first 
five taxable years after 1993 in which it incurs qualified research 
expenditures. In the event that the research credit is extended beyond 
the scheduled expiration date, a start-up firm's fixed-base percentage 
for its sixth through tenth taxable years after 1993 in which it incurs 
qualified research expenditures will be a phased-in ratio based on its 
actual research experience. For all subsequent taxable years, the 
taxpayer's fixed-base percentage will be its actual ratio of qualified 
research expenditures to gross receipts for any five years selected by 
the taxpayer from its fifth through tenth taxable years after 1993 
(sec. 41(c)(3)(B)).
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    In computing the credit, a taxpayer's base amount may not 
be less than 50 percent of its current-year qualified research 
expenditures.
    To prevent artificial increases in research expenditures by 
shifting expenditures among commonly controlled or otherwise 
related entities, research expenditures and gross receipts of 
the taxpayer are aggregated with research expenditures and 
gross receipts of certain related persons for purposes of 
computing any allowable credit (sec. 41(f)(1)). Special rules 
apply for computing the credit when a major portion of a 
business changes hands, under which qualified research 
expenditures and gross receipts for periods prior to the change 
of ownership of a trade or business are treated as transferred 
with the trade or business that gave rise to those expenditures 
and receipts for purposes of recomputing a taxpayer's fixed-
base percentage (sec. 41(f)(3)).

Alternative incremental research credit regime

    As part of the Small Business Job Protection Act of 1996, 
taxpayers are allowed to elect an alternative incremental 
research credit regime. If a taxpayer elects to be subject to 
this alternative regime, the taxpayer is assigned a three-
tiered fixed-base percentage (that is lower than the fixed-base 
percentage otherwise applicable under present law) and the 
credit rate likewise is reduced. Under the alternative credit 
regime, a credit rate of 1.65 percent applies to the extent 
that a taxpayer's current-year research expenses exceed a base 
amount computed by using a fixed-base percentage of 1 percent 
(i.e., the base amount equals 1 percent of the taxpayer's 
average gross receipts for the four preceding years) but do not 
exceed a base amount computed by using a fixed-base percentage 
of 1.5 percent. A credit rate of 2.2 percent applies to the 
extent that a taxpayer's current-year research expenses exceed 
a base amount computed by using a fixed-base percentage of 1.5 
percent but do not exceed a base amount computed by using a 
fixed-base percentage of 2 percent. A credit rate of 2.75 
percent applies to the extent that a taxpayer's current-year 
research expenses exceed a base amount computed by using a 
fixed-base percentage of 2 percent. An election to be subject 
to this alternative incremental credit regime may be made only 
for a taxpayer's first taxable year beginning after June 30, 
1996, and before July 1, 1997, and such an election applies to 
that taxable year and all subsequent years (in the event that 
the credit subsequently is extended by Congress) unless revoked 
with the consent of the Secretary of the Treasury. If a 
taxpayer elects the alternative incremental research credit 
regime for its first taxable year beginning after June 30, 
1996, and before July 1, 1997, then all qualified research 
expenses paid or incurred during the first 11 months of such 
taxable year are treated as qualified research expenses for 
purposes of computing the taxpayer's credit.

Eligible expenditures

    Qualified research expenditures eligible for the research 
tax credit consist of: (1) ``in-house'' expenses of the 
taxpayer for wages and supplies attributable to qualified 
research; (2) certain time-sharing costs for computer use in 
qualified research; and (3) 65 percent of amounts paid by the 
taxpayer for qualified research conducted on the taxpayer's 
behalf (so-called ``contract research expenses'').27
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    \27\ Under a special rule enacted as part of the Small Business Job 
Protection Act of 1996, 75 percent of amounts paid to a research 
consortium for qualified research is treated as qualified research 
expenses eligible for the research credit (rather than 65 percent under 
the general rule under section 41(b)(3) governing contract research 
expenses) if (1) such research consortium is a tax-exempt organization 
that is described in section 501(c)(3) (other than a private 
foundation) or section 501(c)(6) and is organized and operated 
primarily to conduct scientific research, and (2) such qualified 
research is conducted by the consortium on behalf of the taxpayer and 
one or more persons not related to the taxpayer.
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    To be eligible for the credit, the research must not only 
satisfy the requirements of present-law section 174 (described 
below) but must be undertaken for the purpose of discovering 
information that is technological in nature, the application of 
which is intended to be useful in the development of a new or 
improved business component of the taxpayer, and must pertain 
to functional aspects, performance, reliability, or quality of 
a business component. Research does not qualify for the credit 
if substantially all of the activities relate to style, taste, 
cosmetic, or seasonal design factors (sec. 41(d)(3)). In 
addition, research does not qualify for the credit if conducted 
after the beginning of commercial production of the business 
component, if related to the adaptation of an existing business 
component to a particular customer's requirements, if related 
to the duplication of an existing business component from a 
physical examination of the component itself or certain other 
information, or if related to certain efficiency surveys, 
market research or development, or routine quality control 
(sec. 41(d)(4)).
    Expenditures attributable to research that is conducted 
outside the United States do not enter into the credit 
computation. In addition, the credit is not available for 
research in the social sciences, arts, or humanities, nor is it 
available for research to the extent funded by any grant, 
contract, or otherwise by another person (or governmental 
entity).

Relation to deduction

    Under section 174, taxpayers may elect to deduct currently 
the amount of certain research or experimental expenditures 
incurred in connection with a trade or business, 
notwithstanding the general rule that business expenses to 
develop or create an asset that has a useful life extending 
beyond the current year must be capitalized. However, 
deductions allowed to a taxpayer under section 174 (or any 
other section) are reduced by an amount equal to 100 percent of 
the taxpayer's research tax credit determined for the taxable 
year. Taxpayers may alternatively elect to claim a reduced 
research tax credit amount under section 41 in lieu of reducing 
deductions otherwise allowed (sec. 280C(c)(3)).

                        Description of Proposal

    The research tax credit would be extended for one year--
i.e., for the period June 1, 1997, through May 31, 1998.

                             Effective Date

    Extension of the research tax credit would be effective for 
expenditures paid or incurred during the period June 1, 1997, 
through May 31, 1998.

            B. Contributions of Stock to Private Foundations

                               Present Law

    In computing taxable income, a taxpayer who itemizes 
deductions generally is allowed to deduct the fair market value 
of property contributed to a charitable 
organization.28 However, in the case of a charitable 
contribution of short-term gain, inventory, or other ordinary 
income property, the amount of the deduction generally is 
limited to the taxpayer's basis in the property. In the case of 
a charitable contribution of tangible personal property, the 
deduction is limited to the taxpayer's basis in such property 
if the use by the recipient charitable organization is 
unrelated to the organization's tax-exempt 
purpose.29
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    \28\ The amount of the deduction allowable for a taxable year with 
respect to a charitable contribution may be reduced depending on the 
type of property contributed, the type of charitable organization to 
which the property is contributed, and the income of the taxpayer 
(secs. 170(b) and 170(e)).
    \29\ As part of the Omnibus Budget Reconciliation Act of 1993, 
Congress eliminated the treatment of contributions of appreciated 
property (real, personal, and intangible) as a tax preference for 
alternative minimum tax (AMT) purposes. Thus, if a taxpayer makes a 
gift to charity of property (other than short-term gain, inventory, or 
other ordinary income property, or gifts to private foundations) that 
is real property, intangible property, or tangible personal property 
the use of which is related to the donee's tax-exempt purpose, the 
taxpayer is allowed to claim the same fair-market-value deduction for 
both regular tax and AMT purposes (subject to present-law percentage 
limitations).
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    In cases involving contributions to a private foundation 
(other than certain private operating foundations), the amount 
of the deduction is limited to the taxpayer's basis in the 
property. However, under a special rule contained in section 
170(e)(5), taxpayers are allowed a deduction equal to the fair 
market value of ``qualified appreciated stock'' contributed to 
a private foundation prior to May 31, 1997.30 
Qualified appreciated stock is defined as publicly traded stock 
which is capital gain property. The fair-market-value deduction 
for qualified appreciated stock donations applies only to the 
extent that total donations made by the donor to private 
foundations of stock in a particular corporation did not exceed 
10 percent of the outstanding stock of that corporation. For 
this purpose, an individual is treated as making all 
contributions that were made by any member of the individual's 
family.
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    \30\ The special rule contained in section 170(e)(5), which was 
originally enacted in 1984, expired January 1, 1995. The Small Business 
Job Protection Act of 1996 reinstated the rule for 11 months--for 
contributions of qualified appreciated stock made to private 
foundations during the period July 1, 1996, through May 31, 1997.
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                        Description of Proposal

    The proposal would extend the special rule contained in 
section 170(e)(5) for one year--for contributions of qualified 
appreciated stock made to private foundations during the period 
June 1, 1997, through May 31, 1998.

                             Effective Date

    The provision would be effective for contributions of 
qualified appreciated stock to private foundations made during 
the period June 1, 1997, through May 31, 1998.

                     C. Work Opportunity Tax Credit

                               Present Law

In general

    The work opportunity tax credit is available on an elective 
basis for employers hiring individuals from one or more of 
seven targeted groups. The credit generally is equal to 35 
percent of qualified wages. Qualified wages consist of wages 
attributable to service rendered by a member of a targeted 
group during the one-year period beginning with the day the 
individual begins work for the employer. For a vocational 
rehabilitation referral, however, the period will begin on the 
day the individual begins work for the employer on or after the 
beginning of the individual's vocational rehabilitation plan as 
under prior law.
    Generally, no more than $6,000 of wages during the first 
year of employment is permitted to be taken into account with 
respect to any individual. Thus, the maximum credit per 
individual is $2,100. With respect to qualified summer youth 
employees, the maximum credit is 35 percent of up to $3,000 of 
qualified first-year wages, for a maximum credit of $1,050.
    The deduction for wages is reduced by the amount of the 
credit.

Targeted groups eligible for the credit

    (1) Families receiving AFDC

    An eligible recipient is an individual certified by the 
designated local employment agency as being a member of a 
family eligible to receive benefits under AFDC or its successor 
program for a period of at least nine months part of which is 
during the 9-month period ending on the hiring date. For these 
purposes, members of the family are defined to include only 
those individuals taken into account for purposes of 
determining eligibility for the AFDC or its successor program.

    (2) Qualified ex-felon

    A qualified ex-felon is an individual certified as: (1) 
having been convicted of a felony under any State or Federal 
law, (2) being a member of a family that had an income during 
the six months before the earlier of the date of determination 
or the hiring date which on an annual basis is 70 percent or 
less of the Bureau of Labor Statistics lower living standard, 
and (3) having a hiring date within one year of release from 
prison or date of conviction.

    (3) High-risk-youth

    A high-risk youth is an individual certified as being at 
least 18 but not 25 on the hiring date and as having a 
principal place of abode within an empowerment zone or 
enterprise community (as defined under Subchapter U of the 
Internal Revenue Code). Qualified wages will not include wages 
paid or incurred for services performed after the individual 
moves outside an empowerment zone or enterprise community.

    (4) Vocational rehabilitation referral

    Vocational rehabilitation referrals are those individuals 
who have a physical or mental disability that constitutes a 
substantial handicap to employment and who have been referred 
to the employer while receiving, or after completing, 
vocational rehabilitation services under an individualized, 
written rehabilitation plan under a State plan approved under 
the Rehabilitation Act of 1973 or under a rehabilitation plan 
for veterans carried out under Chapter 31 of Title 38, U.S. 
Code. Certification will be provided by the designated local 
employment agency upon assurances from the vocational 
rehabilitation agency that the employee has met the above 
conditions.

    (5) Qualified summer youth employee

    Qualified summer youth employees are individuals: (1) who 
perform services during any 90-day period between May 1 and 
September 15, (2) who are certified by the designated local 
agency as being 16 or 17 years of age on the hiring date, (3) 
who have not been an employee of that employer before, and (4) 
who are certified by the designated local agency as having a 
principal place of abode within an empowerment zone or 
enterprise community (as defined under Subchapter U of the 
Internal Revenue Code). As with high-risk youths, no credit is 
available on wages paid or incurred for service performed after 
the qualified summer youth moves outside of an empowerment zone 
or enterprise community. If, after the end of the 90-day 
period, the employer continues to employ a youth who was 
certified during the 90-day period as a member of another 
targeted group, the limit on qualified first-year wages will 
take into account wages paid to the youth while a qualified 
summer youth employee.

    (6) Qualified Veteran

    A qualified veteran is a veteran who is a member of a 
family certified as receiving assistance under: (1) AFDC for a 
period of at least nine months part of which is during the 12-
month period ending on the hiring date, or (2) a food stamp 
program under the Food Stamp Act of 1977 for a period of at 
least three months part of which is during the 12-month period 
ending on the hiring date. For these purposes, members of a 
family are defined to include only those individuals taken into 
account for purposes of determining eligibility for: (i) the 
AFDC or its successor program, and (ii) a food stamp program 
under the Food Stamp Act of 1977, respectively.
    Further, a qualified veteran is an individual who has 
served on active duty (other than for training) in the Armed 
Forces for more than 180 days or who has been discharged or 
released from active duty in the Armed Forces for a service-
connected disability. However, any individual who has served 
for a period of more than 90 days during which the individual 
was on active duty (other than for training) is not an eligible 
employee if any of this active duty occurred during the 60-day 
period ending on the date the individual was hired by the 
employer. This latter rule is intended to prevent employers who 
hire current members of the armed services (or those departed 
from service within the last 60 days) from receiving the 
credit.

    (7) Families receiving Food Stamps

    An eligible recipient is an individual aged 18 but not 25 
certified by a designated local employment agency as being a 
member of a family receiving assistance under a food stamp 
program under the Food Stamp Act of 1977 for a period of at 
least six months ending on the hiring date. In the case of 
families that cease to be eligible for food stamps under 
section 6(o) of the Food Stamp Act of 1977, the six-month 
requirement is replaced with a requirement that the family has 
been receiving food stamps for at least three of the five 
months ending on the date of hire. For these purposes, members 
of the family are defined to include only those individuals 
taken into account for purposes of determining eligibility for 
a food stamp program under the Food Stamp Act of 1977.

Minimum employment period

    No credit is allowed for wages paid unless the eligible 
individual is employed by the employer for at least 180 days 
(20 days in the case of a qualified summer youth employee) or 
400 hours (120 hours in the case of a qualified summer youth 
employee).

Expiration date

    The credit is effective for wages paid or incurred to a 
qualified individual who begins work for an employer after 
September 30, 1996, and before October 1, 1997.

                        Description of Proposals

    The first proposal would extend for one year the work 
opportunity tax credit.
    The second proposal would add a new targeted group to the 
work opportunity tax credit. The new group is composed of 
individuals aged 18-50 who lost eligibility for food stamps 
under the Administration's proposal to impose time limits on 
food stamp eligibility. However, individuals who have become 
ineligible either by refusing to work or, failing to comply 
with the food stamp program work requirements would not qualify 
as members of this new targeted group. Members of this new 
targeted group would remain in the targeted group for the 12-
month period after losing eligibility for food stamps under the 
Administration's proposal.

                             Effective Date

    The proposal to extend the work opportunity tax credit 
would be effective for wages paid or incurred to qualified 
individuals who begin work for the employer after September 30, 
1997, and before October 1, 1998. The proposal to add a new 
food stamp targeted group would be effective for wages paid or 
incurred to qualified members of that group who begin work for 
the employer on or after the date of enactment and before 
October 1, 2000.

                        D. Orphan Drug Tax Credit

                               Present Law

    A 50-percent nonrefundable tax credit is allowed for 
qualified clinical testing expenses incurred in testing of 
certain drugs for rare diseases or conditions, generally 
referred to as ``orphan drugs.'' Qualified testing expenses are 
costs incurred to test an orphan drug after the drug has been 
approved for human testing by the Food and Drug Administration 
(``FDA'') but before the drug has been approved for sale by the 
FDA. A rare disease or condition is defined as one that (1) 
affects less than 200,000 persons in the United States, or (2) 
affects more than 200,000 persons, but for which there is no 
reasonable expectation that businesses could recoup the costs 
of developing a drug for such disease or condition from U.S. 
sales of the drug. These rare diseases and conditions include 
Huntington's disease, myoclonus, ALS (Lou Gehrig's disease), 
Tourette's syndrome, and Duchenne's dystrophy (a form of 
muscular dystrophy).
    As with other general business credits (sec. 38), taxpayers 
are allowed to carry back unused credits to three years 
preceding the year the credit is earned (but not to a taxable 
year ending before July 1, 1996) and to carry forward unused 
credits to 15 years following the year the credit is earned. 
The credit cannot be used to offset a taxpayer's alternative 
minimum tax liability.
    The orphan drug tax credit is scheduled to expire and will 
not apply to expenses paid or incurred after May 31, 
1997.31
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    \31\ The orphan drug tax credit originally was enacted in 1983 and 
was extended on several occasions. The credit expired on December 31, 
1994, and later was reinstated for the period July 1, 1996, through May 
31, 1997.
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                        Description of Proposal

    The orphan drug tax credit would be extended for one year--
i.e., for the period June 1, 1997, through May 31, 1998.

                             Effective Date

    The proposal would be effective for qualified clinical 
testing expenses paid or incurred during the period June 1, 
1997, through May 31, 1998.
            VIII. CORPORATE REFORMS AND OTHER TAX PROVISIONS

              A. Provisions Relating to Financial Products

1. Deny interest deduction on certain debt instruments

                               Present Law

    Whether an instrument qualifies for tax purposes as debt or 
equity is determined under all the facts and circumstances 
based on principles developed in case law. If an instrument 
qualifies as equity, the issuer generally does not receive a 
deduction for dividends paid. If an instrument qualifies as 
debt, the issuer may receive a deduction for accrued interest 
and the holder generally includes interest in income, subject 
to certain limitations.
    Original issue discount (``OID'') on a debt instrument is 
the excess of the stated redemption price at maturity over the 
issue price of the instrument. An issuer of a debt instrument 
with OID generally accrues and deducts the discount as interest 
over the life of the instrument even though interest may not be 
paid until the instrument matures. The holder of such a debt 
instrument also generally includes the OID in income on an 
accrual basis.
    Section 385(c) provides rules for when an issuer's 
characterization of an interest in a corporation shall be 
binding on the issuer and the holders.

                        Description of Proposal

    Under the proposal, no deduction would be allowed for 
interest or OID on an instrument issued by a corporation (or 
issued by a partnership to the extent of its corporate 
partners) that (1) has a maximum weighted average maturity of 
more than 40 years, or (2) is payable in stock of the issuer or 
a related party (within the meaning of sections 267(b) and 
707(b)), including an instrument a substantial portion of which 
is mandatorily convertible or convertible at the issuer's 
option into stock of the issuer or a related party. In 
addition, an instrument would be treated as payable in stock if 
a substantial portion of the principal or interest is required 
to be determined, or may be determined at the option of the 
issuer or related party, by reference to the value of stock of 
the issuer or related party. An instrument would also be 
treated as payable in stock if it is part of an arrangement 
designed to result in the payment of the instrument with such 
stock, such as in the case of certain issuances of a forward 
contract in connection with the issuance of debt, nonrecourse 
debt that is secured principally by such stock, or certain debt 
instruments that are convertible at the holder's option when it 
is substantially certain that the right will be exercised.
    For purposes of determining the weighted average maturity 
of an instrument or the term of an instrument, any right to 
extend, renew, or relend will be treated as exercised and any 
right to accelerate payment will be ignored.
    The proposal would also clarify that for purposes of 
section 385(c), an issuer will be treated as having 
characterized an instrument as equity if the instrument (1) has 
a maximum term of more than 15 years, and (2) is not shown as 
indebtedness on the separate balance sheet of the issuer. For 
this purpose, in the case of an instrument with a maximum term 
of more than 15 years issued to a related party (other than a 
corporation) that is eliminated in the consolidated balance 
sheet that includes the issuer and the holder, the issuer will 
be treated as having characterized the instrument as equity if 
the holder or some other related party issues a related 
instrument that is not shown as indebtedness on the 
consolidated balance sheet. For this purpose, an instrument 
would not be treated as shown as indebtedness on a balance 
sheet because it is described as such in footnotes or other 
narrative disclosures. The proposal would apply only to 
corporations that file annual financial statements (or are 
included in financial statements filed) with the Securities and 
Exchange Commission (SEC), and the relevant balance sheet is 
the balance sheet filed with the SEC. In addition, this 
proposal would not apply to leveraged leases.
    The proposal generally would not apply to demand loans, 
redeemable ground rents or any other indebtedness specified by 
regulation.
    The proposal is not intended to affect the characterization 
of instruments as debt or equity under current law.

                             Effective Date

    The proposal would be effective generally for instruments 
issued on or after the date of first committee action.

2. Defer interest deduction on certain convertible debt

                               Present Law

    Certain debt instruments contain a feature that allows the 
holder or the issuer, at certain future dates, to convert the 
instrument into shares of stock of the issuer or a related 
party. Some of these instruments may be issued at a discount 
and are convertible into a fixed number of shares of the 
issuer, regardless of the amount of original issue discount 
(``OID'') accrued as of the date of conversion. Treasury 
regulations governing the accrual and deductibility of OID 
ignore options to convert a debt instrument into stock or debt 
of the issuer or a related party or into cash or other property 
having a value equal to the approximate value of such stock or 
debt (Treas. reg. sec. 1.1272-1(c)). Thus, OID on a convertible 
debt instrument generally is deductible as interest as such OID 
accrues, regardless of whether or not the debt is ultimately 
converted. The treatment of a holder of a discount instrument 
is similar to that of the issuer, i.e., a holder includes OID 
in income on an accrual basis.
    Other convertible instruments may be issued with coupon 
interest, rather than OID, and may provide that if the debt is 
converted into stock, the holder does not receive any interest 
that accrued but was unpaid between the latest coupon date and 
the conversion date. Under present law, the issuer of such 
instrument generally cannot deduct such accrued but unpaid 
interest.32
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    \32\ See, Rev. Rul. 74-127, 1974-1 C.B. 47 and Scott Paper v. 
Comm., 74 T.C. 137 (1980).
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                        Description of Proposal

    The proposal would defer interest deductions on convertible 
debt until such time as the interest is paid. For this purpose, 
payment would not include: (1) the conversion of the debt into 
equity of the issuer or a related person (as determined under 
secs. 267(b) and 707(b)) or (2) the payment of cash or other 
property in an amount that is determined by reference to the 
amount of such equity. Convertible debt would include debt: (1) 
exchangeable into the stock of a party related to the issuer, 
(2) with cash-settlement conversion features, or (3) issued 
with warrants (or similar instruments) as part of an investment 
unit in which the debt instrument may be used to satisfy the 
exercise price of the warrant. Convertible debt would not 
include debt that is ``convertible'' because a fixed payment of 
principal or interest could be converted by the holder into 
equity of the issuer or a related party having a value equal to 
the amount of such principal or interest. Holders of 
convertible debt would continue to include the interest on such 
instruments in gross income as under present law.

                             Effective Date

    The proposal would be effective for convertible debt issued 
on or after the date of first committee action.

3. Limit dividends-received deduction

    a. Reduce dividends-received deduction to 50 percent

                               Present Law

    If an instrument issued by a U.S. corporation is classified 
for tax purposes as equity, a corporate holder of that 
instrument generally is entitled to a deduction for dividends 
received on that instrument. This deduction is 70 percent of 
dividends received if the recipient owns less than 20 percent 
(by vote and value) of stock of the payor. If the recipient 
owns more than 20 percent of the stock the deduction is 
increased to 80 percent. If the recipient owns more than 80 
percent of the payor's stock, the deduction is further 
increased to 100 percent for qualifying dividends.

                        Description of Proposal

    Under the proposal, the dividends-received deduction 
available to corporations owning less than 20 percent (by vote 
and value) of the stock of a U.S. corporation would be reduced 
to 50 percent of the dividends received.

                             Effective Date

    The proposal would be effective for dividends paid or 
accrued after the 30th day after the date of enactment of the 
provision.

    b. Modify holding period for dividends-received

        deduction

                               Present Law

    If an instrument issued by a U.S. corporation is classified 
for tax purposes as equity, a corporate holder of the 
instrument generally is entitled to a dividends received 
deduction for dividends received on that instrument.
    The dividends-received deduction is allowed to a corporate 
shareholder only if the shareholder satisfies a 46-day holding 
period for the dividend-paying stock (or a 91-day period for 
certain dividends on preferred stock). The 46- or 91-day 
holding period generally does not include any time in which the 
shareholder is protected from the risk of loss otherwise 
inherent in the ownership of an equity interest. The holding 
period must be satisfied only once, rather than with respect to 
each dividend received.

                        Description of Proposal

    The proposal would provide that a taxpayer is not entitled 
to a dividends-received deduction if the taxpayer's holding 
period for the dividend-paying stock is not satisfied over a 
period immediately before or immediately after the taxpayer 
becomes entitled to receive the dividend.

                             Effective Date

    The proposal would be effective for dividends paid or 
accrued after the 30th day after the date of the enactment of 
the provision.

    c. Deny dividends-received deduction for preferred

        stock with certain non-stock characteristics

                               Present Law

    A corporate taxpayer is entitled to a deduction of 70 
percent of the dividends it receives from a domestic 
corporation. The percentage deduction is generally increased to 
80 percent if the taxpayer owns at least 20 percent (by vote 
and value) of the stock of the dividend-paying corporation, and 
to 100 percent for ``qualifying dividends,'' which generally 
are from members of the same affiliated group as the taxpayer.
    The dividends-received deduction is disallowed unless the 
taxpayer satisfies a 46-day holding period for the stock (or a 
91-day period for certain preferred stock). The holding period 
generally does not include any period during which the taxpayer 
has a right or obligation to sell the stock, or is otherwise 
protected from the risk of loss otherwise inherent in the 
ownership of an equity interest. If an instrument were treated 
as stock for tax purposes, but provided for payment of a fixed 
amount on a specified maturity date and afforded holders the 
rights of creditors to enforce such payment, the Internal 
Revenue Service has ruled that no dividends-received deduction 
would be allowed for distributions on the 
instrument.33
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    \33\ See Rev. Rul. 94-28, 1994-1 C.B. 86.
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                        Description of Proposal

    Except in the case of ``qualifying dividends,'' the 
dividends-received deduction would be eliminated for dividends 
on limited term preferred stock. For this purpose, preferred 
stock includes only stock that is limited and preferred as to 
dividends and that does not participate (through a conversion 
privilege or otherwise) in corporate growth to any significant 
extent. Stock is only treated as having a limited term if (1) 
the holder has the right to require the issuer or a related 
person to redeem or purchase the stock; (2) the holder or a 
related person is required to redeem or purchase the stock; (3) 
the issuer or a related person has the right to redeem or 
purchase the stock and, as of the issue date, it is more likely 
than not that such right will be exercised; or (4) the dividend 
rate on the stock varies in whole or in part (directly or 
indirectly) with reference to interest rates, commodity prices, 
or similar indices, regardless of whether such varying rate is 
provided as an express term of the stock (as in the case of an 
adjustable rate stock) or as a practical result of other 
aspects of the stock (as in the case of auction rate stock). 
For this purpose, clauses (1), (2), and (3) apply if the right 
or obligation may be exercised within 20 years of the issue 
date and is not subject to a contingency which, as of the issue 
date, makes the likelihood of the redemption or purchase 
remote.
    No inference regarding the present-law tax treatment of the 
above-described stock is intended by this proposal.

                             Effective Date

    The proposal would apply to dividends on stock issued after 
the 30th day after the date of enactment of the provision.

4. Disallowance of interest on indebtedness allocable to tax-exempt 
        obligations

                               Present Law

In general

    Present law disallows a deduction for interest on 
indebtedness incurred or continued to purchase or carry 
obligations the interest on which is not subject to tax (tax-
exempt obligations) (sec. 265). This rule applies to tax-exempt 
obligations held by individual and corporate taxpayers. The 
rule also applies to certain cases in which a taxpayer incurs 
or continues indebtedness and a related person acquires or 
holds tax-exempt obligations.34
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    \34\ Section 7701(f) (as enacted in the Deficit Reduction Act of 
1984 (sec. 53(c) of Pub. L. No. 98-369)) provides that the Treasury 
Secretary shall prescribe such regulations as may be necessary or 
appropriate to prevent the avoidance of any income tax rules which deal 
with linking of borrowing to investment or diminish risk through the 
use of related persons, pass-through entities, or other intermediaries.
---------------------------------------------------------------------------

Application to non-financial corporations

    In Rev. Proc. 72-18, 1972-1 C.B. 740, the IRS provided 
guidelines for application of the disallowance provision to 
individuals, dealers in tax-exempt obligations, other business 
enterprises, and banks in certain situations. Under Rev. Proc. 
72-18, a deduction is disallowed only when indebtedness is 
incurred or continued for the purpose of purchasing or carrying 
tax-exempt obligations.
    This purpose may be established either by direct or 
circumstantial evidence. Direct evidence of a purpose to 
purchase tax-exempt obligations exists when the proceeds of 
indebtedness are directly traceable to the purchase of tax-
exempt obligations or when such obligations are used as 
collateral for indebtedness. In the absence of direct evidence, 
a deduction is disallowed only if the totality of facts and 
circumstances establishes a sufficiently direct relationship 
between the borrowing and the investment in tax-exempt 
obligations.
    Two-percent de minimis exception.--In the case of an 
individual, interest on indebtedness generally is not 
disallowed if during the taxable year the average adjusted 
basis of the tax-exempt obligations does not exceed 2 percent 
of the average adjusted basis of the individual's portfolio 
investments and trade or business assets. In the case of a 
corporation other than a financial institution or a dealer in 
tax-exempt obligations, interest on indebtedness generally is 
not disallowed if during the taxable year the average adjusted 
basis of the tax-exempt obligations does not exceed 2 percent 
of the average adjusted basis of all assets held in the active 
conduct of the trade or business. These safe harbors are 
inapplicable to financial institutions and dealers in tax-
exempt obligations.
    Interest on installment sales to State and local 
governments.--If a taxpayer sells property to a State or local 
government in exchange for an installment obligation, interest 
on the obligation may be exempt from tax. Present law has been 
interpreted to not disallow interest on a taxpayer's 
indebtedness if the taxpayer acquires nonsalable tax-exempt 
obligations in the ordinary course of business in payment for 
services performed for, or goods supplied to, State or local 
governments.35
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    \35\ R.B. George Machinery Co., 26 B.T.A. 594 (1932) acq. C.B. XI-
2, 4; Rev. Proc. 72-18, as modified by Rev. Proc. 87-53, 1987-2 C.B. 
669.
---------------------------------------------------------------------------

Application to financial corporations and dealers in tax-exempt 
        obligations

    In the case of a financial institution, the allocation of 
the interest expense of the financial institution (which is not 
otherwise allocable to tax-exempt obligations) is based on the 
ratio of the average adjusted basis of the tax-exempt 
obligations acquired after August 7, 1987, to the average 
adjusted basis of all assets of the taxpayer (sec. 265). In the 
case of an obligation of an issuer which reasonably anticipates 
to issue not more than $10 million of tax-exempt obligations 
(other than certain private activity bonds) within a calendar 
year (the ``small issuer exception''), only 20 percent of the 
interest allocable to such tax-exempt obligations is disallowed 
(sec. 291(a)(3)). A similar pro rata rule applies to dealers in 
tax-exempt obligations, but there is no small issuer exception 
and the 20-percent disallowance rule does not 
apply.36
---------------------------------------------------------------------------
    \36\ Rev. Proc. 72-18.
---------------------------------------------------------------------------

                        Description of Proposal

    The proposal would extend to all corporations (other than 
insurance companies) the rule that applies to financial 
institutions that disallows interest deductions of a taxpayer 
(that are not otherwise disallowed as allocable under present 
law to tax-exempt obligations) in the same proportion as the 
average basis of its tax-exempt obligations bears to the 
average basis of all of the taxpayer's assets. The proposal 
would not extend the small-issuer exception to taxpayers which 
are not financial institutions. Nonetheless, the proposal would 
not apply to nonsaleable tax-exempt debt acquired by a 
corporation in the ordinary course of business in payment for 
goods or services sold to a State or local government. Under 
the proposal, insurance companies would not be subject to the 
pro rata rule and would be subject to present law. Finally, the 
proposal would apply the interest disallowance provision to all 
related persons (within the meaning of section 267(f)). 
Accordingly, in the case of related parties that are members of 
the same consolidated group, the pro rata disallowance rule 
would apply as if all the members of the group were a single 
taxpayer. The consolidated group rule would be applied without 
regard to any member that is an insurance company. In the case 
of related persons that are not members of the same 
consolidated group, the tracing rules would be applied by 
treating all of the related persons as a single entity. The 
proposal is not intended to affect the application of section 
265 to related parties under current law.

                             Effective Date

    The proposal would be effective for taxable years beginning 
after the date of enactment with respect to obligations 
acquired after the date of first committee action.

5. Basis of substantially identical securities determined on an average 
        basis

                               Present Law

    A taxpayer generally recognizes gain or loss on the sale of 
property measured by the difference between the amount realized 
on the disposition and the taxpayer's adjusted basis in the 
property. The gain or loss may be treated as long-term capital 
gain or loss depending upon the character and holding period of 
the property. Under Treasury regulations, if a taxpayer sells a 
portion of his or her holdings in stocks or bonds, the taxpayer 
is allowed to identify the securities disposed of for purposes 
of determining gain or loss on the disposition. If the taxpayer 
does not make an adequate identification, he or she generally 
is deemed to have disposed of the securities first acquired. 
Mutual fund investors are allowed to determine the adjusted 
bases of their shares based on the average cost of all such 
shares.

                        Description of Proposal

    In the case of substantially identical securities, the 
basis of the securities would be determined on an average 
basis. If a taxpayer disposes of less than all of such 
securities, the taxpayer would be treated as having disposed of 
the securities first acquired. The Secretary of the Treasury 
may provide, by regulation, that the average basis rule would 
not apply to certain substantially identical securities if such 
securities have a special status under a Code provision. For 
example, regulations could provide that the basis of shares of 
stock contributed to a partnership (and subject to Code section 
704(c)) would not be averaged with the basis of substantially 
identical shares of stock purchased by the partnership.
    For purposes of the proposal, a ``security'' generally 
would mean any of the securities described in section 
475(c)(2), other than subparagraph (F) thereof, including (1) 
stock in a corporation; (2) a partnership or beneficial 
interest in widely held or publicly traded partnership or 
trust; (3) a note, bond, debenture, or other evidence of 
indebtedness; (4) certain interest rate, currency, or equity 
notational principal contracts; or (5) evidence in an interest 
in, or a derivative financial instrument in, any security 
described above. The proposal generally would not apply to 
contractual financial products, such as over-the-counter 
options, notional principal contracts, or forward contracts 
because a taxpayer generally would not have multiple contracts 
that are substantially identical.

                             Effective Date

    The proposal would be effective for determinations made 30 
days after the date of enactment.

6. Require recognition of gain on certain appreciated positions in 
        personal property

                               Present Law

    In general, gain or loss is taken into account for tax 
purposes when realized. Gain or loss is usually realized with 
respect to a capital asset at the time the asset is sold, 
exchanged, or otherwise disposed of. Gain or loss is determined 
by comparing the amount realized with the adjusted basis of the 
particular property sold. In the case of corporate stock, the 
basis of shares purchased at different dates or different 
prices is generally determined by reference to the actual lot 
sold if it can be identified. Special rules under the Code can 
defer or accelerate recognition in certain situations.
    The recognition of gain or loss is postponed for open 
transactions. For example, in the case of a ``short sale'' 
(i.e., when a taxpayer sells borrowed property such as stock 
and closes the sale by returning identical property to the 
lender) no gain or loss on the transaction is recognized until 
the closing of the borrowing.
    Transactions designed to reduce or eliminate risk of loss 
on financial assets generally do not cause realization. For 
example, a taxpayer may lock in gain on securities by entering 
into a ``short sale against the box,'' i.e., when the taxpayer 
owns securities that are the same as, or substantially 
identical to, the securities borrowed and sold short. The form 
of the transaction is respected for income tax purposes and 
gain on the substantially identical property is not recognized 
at the time of the short sale. Pursuant to rules that allow 
specific identification of securities delivered on a sale, the 
taxpayer can obtain open transaction treatment by identifying 
the borrowed securities as the securities delivered. When it is 
time to close out the borrowing, the taxpayer can choose to 
deliver either the securities held or newly purchased 
securities. The Code provides rules only to prevent taxpayers 
from using short sales against the box to accelerate loss or to 
convert short-term capital gain into long-term capital gain or 
long-term capital loss into short-term capital loss.
    Taxpayers also can lock in gain on certain property by 
entering into straddles without recognizing gain for tax 
purposes. A straddle consists of offsetting positions with 
respect to personal property. A taxpayer can take losses on 
positions in straddles into account only to the extent the 
losses exceed the unrecognized gain in the other positions in 
the straddle. In addition, rules similar to the short sale 
rules prevent taxpayers from changing the tax character of 
gains and losses recognized on straddles.
    Taxpayers may engage in other arrangements, such as 
``equity swaps'' and other ``notional principal contracts,'' 
where the risk of loss and opportunity for gain with respect to 
property are shifted to another party (the ``counterparty''). 
These arrangements do not result in the recognition of gain by 
the taxpayer.
    The Code accelerates the recognition of gains and losses in 
certain cases. For example, taxpayers are required each year to 
mark to market certain regulated futures contracts, foreign 
currency contracts, non-equity options, and dealer equity 
options, and to take any capital gain or loss thereon into 
account as 40 percent short-term and 60 percent long-term. 
Securities dealers also are required to mark their securities 
to market.

                        Description of Proposal

    The proposal would require a taxpayer to recognize gain 
(but not loss) upon entering into a constructive sale of any 
appreciated position in either stock, a debt instrument, or a 
partnership interest. A taxpayer would be treated as making a 
constructive sale of an appreciated position when the taxpayer 
(or, in certain limited circumstances, a person related to the 
taxpayer) substantially eliminates risk of loss and opportunity 
for gain by entering into one or more positions with respect to 
the same or substantially identical property. For example, a 
taxpayer that holds appreciated stock and enters into a short 
position with respect to that stock would recognize any gain on 
the stock. An equity swap with regard to the stock that 
substantially eliminates risk of loss and opportunity for gain 
would also be subject to provision. Similarly, a taxpayer that 
holds appreciated stock and grants a call option or enters into 
a put option on the stock would generally recognize gain on the 
stock if there is a substantial certainty that the option will 
be exercised. In addition, a taxpayer would recognize gain on 
an appreciated position in stock, debt or partnership interests 
if the taxpayer enters into a transaction that is marketed or 
sold as substantially eliminating the risk of loss and 
opportunity for gain, regardless of whether the transaction 
involves the same or substantially identical property.
    The taxpayer would recognize gain in a constructive sale as 
if the position were sold at its fair market value on the date 
of the sale and immediately repurchased. An appropriate 
adjustment (such as an increase in the basis of the position) 
would be made in the amount of any additional gain or loss 
subsequently realized with respect to the position; and a new 
holding period of such position would begin as if the taxpayer 
had acquired the position on the date of the constructive sale.
    An appreciated financial position is defined as any 
position with respect to any stock, debt instrument, or 
partnership interest, if there would be gain were the position 
sold. Certain actively traded trust instruments are treated as 
stock for this purpose. A position is defined as any interest, 
including a futures or forward contract, short sale, or option.
    Constructive sales would not include a transaction if the 
appreciated financial position that is part of such transaction 
is marked to market under present law sections 475 (mark to 
market for securities dealers) or 1256 (mark to market for 
futures contracts, options and currency contracts).
    A constructive sale also would not include any contract for 
the sale of any stock, debt instrument, or partnership interest 
that is not a marketable security (as defined in the section 
453(f)(2) rules that apply to installment sales) if the sale is 
reasonably expected to occur within one year after the date 
such contract is entered into.
    A person would be considered related to another for 
purposes of the proposal if the relationship was one described 
in sections 267 or 707(b) and the transaction is entered into 
with a view toward avoiding the purposes of the provision.
    If there is a constructive sale of less than all of the 
appreciated financial positions held by the taxpayer, the 
proposal would apply to such positions in the order in which 
acquired or entered into. If the taxpayer actually disposed of 
a position previously constructively sold, the offsetting 
positions creating the constructive sale still held by the 
taxpayer would be treated as causing a new constructive sale of 
appreciated positions in substantially identical property, if 
any, the taxpayer holds at that time.
    The application of this proposal would be affected by the 
separate proposal described above that would require a 
computation of average cost basis and a FIFO ordering rule for 
substantially identical securities. For example, the average 
cost/FIFO proposal effectively would eliminate the ability for 
a taxpayer to defer gain under a typical short-against-the-box 
transaction (i.e., where a taxpayer with appreciated securities 
borrows identical securities, currently sells the borrowed 
securities, and later delivers the appreciated securities to 
close out the borrowing). Under the average cost/FIFO proposal, 
the taxpayer would be deemed to have sold his appreciated 
securities, thus recognizing gain.

                             Effective Date

    The proposal would be effective for constructive sales 
entered into after the date of enactment. It also would apply 
to constructive sales entered into after January 12, 1996 and 
before the date of enactment that remain open 30 days after the 
date of enactment. The proposal would apply to these pre-
enactment transactions as if the constructive sale occurred on 
the date which is 30 days after the date of enactment.
    In the case of a decedent dying after the date of 
enactment, if a constructive sale of an appreciated financial 
position (as defined in the proposal) had occurred before the 
date of enactment and remains open on the day before the 
decedent's death, and no gain had been recognized under the 
constructive sale rules on the position, such position (and any 
property related to it, under principles of the provision) 
would be treated as property constituting rights to receive 
income in respect of a decedent under section 691.

7. Gains and losses from certain terminations with respect to property

                               Present Law

    Extinguishment treated as sale or exchange.--The definition 
of capital gains and losses in section 1222 requires that there 
be a ``sale or exchange'' of a capital asset. Court decisions 
interpreted this requirement to mean that when a disposition is 
not a sale or exchange of a capital asset, for example, a 
lapse, cancellation, or abandonment, the disposition produces 
ordinary income or loss.37 Under a special 
provision, gains and losses attributable to the cancellation, 
lapse, expiration, or other termination of a right or 
obligation with respect to certain personal property are 
treated as gains or losses from the sale of a capital asset 
(sec. 1234A). The personal property subject to this rule is (1) 
personal property (other than stock that is not part of 
straddle or of a corporation that is not formed or availed of 
to take positions which offset positions in personal property 
of its shareholders) of a type which is actively traded and 
which is, or would be on acquisition, a capital asset in the 
hands of the taxpayer and (2) a ``section 1256 contract'' 
38 which is capital asset in the hands of the 
taxpayer. Section 1234A does not apply to the retirement of a 
debt instrument.
---------------------------------------------------------------------------
    \37\ See Fairbanks v. U.S., 306 U.S. 436 (1039); Comm'r v. Pittston 
Co., 252 F. 2d 344 (2nd Cir.), cert. denied, 357 U.S. 919 (1958).
    \38\ A ``section 1256 contract'' means (1) any regulated futures 
contract, (2) foreign currency contract, (3) nonequity option, or (4) 
dealer equity option.
---------------------------------------------------------------------------
    Character of gain on retirement of debt obligations.--
Amounts received on the retirement of any debt instrument are 
treated as amounts received in exchange therefor (sec. 
1271(a)(1)). In addition, gain on the sale or exchange of a 
debt instrument with OID 39 generally is treated as 
ordinary income to the extent of its OID if there was an 
intention at the time of its issuance to call the debt 
instrument before maturity (sec. 1271(a)(2)). These rules do 
not apply to (1) debt issued by a natural person or (2) debt 
issued before July 2, 1982, by a noncorporate or nongovernment 
issuer.
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    \39\ The issuer of a debt instrument with OID generally accrues and 
deducts the discount, as interest, over the life of the obligation even 
though the amount of such interest is not paid until the debt matures. 
The holder of such a debt instrument also generally includes the OID in 
income as it accrues as interest on an accrual basis. The mandatory 
inclusion of OID in income does not apply, among other exceptions, to 
debt obligations issued by natural persons before March 2, 1984, and 
loans of less than $10,000 between natural persons if such loan is not 
made in the ordinary course of business of the lender (secs. 
1272(a)(2)(D) and (E)).
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                        Description of Proposal

    Extension of relinquishment rule to all types of 
property.--The proposal would extend the rule which treats gain 
or loss from the cancellation, lapse, expiration, or other 
termination of a right or obligation with respect to property 
which is (or on acquisition would be) a capital asset in the 
hands of the taxpayer to all types of property.
    Character of gain on retirement of debt obligations issued 
by natural persons.--The proposal would repeal the provision 
that exempts debt obligations issued by natural persons from 
the rule which treats gain realized on retirement of the debt 
as exchanges. Thus, under the proposal, gain or loss on the 
retirement of such debt will be capital gain or loss. The 
proposal would retain the present-law exceptions for debt 
issued before July 2, 1982, by noncorporations or 
nongovernments.

                             Effective Date

    The proposal would be effective 30 days after the date of 
enactment.

8. Determination of original issue discount where pooled debt 
        obligations subject to acceleration

                               Present Law

    A taxpayer generally may deduct the amount of interest paid 
or accrued within the taxable year on indebtedness issued by 
the taxpayer. The issuer of a debt instrument with original 
issue discount (``OID'') generally accrues and deducts, as 
interest, the OID over the life of the obligation, even though 
the amount of the interest may not be paid until the maturity 
of the instrument.
    The amount of OID with respect to a debt instrument is the 
excess of the stated redemption price at maturity over the 
issue price of the debt instrument. The stated redemption price 
at maturity includes all amounts payable at maturity. The 
amount of OID in a debt instrument is allocated over the life 
of the instrument through a series of adjustments to the issue 
price for each accrual period. The adjustment to the issue 
price is determined by multiplying the adjusted issue price 
(i.e., the issue price increased by adjustments prior to the 
accrual period) by the instrument's yield to maturity, and then 
subtracting the interest payable during the accrual period. 
Thus, in order to compute the amount of OID and the portion of 
OID allocable to a period, the stated redemption price at 
maturity and the time of maturity must be known.
    Special rules for determining the amount of OID allocated 
to a period apply to certain instruments that may be subject to 
prepayment. Specifically, in the case of (1) any regular 
interest in a REMIC, (2) qualified mortgages held by a REMIC, 
or (3) any other debt instrument if payments under the 
instrument may be accelerated by reason of prepayments of other 
obligations securing the instrument, the daily portions of the 
OID on such debt instruments are determined by taking into 
account an assumption regarding the prepayment of principal for 
such instruments.
    If the principal amount of an indebtedness may be paid 
without interest by a specified date (as is the case with 
certain credit card balances), present law does not require the 
lender to accrue interest until after the specified date has 
passed. In addition, if a borrower can reduce the yield on a 
debt by exercising a prepayment option, the OID rules assume 
that the borrower will prepay the debt.

                        Description of Proposal

    The proposal would apply the special OID rule applicable to 
any regular interest in a REMIC, qualified mortgages held by a 
REMIC, or certain other debt instruments to any pool of debt 
instruments the payments on which may be accelerated by reason 
of prepayments. Thus, under the proposal, if a taxpayer holds a 
pool of credit card receivables that require interest to be 
paid if the borrowers do not pay their accounts by a specified 
date, the taxpayer would be required to accrue interest or OID 
on such pool based upon a reasonable assumption regarding the 
timing of the payments of the accounts in the pool.
    The proposal is not intended to apply to pools of 
receivables for which interest charges are incidental. Thus, 
for example, it is intended that the proposal would not apply 
to a merchant that (1) permits customers to pay their bills 
within a reasonable time and (2) does not routinely receive 
interest from a substantial portion of its customers. In 
addition, the Secretary of the Treasury would be authorized to 
provide appropriate exemptions from the proposal, including 
exemptions for taxpayers that hold a limited amount of debt 
instruments.

                             Effective Date

    The proposal would be effective for taxable years beginning 
after the date of enactment. If a taxpayer is required to 
change its method of accounting under the proposal, such change 
would be treated as initiated by the taxpayer with the consent 
of the Secretary of the Treasury and any section 481 adjustment 
would be included in income ratably over a four-year period.

                      B. Corporate Tax Provisions

1. Require gain recognition for certain extraordinary dividends

                               Present Law

    A corporate shareholder generally can deduct at least 70 
percent of a dividend received from another corporation. This 
dividends received deduction is 80 percent if the corporate 
shareholder owns at least 20 percent of the distributing 
corporation and generally 100 percent if the shareholder owns 
at least 80 percent of the distributing corporation.
    Section 1059 of the Code requires a corporate shareholder 
that receives an ``extraordinary dividend'' to reduce the basis 
of the stock with respect to which the dividend was received by 
the nontaxed portion of the dividend. Whether a dividend is 
``extraordinary'' is determined, among other things, by 
reference to the size of the dividend in relation to the 
adjusted basis of the shareholder's stock. Also, a dividend 
resulting from a non pro rata redemption or a partial 
liquidation is an extraordinary dividend. If the reduction in 
basis of stock exceeds the basis in the stock with respect to 
which an extraordinary dividend is received, the excess is 
taxed as gain on the sale or disposition of such stock, but not 
until that time (sec. 1059(a)(2)). The reduction in basis for 
this purpose occurs immediately before any sale or disposition 
of the stock (sec. 1059(d)(1)(A)). The Treasury Department has 
general regulatory authority to carry out the purposes of the 
section.
    Except as provided in regulations, the extraordinary 
dividend provisions do not apply to result in a double 
reduction in basis in the case of distributions between members 
of an affiliated group filing consolidated returns, where the 
dividend is eliminated or excluded under the consolidated 
return regulations. Double inclusion of earnings and profits 
(i.e., from both the dividend and from gain on the disposition 
of stock with a reduced basis) also should generally be 
prevented.40 Treasury regulations provide for 
application of the provision when a corporation is a partner in 
a partnership that receives a distribution.41
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    \40\ See H.R. Rep. 99-841, II-166, 99th Cong. 2d Sess. (Sept. 18, 
1986).
    \41\ See Treas. Reg. sec. 1.701-2(f), Example (2).
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    In general, a distribution in redemption of stock is 
treated as a dividend, rather than as a sale of the stock, if 
it is essentially equivalent to a dividend (sec. 302). A 
redemption of the stock of a shareholder generally is 
essentially equivalent to a dividend if it does not result in a 
meaningful reduction in the shareholder's proportionate 
interest in the distributing corporation. Section 302(b) also 
contains several specific tests (e.g., a substantial reduction 
computation and a termination test) to identify redemptions 
that are not essentially equivalent to dividends. The 
determination whether a redemption is essentially equivalent to 
a dividend includes reference to the constructive ownership 
rules of section 318, including the option attribution rules of 
section 318(a)(4). The rules relating to treatment of cash or 
other property received in a reorganization contain a similar 
reference (sec. 356(a)(2)).

                        Description of Proposal

    Under the proposal, except as provided in regulations, a 
corporate shareholder would recognize gain immediately with 
respect to any redemption treated as a dividend (in whole or in 
part) when the nontaxed portion of the dividend exceeds the 
basis of the shares surrendered, if the redemption is treated 
as a dividend due to options being counted as stock 
ownership.42
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    \42\ Thus, for example, where a portion of such a distribution 
would not have been treated as a dividend due to insufficient earnings 
and profits, the rule applies to the portion treated as a dividend.
---------------------------------------------------------------------------
    In addition, the proposal would require immediate gain 
recognition whenever the basis of stock with respect to which 
any extraordinary dividend was received is reduced below zero. 
The reduction in basis of stock would be treated as occurring 
at the beginning of the ex-dividend date of the extraordinary 
dividend to which the reduction relates.
    Reorganizations or other exchanges involving amounts that 
are treated as dividends under section 356 of the Code are 
treated as redemptions for purposes of applying the rules 
relating to redemptions under section 1059(e). For example, if 
a recapitalization or other transaction that involves a 
dividend under section 356 has the effect of a non pro rata 
redemption or is treated as a dividend due to options being 
counted as stock, the rules of section 1059 apply. Redemptions 
of shares, or other extraordinary dividends on shares, held by 
a partnership will be subject to section 1059 to the extent 
there are corporate partners (e.g., appropriate adjustments to 
the basis of the shares held by the partnership and to the 
basis of the corporate partner's partnership interest will be 
required).
    Under continuing section 1059(g) of present law, the 
Treasury Department would be authorized to issue regulations 
where necessary to carry out the purposes and prevent the 
avoidance of the bill.

                             Effective Date

    The proposal would generally be effective for distributions 
after May 3, 1995, unless made pursuant to the terms of a 
written binding contract in effect on May 3, 1995 and at all 
times thereafter before such distribution, or a tender offer 
outstanding on May 3, 1995.43 However, in applying 
the new gain recognition rules to any distribution that is not 
a partial liquidation, a non pro rata redemption, or a 
redemption that is treated as a dividend by reason of options, 
September 13, 1995 is substituted for May 3, 1995 in applying 
the transition rules.
---------------------------------------------------------------------------
    \43\ Thus, for example, in the case of a distribution prior to the 
effective date, the provisions of present law would continue to apply, 
including the provisions of present law sections 1059(a) and 
1059(d)(1), requiring reduction in basis immediately before any sale or 
disposition of the stock, and requiring recognition of gain at the time 
of such sale or disposition.
---------------------------------------------------------------------------
    No inference is intended regarding the tax treatment under 
present law of any transaction within the scope of the 
provision, including transactions utilizing options.
    In addition, no inference is intended regarding the rules 
under present law (or in any case where the treatment is not 
specified in the provision) for determining the shares of stock 
with respect to which a dividend is received or that experience 
a basis reduction.

2. Repeal percentage depletion for nonfuel minerals mined on certain 
        Federal lands

                               Present Law

    Taxpayers are allowed to deduct a reasonable allowance for 
depletion relating to the acquisition and certain related costs 
of mines or other hard mineral deposits. The depletion 
deduction for any taxable year is calculated under either the 
cost depletion method or the percentage depletion method, 
whichever results in the greater allowance for depletion for 
the year.
    Under the cost depletion method, the taxpayer deducts that 
portion of the adjusted basis of the property which is equal to 
the ratio of the units sold from that property during the 
taxable year, to the estimated total units remaining at the 
beginning of that year.
    Under the percentage depletion method, a deduction is 
allowed in each taxable year for a statutory percentage of the 
taxpayer's gross income from the property. The statutory 
percentage for gold, silver, copper, and iron ore is 15 
percent; the statutory percentage for uranium, lead, tin, 
nickel, tungsten, zinc, and most other hard rock minerals is 22 
percent. The percentage depletion deduction for these minerals 
may not exceed 50 percent of the net income from the property 
for the taxable year (computed without allowance for 
depletion). Percentage depletion is not limited to the 
taxpayer's basis in the property; thus, the aggregate amount of 
percentage depletion deductions claimed may exceed the amount 
expended by the taxpayer to acquire and develop the property.
    The Mining Law of 1872 permits U.S. citizens and businesses 
to freely prospect for hard rock minerals on Federal lands, and 
allows them to mine the land if an economically recoverable 
deposit is found. No Federal rents or royalties are imposed 
upon the sale of the extracted minerals. A prospecting entity 
may establish a claim to an area that it believes may contain a 
mineral deposit of value and preserve its right to that claim 
by paying an annual holding fee of $100 per claim. Once a 
claimed mineral deposit is determined to be economically 
recoverable, and at least $500 of development work has been 
performed, the claim holder may apply for a ``patent'' to 
obtain title to the surface and mineral rights. If approved, 
the claimant can obtain full title to the land for $2.50 or 
$5.00 per acre.

                        Description of Proposal

    The proposal would repeal the present-law percentage 
depletion provisions for nonfuel minerals extracted from any 
land where title to the land or the right to extract minerals 
from such land was originally obtained pursuant to the 
provisions of the Mining Law of 1872.

                             Effective Date

    The proposal would be effective for taxable years beginning 
after the date of enactment.

3. Modify net operating loss carryback and carryforward rules

                               Present Law

    The net operating loss (``NOL'') of a taxpayer (generally, 
the amount by which the business deductions of a taxpayer 
exceeds its gross income) may be carried back three years and 
carried forward fifteen years to offset taxable income in such 
years. A taxpayer may elect to forgo the carryback of an NOL. 
Special rules apply to REITs (no carrybacks), specified 
liability losses (10-year carryback), excess interest losses 
(no carrybacks), and net capital losses of corporations 
(carryforward limited to five years).

                        Description of Proposal

    The proposal would limit the NOL carryback period to one 
year and extend the NOL carryforward period to 20 years. The 
proposal would not apply to the carryback rules relating to 
REITs, specified liability losses, excess interest losses, and 
corporate capital losses.

                             Effective Date

    The proposal would be effective for NOLs arising in taxable 
years beginning after the date of enactment.

4. Treat certain preferred stock as ``boot''

                               Present Law

    In reorganization transactions within the meaning of 
section 368, no gain or loss is recognized except to the extent 
``other property'' (often called ``boot'') is received, that 
is, property other than certain stock, including preferred 
stock. Thus, preferred stock can be received tax-free in a 
reorganization, notwithstanding that many preferred stocks are 
functionally equivalent to debt securities. Upon the receipt of 
``other property,'' gain but not loss can be recognized. A 
special rule permits debt securities to be received tax-free, 
but only to the extent debt securities of no lesser principal 
amount are surrendered in the exchange. Other than this debt-
for-debt rule, similar rules generally apply to transactions 
described in section 351.

                        Description of Proposal

    The proposal would amend the relevant provisions (sections 
351, 354, 355, 356 and 1036) to treat certain preferred stock 
as ``other property'' (i.e., ``boot'') subject to certain 
exceptions. Thus, when a taxpayer exchanges property for this 
preferred stock in a transaction that qualifies under either 
section 351 or section 368, gain but not loss would be 
recognized.
    The proposal would apply to preferred stock (i.e., stock 
that is limited and preferred as to dividends and does not 
participate, including through a conversion privilege, in 
corporate growth to any significant extent), where (1) the 
holder has the right to require the issuer or a related person 
(within the meaning of sections 267(b) and 707(b)) to redeem or 
purchase the stock, (2) the issuer or a related person is 
required to redeem or purchase the stock, (3) the issuer (or a 
related person) has the right to redeem or purchase the stock 
and, as of the issue date, it is more likely than not that such 
right will be exercised, or (4) the dividend rate on the stock 
varies in whole or in part (directly or indirectly) with 
reference to interest rates, commodity prices, or other similar 
indices, regardless of whether such varying rate is provided as 
an express term of the stock (for example, in the case of an 
adjustable rate stock) or as a practical result of other 
aspects of the stock (for example, in the case of auction rate 
stock). For this purpose, the rules of (1), (2), and (3) apply 
if the right or obligation may be exercised within 20 years of 
the date the instrument is issued and such right or obligation 
is not subject to a contingency which, as of the issue date, 
makes remote the likelihood of the redemption or purchase. In 
addition, a right or obligation would be disregarded if it may 
be exercised only upon the death, disability, or mental 
incompetency of the holder or, in the case of stock transferred 
in connection with the performance of services, upon the 
holder's retirement.
    The following exchanges would be excluded from this gain 
recognition: (1) certain exchanges of preferred stock for 
comparable preferred stock of the same or lesser value; (2) an 
exchange of preferred stock for common stock; (3) certain 
exchanges of debt securities for preferred stock of the same or 
lesser value; and (4) exchanges of stock in certain 
recapitalizations of family-owned corporations. For this 
purpose, a family-owned corporation would be defined as any 
corporation if at least 50 percent of the total voting power 
and value of the stock of such corporation is owned by members 
of the same family for five years preceding the 
recapitalization. In addition, a recapitalization does not 
qualify for the exception if the same family does not own 50 
percent of the total voting power and value of the stock 
throughout the three-year period following the 
recapitalization. Members of the same family would be defined 
by reference to the definition in section 447(e). Thus, a 
family would include children, parents, brothers, sisters, and 
spouses, with a limited attribution for directly and indirectly 
owned stock of the corporation. Shares held by a family member 
would be treated as not held by a family member to the extent a 
non-family member had a right, option or agreement to acquire 
the shares (directly or indirectly, for example, through 
redemptions by the issuer), or with respect to shares as to 
which a family member has reduced its risk of loss with respect 
to the share, for example, through an equity swap. Even though 
the provision excepts certain family recapitalizations, the 
special valuation rules of section 2701 for estate and gift tax 
consequences still apply.
    An exchange of nonqualified preferred stock for 
nonqualified preferred stock in an acquiring corporation may 
qualify for tax-free treatment under section 354, but not 
section 351. In cases in which both sections 354 and 351 may 
apply to a transaction, section 354 generally will apply for 
purposes of this proposal. Thus, in that situation, the 
exchange would be tax free.
    The Treasury Secretary would have regulatory authority to 
(1) apply installment sale-type rules to preferred stock that 
is subject to this proposal in appropriate cases and (2) 
prescribe treatment of preferred stock subject to this 
provision under other provisions of the Code (e.g., sections 
304, 306, 318, and 368(c)). Until regulations are issued, 
preferred stock that is subject to the proposal shall continue 
to be treated as stock under other provisions of the Code.

                             Effective Date

    The proposal would be effective for transactions on or 
after the date of first committee action.

5. Conversion of large corporations into S corporations treated as 
        complete liquidations

                               Present Law

    The income of a corporation described in subchapter C of 
the Internal Revenue Code (a ``C corporation'') is subject to 
corporate-level tax when the income is earned and individual-
level tax when the income is distributed. The income of a 
corporation described in subchapter S of the Internal Revenue 
Code (an ``S corporation'') generally is subject to individual-
level, but not corporate-level, tax when the income is earned. 
The income of an S corporation generally is not subject to tax 
when it is distributed to the shareholders. The tax treatment 
of an S corporation is similar to the treatment of a 
partnership or sole proprietorship.
    The liquidation of a subchapter C corporation generally is 
a taxable event to both the corporation and its shareholders. 
Corporate gain is measured by the difference between the fair 
market values and the adjusted bases of the corporation's 
assets. The shareholder gain is measured by the difference 
between the value of the assets distributed and the 
shareholder's adjusted basis in his or her stock. The 
conversion of a C corporation into a partnership or sole 
proprietorship is treated as the liquidation of the 
corporation.
    The conversion from C to S corporation status (or the 
merger of a C corporation into an S corporation) generally is 
not a taxable event to either the corporation or its 
shareholders.
    Certain rules attempt to limit the potential for C 
corporations to avoid corporate-level tax by shifting 
appreciated assets to S corporation status prior to the 
recognition of such gains. Specifically, an S corporation is 
subject to a tax computed by applying the highest marginal 
corporate tax rate to the lesser of (1) the S corporation's 
recognized built-in gains or (2) the amount that would be 
taxable income if such corporation was not an S corporation 
(sec. 1374). For this purpose, a recognized built-in gain 
generally is any gain the S corporation recognizes from the 
disposition of any asset within a 10-year recognition period 
after the conversion from C corporation status or any income 
that is properly taken into account during the recognition 
period that is attributable to prior periods. However, a gain 
is not a recognized built-in gain if the taxpayer can establish 
that the asset was not held by the corporation on the date of 
conversion or to the extent the gain exceeds the amount of gain 
that would have been recognized on such date. In addition, the 
cumulative amount of recognized built-in gains that an S 
corporation must take into account may not exceed the amount by 
which the fair market value of the corporation's assets exceeds 
the aggregated adjusted basis of such assets on the date of 
conversion from C corporation status. Finally, net operating 
loss or tax credit carryovers from years in which the 
corporation was a C corporation may reduce or eliminate the tax 
on recognized built-in gains.
    The amount of built-in gain that is subject to corporate-
level tax also flows-through to the shareholders of the S 
corporation as an item of income subject to individual-level 
tax. The amount of tax paid by the S corporation on built-in 
gains flows-through to the shareholders as an item of loss that 
is deductible against such built-in gain income on the 
individual level.

                        Description of Proposal

    The proposal would repeal section 1374 for large S 
corporations. A C-to-S corporation conversion (whether by a C 
corporation electing S corporation status or by a C corporation 
merging into an S corporation) would be treated as a 
liquidation of the C corporation followed by a contribution of 
the assets to an S corporation by the recipient shareholders. 
Thus, the proposal would require immediate gain recognition by 
both the corporation (with respect to its appreciated assets) 
and its shareholders (with respect to their stock) upon the 
conversion to S corporation status.
    For this purpose, a large S corporation is one with a value 
of more than $5 million at the time of conversion. The value of 
the corporation would be the fair market value of all the stock 
of the corporation on the date of conversion.

                             Effective Date

    The proposal generally would be effective for subchapter S 
elections that become effective for taxable years beginning 
after January 1, 1998. The proposal would apply to acquisitions 
(e.g., the merger of a C corporation into an existing S 
corporation) after December 31, 1997. Thus, C corporations 
would continue to be permitted to elect S corporation status 
effective for taxable years beginning in 1997 or on January 1, 
1998.
    In addition, the Internal Revenue Service would revise 
Notice 88-19 44 to conform to the proposed amendment 
to section 1374, with an effective date similar to the 
statutory proposal. As a result, the conversion of a large C 
corporation to a regulated investment company (``RIC'') or a 
real estate investment trust (``REIT'') after the revisions 
would result in immediate recognition by the C corporation of 
the net built-in gain in its assets.
---------------------------------------------------------------------------
    \44\ Notice 88-19, 1988-1 C.B. 486, allows C corporations that 
become RICs or REITs to be subject to rules similar to those of section 
1374, rather than being subject to the rules applicable to complete 
liquidations.
---------------------------------------------------------------------------

6. Require gain recognition on certain distributions of controlled 
        corporation stock

                               Present Law

    A corporation is generally required to recognize gain on 
the distribution of property (including stock of a subsidiary) 
as if such property had been sold for its fair market value. 
The shareholders generally treat the receipt of property as a 
taxable event as well. Section 355 of the Internal Revenue Code 
provides an exception to this rule for certain distributions of 
stock in a controlled corporation, provided that various 
requirements are met, including certain restrictions relating 
to acquisitions and dispositions of stock of the distributing 
corporation (``distributing'') or the controlled corporation 
(``controlled'') prior and subsequent to a distribution.

                        Description of Proposal

    The proposal would adopt additional restrictions under 
section 355 on acquisitions and dispositions of the stock of 
distributing and controlled. Under the proposal, the 
distributing corporation (but not the shareholders) would be 
required to recognize gain on the distribution of the stock of 
controlled unless the direct and indirect shareholders of 
distributing, as a group, control both distributing and 
controlled at all times during the four year period commencing 
two years prior to the distribution. Control for this purpose 
means ownership of stock possessing at least 50 percent of the 
total combined voting power and at least 50 percent of the 
total value of all classes of stock.
    In determining whether shareholders retain control in both 
corporations throughout the four-year time period, any 
acquisitions or dispositions of stock that are unrelated to the 
distribution will be disregarded. A transaction is unrelated to 
the distribution if it is not pursuant to a common plan or 
arrangement that includes the distribution. For example, public 
trading of the stock of either distributing or controlled is 
disregarded, even if that trading occurs in contemplation of 
the distribution. Similarly, an acquisition of distributing or 
controlled in a merger or otherwise that is not pursuant to a 
common plan or arrangement existing at the time of the 
distribution is not related to the distribution. For example, a 
hostile acquisition of distributing or controlled commencing 
after the distribution will be disregarded. On the other hand, 
a friendly acquisition will generally be considered related to 
the distribution if it is pursuant to an arrangement negotiated 
(in whole or in part) prior to the distribution, even if at the 
time of distribution it is subject to various conditions, such 
as the approval of shareholders or a regulatory body.

                             Effective Date

    The proposal would be effective for distributions after the 
date of first committee action.

7. Reform tax treatment of certain corporate stock transfers

                               Present Law

    Under section 304, if one corporation purchases stock of a 
related corporation, the transaction generally is 
recharacterized as a redemption. In determining whether a 
transaction so recharacterized is treated as a sale or a 
dividend, reference is made to the changes in the selling 
corporation's ownership of stock in the issuing corporation 
(applying the constructive ownership rules of section 318(a) 
with modifications under section 304(c)). Sales proceeds 
received by a corporate transferor that are characterized as a 
dividend may qualify for the dividends received deduction under 
section 243, and such dividend may bring with it foreign tax 
credits under section 902. Section 304 does not apply to 
transfers of stock between members of a consolidated group.
    Section 1059 applies to ``extraordinary dividends,'' 
including certain redemption transactions treated as dividends 
qualifying for the dividends received deduction. If a 
redemption results in an extraordinary dividend, section 1059 
generally requires the shareholder to reduce its basis in the 
stock of the redeeming corporation by the nontaxed portion of 
such dividend.

                        Description of Proposal

    Under the proposal, to the extent that a section 304 
transaction is treated as a distribution under section 301, the 
transferor and the acquiring corporation would be treated as if 
(1) the transferor had transferred the stock involved in the 
transaction to the acquiring corporation in exchange for stock 
of the acquiring corporation in a transaction to which section 
351(a) applies, and (2) the acquiring corporation had then 
redeemed the stock it is treated as having issued. Thus, the 
acquiring corporation would be treated for all purposes as 
having redeemed the stock it is treated as having issued to the 
transferor. In addition, the proposal would amend section 1059 
so that, if the section 304 transaction is treated as a 
dividend to which the dividends received deduction applies, the 
dividend would be treated as an extraordinary dividend in which 
only the basis of the transferred shares would be taken into 
account under section 1059.
    Under the proposal, a special rule would apply to section 
304 transactions involving acquisitions by foreign 
corporations. The proposal would limit the earnings and profits 
of the acquiring foreign corporation that would be taken into 
account in applying section 304. The earnings and profits of 
the acquiring foreign corporation to be taken into account 
would not exceed the portion of such earnings and profits that 
(1) is attributable to stock of such acquiring corporation held 
by a corporation or individual who is the transferor (or a 
person related thereto) and who is a U.S. shareholder (within 
the meaning of section 951(b)) of such corporation, and (2) was 
accumulated during periods in which such stock was owned by 
such person while such acquiring corporation was a controlled 
foreign corporation. For purposes of this rule, except as 
otherwise provided by the Secretary of the Treasury, the rules 
of section 1248(d) (relating to certain exclusions from 
earnings and profits) would apply. The Secretary of the 
Treasury would prescribe regulations as appropriate, including 
regulations determining the earnings and profits that are 
attributable to particular stock of the acquiring corporation.
    No inference is intended as to the treatment of any 
transaction under present law.

                             Effective Date

    The proposal would be effective for transactions after the 
date of first committee action.

8. Modify the extension of section 29 credit for biomass and coal 
        facilities

                               Present Law

    Certain fuels produced from ``nonconventional sources'' and 
sold to unrelated parties are eligible for an income tax credit 
equal to $3 (generally adjusted for inflation) per barrel or 
BTU oil barrel equivalent (sec. 29). Qualified fuels must be 
produced within the United States.
    Qualified fuels include: (1) oil produced from shale and 
tar sands; (2) gas produced from geopressured brine, Devonian 
shale, coal seams, tight formations (``tight sands''), or 
biomass; and (3) liquid, gaseous, or solid synthetic fuels 
produced from coal (including lignite).
    In general, the credit is available only with respect to 
fuels produced from wells drilled or facilities placed in 
service after December 31, 1979, and before January 1, 1993. An 
exception extends the January 1, 1993 expiration date for 
facilities producing gas from biomass and synthetic fuel from 
coal if the facility producing the fuel is placed in service 
before July 1, 1998, pursuant to a binding contract entered 
into before January 1, 1997.
    The credit may be claimed for qualified fuels produced and 
sold before January 1, 2003 (in the case of nonconventional 
sources subject to the January 1, 1993 expiration date) or 
January 1, 2008 (in the case of biomass gas and synthetic fuel 
facilities eligible for the extension period).

                        Description of Proposal

    The proposal would shorten by one year the ``placed in 
service'' period for facilities producing gas from biomass and 
synthetic fuel, such that only facilities placed in service 
before July 1, 1997, pursuant to a binding contract entered 
into before January 1, 1997, would be eligible for the credit.

                             Effective Date

    The proposal would be effective on the date of enactment.

                         C. Foreign Provisions

1. Expand subpart F provisions regarding income from notional principal 
        contracts and stock lending transactions

                               Present Law

    Under the subpart F rules, the U.S. 10-percent shareholders 
of a controlled foreign corporation (``CFC'') are subject to 
U.S. tax currently on certain income earned by the CFC, whether 
or not such income is distributed to the shareholders. The 
income subject to this current inclusion rule includes, among 
other things, ``foreign personal holding company income.''
    Foreign personal holding company income generally consists 
of the following: dividends, interest, royalties, rents and 
annuities; net gains from sales or exchanges of (a) property 
that gives rise to the foregoing types of income, (b) property 
that does not give rise to income, and (c) interests in trusts, 
partnerships, and REMICs; net gains from commodities 
transactions; net gains from foreign currency transactions; and 
income that is equivalent to interest. Income from notional 
principal contracts referenced to commodities, foreign 
currency, interest rates, or indices thereon is treated as 
foreign personal holding company income. In addition, income 
derived from transfers of debt securities (but not equity 
securities) pursuant to the rules governing securities lending 
transactions (sec. 1058) is treated as foreign personal holding 
company income.
    A variety of exceptions from foreign personal holding 
company income are provided for income earned by a CFC that is 
a regular dealer in the property sold or exchanged. However, no 
exception is available for a CFC that is a regular dealer in 
financial instruments referenced to commodities.
    A U.S. shareholder of a passive foreign investment company 
(``PFIC'') is subject to U.S. tax and an interest charge with 
respect to certain distributions from the PFIC and gains on 
dispositions of the stock of the PFIC, unless the shareholder 
elects to include in income currently for U.S. tax purposes its 
share of the earnings of the PFIC. A foreign corporation is a 
PFIC if it satisfies either a passive income test or a passive 
assets test. For this purpose, passive income is defined by 
reference to foreign personal holding company income.

                        Description of Proposal

    The proposal would add net income from notional principal 
contracts as a new category of foreign personal holding company 
income. In addition, the proposal would treat income derived 
from equity securities lending transactions pursuant to section 
1058 as foreign personal holding company income.
    Under the proposal, income, gain, deduction or loss from a 
notional principal contract entered into to hedge an item of 
income in another category of foreign personal holding company 
income would be included in that category.
    The proposal would provide an exception from foreign 
personal holding company income for income from transactions 
entered into in the ordinary course of a CFC's business as a 
regular dealer in forward contracts, options, notional 
principal contracts, and similar financial instruments 
(including instruments referenced to commodities).

                             Effective Date

    The proposal would apply to taxable years beginning after 
the date of enactment.

2. Taxation of certain captive insurance companies and their 
        shareholders

                               Present Law

    A deduction generally is allowed for insurance premiums 
incurred in connection with a taxpayer's trade or business. In 
contrast, no deduction is allowed for amounts set aside by the 
taxpayer to fund future losses.
    An insurance company is defined under Treasury regulations 
as a company whose primary and predominant business activity is 
the issuance of insurance or annuity contracts or the 
reinsuring of risks underwritten by insurance companies.
    The term ``insurance'' is not defined in the Code. In 
general, courts have held that an insurance transaction 
involves risk shifting and risk distribution. See Helvering v. 
LeGierse, 312 U.S. 531 (1941).
    Under the subpart F rules, certain U.S. shareholders of a 
controlled foreign corporation (CFC) are required to include in 
income currently their shares of certain income of the CFC, 
whether or not such income is actually distributed to the 
shareholders. This current inclusion rule applies to certain 
insurance income of the CFC. In addition, special provisions 
under the subpart F rules apply to the related person insurance 
income of a CFC. Further, present law applies a look-through 
rule in characterizing certain subpart F insurance income for 
purposes of determining unrelated business income of a tax-
exempt organization.
    Premiums paid by a U.S. person to a foreign insurer or 
reinsurer with respect to the insurance of U.S. risks are 
subject to an excise tax, absent an applicable tax treaty that 
includes a waiver of this tax.

                        Description of Proposal

In general

    Under the proposal, ``disqualified shareholder insurance'' 
would be treated as derived from a business other than 
insurance for purposes of determining whether a corporation 
qualifies as an insurance company under the primary and 
predominant business activity test of present law. In the case 
of a corporation that fails to qualify as an insurance company 
because of disqualified shareholder insurance (i.e., a 
disqualified corporation), premiums with respect to 
disqualified shareholder insurance would not be deductible when 
paid. Special rules (described below) would apply in 
determining the deductions and income inclusions of both the 
disqualified corporation and the insured with respect to 
disqualified shareholder insurance.
    Disqualified shareholder insurance would be an insurance or 
reinsurance policy issued directly or indirectly with respect 
to a person who is a ``large shareholder'' of the issuing 
corporation, or a person related to such a shareholder. An 
insurance or reinsurance policy would not constitute 
disqualified shareholder insurance if the ultimate insured is 
not a large shareholder or a related person (e.g., a third-
party risk that is reinsured by the issuing company's 
affiliate).
    A large shareholder would be any person who owns or is 
considered as owning 10 percent or more of the total combined 
voting power of all classes of stock of such corporation 
entitled to vote. For this purpose, the indirect and 
constructive ownership rules of section 958 would apply, other 
than section 958(b)(4). Policyholders of a mutual company would 
be treated as shareholders. A person would be considered to be 
related based on the application of rules similar to the rules 
of section 954(d)(3). Moreover, in the case of an insurance 
policy covering liability arising from services performed as a 
director, officer, or employee of a corporation or as a partner 
or employee of a partnership, the person performing such 
services would be treated as related to such corporation or 
partnership.

Treatment of disqualified corporation

    Under the proposal, a disqualified corporation would not be 
subject to tax under subchapter L of the Code and would not be 
eligible for tax-exempt status under section 501(c)(15). The 
disqualified shareholder insurance generally would not 
constitute insurance for purposes of the Code.
    The disqualified corporation would not include in income 
premiums for disqualified shareholder insurance. The 
disqualified corporation would include in income, in the year 
the insurance expires, the excess, if any, of the premiums 
received with respect to such insurance over the aggregate 
claims paid. The disqualified corporation could deduct the 
excess, if any, of the aggregate claims paid with respect to 
such insurance over the premiums received.

Treatment of large shareholder and related persons

    Under the proposal, premiums paid to a disqualified 
corporation for disqualified shareholder insurance would not be 
deductible. Claims paid with respect to such disqualified 
shareholder insurance would be includible in the income of the 
insured to the extent such aggregate payments exceed the 
premiums paid. The insured would be allowed a deduction, in the 
year the insurance expires, to the extent that the premiums 
with respect to such disqualified shareholder insurance exceed 
the aggregate claims paid. For purposes of section 165(a), the 
proceeds of such disqualified shareholder insurance would not 
constitute compensation by insurance or otherwise.

Application to reinsurance

    For purposes of applying this proposal to arrangements 
involving reinsurance, premiums paid indirectly and claim 
amounts received indirectly would be taken into account. If any 
portion of disqualified shareholder insurance is ceded to a 
person that is not related to the ultimate insured with respect 
to such insurance, or to any person related to the ultimate 
insured, that portion would not constitute disqualified 
shareholder insurance. The proposal would not apply to 
reinsurance transactions between affiliated insurance 
companies, if the insured risks were not related party risks 
with respect to the ceding or the assuming insurance companies.

Foreign personal holding company income

    In the case of a foreign corporation that is a disqualified 
corporation, the proposal would create a new category of 
foreign personal holding company income under subpart F for 
income with respect to disqualified shareholder insurance. This 
new category of foreign personal holding income would consist 
of the excess, if any, of the amount of premiums received with 
respect to disqualified shareholder insurance over the claims 
paid with respect thereto.

Application of excise tax

    Disqualified shareholder insurance would be treated as 
insurance for purposes of the insurance excise tax if the 
ultimate insured with respect to such disqualified shareholder 
insurance claims a deduction on its tax return for premiums 
paid directly or indirectly for such insurance.

Information reporting

    Under the proposal, recordkeeping and information reporting 
requirements would apply in cases in which a corporation issues 
an insurance or reinsurance policy where the person directly or 
indirectly insured is a shareholder of the corporation or a 
person related to a shareholder. In such a case, the 
shareholder or the related person would be required to maintain 
records and provide information as prescribed in Treasury 
guidance. If any person fails to satisfy these requirements 
with respect to any insurance or reinsurance policy, no 
deduction would be allowed for premiums paid directly or 
indirectly by such person for such policy.

Regulatory authority

    The Secretary of the Treasury would have authority to 
prescribe regulations as necessary or appropriate to carry out 
the purposes of the proposal. The Secretary could issue 
regulations (1) preventing avoidance of these rules through 
cross-insurance or multiple-contact arrangements or otherwise; 
(2) preventing items from being taken into account more than 
once; (3) providing that the determination of whether a 
corporation with disqualified shareholder insurance qualifies 
as an insurance company is made on the basis of the average of 
its net written premiums over multiple years; and (4) treating 
persons as related by reason of contractual arrangements or 
otherwise.

                             Effective Date

    The proposal would be effective for taxable years beginning 
after the date of enactment.

3. Modify foreign tax credit carryover rules

                               Present Law

    U.S. persons may credit foreign taxes against U.S. tax on 
foreign source income. The amount of foreign tax credits that 
can be claimed in a year is subject to a limitation that 
prevents taxpayers from using foreign tax credits to offset 
U.S. tax on U.S. source income. The foreign tax credit 
limitation is calculated separately for specific categories of 
income.
    The amount of creditable taxes paid or accrued (or deemed 
paid) in any taxable year which exceeds the foreign tax credit 
limitation is permitted to be carried back two years and 
forward five years. The amount carried over may be used as a 
credit in a carryover year to the extent the taxpayer otherwise 
has excess foreign tax credit limitation for such year. The 
separate foreign tax credit limitations apply for purposes of 
the carryover rules.

                        Description of Proposal

    The proposal would reduce the carryback period for excess 
foreign tax credits from two years to one year. The proposal 
also would extend the excess foreign tax credit carryforward 
period from five years to seven years.

                             Effective Date

    The proposal would apply to foreign tax credits arising in 
taxable years beginning after December 31, 1997.

4. Reform treatment of foreign oil and gas income and dual-capacity 
        taxpayers

                               Present Law

    U.S. persons are subject to U.S. income tax on their 
worldwide income. A credit against U.S. tax on foreign source 
income is allowed for foreign taxes. The foreign tax credit is 
available only for foreign income, war profits, and excess 
profits taxes and for certain taxes imposed in lieu of such 
taxes. Other foreign levies generally are treated as deductible 
expenses only. Treasury regulations provide detailed rules for 
determining whether a foreign levy is a creditable income tax. 
A levy generally is a tax if it is a compulsory payment under 
the authority of a foreign country to levy taxes and is not 
compensation for a specific economic benefit provided by a 
foreign country. A taxpayer that is subject to a foreign levy 
and also receives a specific economic benefit from such country 
is considered a ``dual capacity taxpayer.'' Under a safe harbor 
provided in the regulations, the portion of a foreign levy paid 
by a dual capacity taxpayer that is creditable is determined 
based on the foreign country's generally applicable tax or, if 
the foreign country has no general tax, the U.S. tax (Treas. 
Reg. sec. 1.901-2A(e)).
    The amount of foreign tax credits that a taxpayer may claim 
in a year is subject to a limitation that prevents taxpayers 
from using foreign tax credits to offset U.S. tax on U.S. 
source income. The foreign tax credit limitation is calculated 
separately for specific categories of income. The amount of 
creditable taxes paid or accrued (or deemed paid) in any 
taxable year which exceeds the foreign tax credit limitation is 
permitted to be carried back two years and carried forward five 
years. Under a special limitation, taxes on foreign oil and gas 
extraction income are creditable only to the extent that they 
do not exceed a specified amount (e.g., 35 percent of such 
income in the case of a corporation). A taxpayer must have 
excess limitation under the special rules applicable to foreign 
extraction taxes and excess limitation under the general 
foreign tax credit provisions in order to utilize excess 
foreign oil and gas extraction taxes in a carryback or 
carryforward year. A recapture rule applicable to foreign oil 
and gas extraction losses treats income that would otherwise be 
foreign oil and gas extraction income as foreign source income 
that is not considered oil and gas extraction income; the taxes 
on such income retain their character as foreign oil and gas 
extraction taxes and continue to be subject to the special 
limitation imposed on such taxes.
    Under the subpart F rules, U.S. 10-percent shareholders of 
a controlled foreign corporation (``CFC'') are subject to U.S. 
tax currently on their shares of certain income earned by the 
corporation, whether or not such income is distributed to the 
shareholders. Such income includes foreign base company oil 
related income (sec. 954(g)). Foreign base company oil related 
income is foreign oil related income other than income derived 
from a source within a foreign country in connection with (1) 
oil or gas which was extracted from a well located in such 
foreign country or (2) oil, gas, or a primary product of oil or 
gas which is sold by the foreign corporation or a related 
person for use or consumption within such country or is loaded 
in such country as fuel on a vessel or aircraft. Foreign base 
company oil related income does not include income of small 
producers (i.e., corporations whose average daily oil and 
natural gas production, including production by related 
corporations, is less than 1,000 barrels).

                        Description of Proposal

    The proposal would deny the foreign tax credit with respect 
to all amounts paid or accrued (or deemed paid) to any foreign 
country by a dual-capacity taxpayer if the country does not 
impose a ``generally applicable income tax.'' A generally 
applicable income tax would be an income tax that is imposed on 
the income derived from business activities conducted within 
that country, provided that the tax has substantial application 
to persons who are not dual capacity taxpayers and to persons 
who are citizens or residents of the foreign country. If the 
foreign country imposes a generally applicable income tax, the 
foreign tax credit available to a dual-capacity taxpayer would 
not exceed the amount of tax that would be imposed under the 
generally applicable income tax. The proposal would not apply 
to the extent contrary to any treaty obligation of the United 
States.
    The proposal would replace the special limitation rules 
applicable to foreign oil and gas extraction income with a 
separate foreign tax credit limitation with respect to 
``foreign oil and gas income.'' For this purpose, foreign oil 
and gas income would include foreign oil and gas extraction 
income and foreign oil related income. The proposal would 
repeal the special carryover rules applicable to excess foreign 
oil and gas extraction taxes and would repeal the recapture 
rule for foreign oil and gas extraction losses.
    The proposal would treat foreign oil and gas extraction 
income as income which is subject to current U.S. taxation 
under the rules of subpart F.

                             Effective Date

    The proposal would apply to taxable years beginning after 
the date of enactment.

5. Replace sales source rules with activity-based rule

                               Present Law

    U.S. persons are subject to U.S. tax on their worldwide 
income. A credit against U.S. tax on foreign source income is 
allowed for foreign taxes. Specific rules apply in determining 
whether income is from U.S. or foreign sources. Income from the 
sale or exchange of inventory property that is produced (in 
whole or in part) within the United States and sold or 
exchanged outside the United States is treated as partly from 
U.S. sources and partly from foreign sources. Under Treasury 
regulations, a taxpayer may treat 50 percent of such income as 
attributable to production activities and 50 percent of such 
income as attributable to sales activities. Alternatively, a 
taxpayer may determine the income from production activities 
based upon an independent factory price. The portion of the 
income that is attributable to production activities generally 
is sourced based on the location of the production assets. The 
portion of the income that is attributable to sales activities 
generally is sourced where the sale occurs.

                        Description of Proposal

    Under the proposal, income from the sale or exchange of 
inventory property that is produced in the United States and 
sold or exchanged abroad would be apportioned between 
production activities and sales activities based on actual 
economic activity.

                             Effective Date

    The proposal would apply to taxable years beginning after 
the date of enactment.

                        D. Accounting Provisions

1. Termination of suspense accounts for family farm corporations 
        required to use accrual method of accounting

                               Present Law

    A corporation (or a partnership with a corporate partner) 
engaged in the trade or business of farming must use an accrual 
method of accounting for such activities unless such 
corporation (or partnership), for each prior taxable year 
beginning after December 31, 1975, did not have gross receipts 
exceeding $1 million. If a farm corporation is required to 
change its method of accounting, the section 481 adjustment 
resulting from such change is included in gross income ratably 
over a 10-year period, beginning with the year of change. This 
rule does not apply to a family farm corporation.
    A provision of the Revenue Act of 1987 (``1987 Act'') 
requires a family corporation (or a partnership with a family 
corporation as a partner) to use an accrual method of 
accounting for its farming business unless, for each prior 
taxable year beginning after December 31, 1985, such 
corporation (and any predecessor corporation) did not have 
gross receipts exceeding $25 million. A family corporation is 
one where 50 percent or more of the stock of the corporation is 
held by one family (or in some limited cases, two or three 
families).
    A family farm corporation that must change to an accrual 
method of accounting as a result of the 1987 Act provision is 
to establish a suspense account in lieu of including the entire 
amount of the section 481 adjustment in gross income. The 
initial balance of the suspense account equals the lesser of 
(1) the section 481 adjustment otherwise required for the year 
of change, or (2) the section 481 adjustment computed as if the 
change in method of accounting had occurred as of the beginning 
of the taxable year preceding the year of change.
    The amount of the suspense account is required to be 
included in gross income if the corporation ceases to be a 
family corporation. In addition, if the gross receipts of the 
corporation attributable to farming for any taxable year 
decline to an amount below the lesser of (1) the gross receipts 
attributable to farming for the last taxable year for which an 
accrual method of accounting was not required, or (2) the gross 
receipts attributable to farming for the most recent taxable 
year for which a portion of the suspense account was required 
to be included in income, a portion of the suspense account is 
required to be included in gross income.

                        Description of Proposal

    The proposal would repeal the ability of a family farm 
corporation to establish a suspense account when it is required 
to change to an accrual method of accounting. Thus, under the 
proposal, any family farm corporation required to change to an 
accrual method of accounting would restore the section 481 
adjustment applicable to the change in gross income ratably 
over a 10-year period beginning with the year of change. In 
addition, any taxpayer with an existing suspense account would 
be required to restore the account into income ratably over a 
10-period, beginning with the first taxable year beginning 
after the effective date.

                             Effective Date

    The proposal would be effective for taxable years ending 
after the date of first committee action.

2. Repeal lower of cost or market inventory accounting method

                               Present Law

    A taxpayer that sells goods in the active conduct of its 
trade or business generally must maintain inventory records in 
order to determine the cost of goods it sold during the taxable 
period. Cost of goods sold generally is determined by adding 
the taxpayer's inventory at the beginning of the period to 
purchases made during the period and subtracting from that sum 
the taxpayer's inventory at the end of the period.
    Because of the difficulty of accounting for inventory on an 
item-by-item basis, taxpayers often use conventions that assume 
certain item or cost flows. Among these conventions are the 
``first-in-first-out'' (``FIFO'') method which assumes that the 
items in ending inventory are those most recently acquired by 
the taxpayer, and the ``last-in-first-out'' (``LIFO'') method 
which assumes that the items in ending inventory are those 
earliest acquired by the taxpayer.
    Treasury regulations provide that taxpayers that maintain 
inventories under the FIFO method may determine the value of 
ending inventory under a (1) cost method or (2) ``lower of cost 
or market'' (``LCM'') method (Treas. reg. sec. 1.471-2(c)). 
Under the LCM method, the value of ending inventory is written 
down if its market value is less than its cost. Similarly, 
under the subnormal goods method, any goods that are unsalable 
at normal prices or unusable in the normal way because of 
damage, imperfections, shop wear, changes of stye, odd or 
broken lots, or other similar causes, may be written down to 
net selling price.
    Retail merchants may use the ``retail method'' in valuing 
ending inventory. Under the retail method, the total of the 
retail selling prices of goods on hand at year end is reduced 
to approximate cost by deducting an amount that represents the 
gross profit embedded in the retail prices. The amount of the 
reduction generally is determined by multiplying the retail 
price of goods available at yearend by a fraction, the 
numerator of which is the cost of goods available for sale 
during the year and the denominator of which is the total 
retail selling prices of the goods available for sale during 
the year, with adjustments for mark-ups and mark-downs (Treas. 
reg. sec. 1.471-8(a)). Under certain conditions, a taxpayer 
using the FIFO method may determine the approximate cost or 
market of inventory by not taking into account retail price 
mark-downs for the goods available for sale during the year, 
even though such mark-downs are reflected in the retail selling 
prices of the goods of goods on hand at year end (Treas. reg. 
sec. 1.471-8(d)). As a result, such taxpayer may write down the 
value of inventory below both its cost and its market value.

                        Description of Proposal

    The proposal would repeal the LCM method and the subnormal 
goods method. Appropriate wash-sale rules would be provided. 
The proposal would not apply to taxpayers with average annual 
gross receipts over a three-year period of $5 million or less.

                             Effective Date

    The proposal would be effective for taxable years beginning 
after the date of enactment. Any section 481(a) adjustment 
required to be taken into account pursuant to the change of 
method of accounting under the proposal would be taken into 
account ratably over a four taxable year period beginning with 
the first taxable year the taxpayer is required to change its 
method of accounting.

3. Repeal components of cost inventory accounting method

                               Present Law

    Taxpayers using the LIFO method to account for inventories 
may use the ``dollar-value'' LIFO method. Under the dollar-
value LIFO method, inventory items are expressed in terms of 
constant dollars and ``base-year'' costs (rather than units), 
and are grouped in inventory pools. Total base-year costs by 
pool, rather than the quantity of specific goods, are used to 
measure inventory increases and decreases. If ending inventory 
at base-year costs is greater than beginning inventory at base-
year costs (i.e., there has been an increase in inventory), 
such increase is valued at current-year costs. Taxpayers define 
items in the pool under the ``total product cost'' (``TPC'') 
method or the ``components of cost'' (``COC'') method. Under 
the TPC method, ending inventory is determined by valuing the 
items in ending inventory by the base-year cost of producing 
such items. Under the COC method, taxpayers do not measure 
ending inventory with reference to the total product cost of 
producing the items in ending inventory, but rather treat the 
units of production (i.e., the amount of material, labor, and 
overhead) that were used to produce the inventory as separate 
items.
    The proper application of the COC method to labor and 
overhead is unclear under present law.45 
Accordingly, the COC method as applied by some taxpayers may 
produce different results than the TPC method whenever a 
taxpayer's production processes change between the base year 
and the current year. For example, assume that in the base year 
the taxpayer can produce an item by applying 5 units of 
material at $8 a unit, 10 hours of direct labor at $10 an hour, 
and 10 hours of overhead at $5 an hour.46 Thus, it 
costs $190 to produce an item in the base year (5 times $8, 
plus 10 times $10, plus 10 times $5). Further assume that: (1) 
the taxpayer's production processes change such that in the 
current year it now takes 5 units of materials, 5 hours of 
direct labor, and 5 hours of overhead to produce the same item; 
(2) the prices for materials, labor, and overhead have remained 
constant from the base year to the current year; and (3) one 
item of inventory remains at the end of the current year. Under 
the TPC method, because prices have remained constant, ending 
inventory would be valued at $190 (the total product cost of 
producing one item in the base year). Under the COC method as 
applied by some taxpayers, ending inventory could be valued at 
$115 (5 units of materials times $8, plus 5 hours of direct 
labor times $10, plus 5 hours of overhead times $5).
---------------------------------------------------------------------------
    \45\ The use of the COC method as applied by some taxpayers with 
respect to labor and overhead costs is not specifically provided for in 
the Code or regulations, but such method may be used for financial 
accounting purposes. Treasury regulations allow taxpayers to treat raw 
materials (and the raw material content of work-in-process and finished 
goods) as a separate item under the LIFO method (Treas. Reg. sec. 
1.472-1(c)). The Internal Revenue Service (``IRS'') has ruled under the 
particular facts and circumstances of one taxpayer that the application 
of the COC method by that taxpayer did not clearly reflect income (TAM 
9405005).
    \46\ In this example, overhead is allocated to inventory pursuant 
to a burden rate based on direct labor hours. Such allocations are 
common.
---------------------------------------------------------------------------
    Thus, in this example, application of the COC method in 
this manner would reduce taxable income by $75 ($190 less $115) 
in the current year as compared to the TPC method. The $75 
reduction in taxable income is comprised of the following: (1) 
$50 of direct labor reductions (5 less direct labor hours times 
the $10 per hour labor rate) and (2) $25 of overhead 
reductions. In this case, the reduction in labor hours is 
demonstrable. However, the reduction in overhead results 
because of the use of the burden rate that allocates overhead 
based on direct labor hours rather than because of a 
demonstrable reduction of the appropriate amount of overhead to 
be applied to inventory. In fact, a reduction of labor hours in 
the current year may be attributable to an increased reliance 
upon overhead costs in the production process (e.g., reductions 
in workforce may result because of increased mechanization).

                        Description of Proposal

    The proposal would repeal the COC method.

                             Effective Date

    The proposal would be effective for taxable years beginning 
after the date of enactment. For taxpayers continuing to use a 
LIFO method of valuing inventory, the proposal would be applied 
on a cut-off basis. For taxpayers switching to a FIFO or other 
method of valuing inventory, the proposal would be applied 
pursuant to the present-law rules governing such changes in 
methods of accounting.
    The proposal is not intended to affect the determination of 
whether the COC method is an appropriate method under present 
law and it is intended that the IRS would not be precluded from 
challenging its use in taxable years beginning on or before the 
date of enactment.

                      E. Gain Deferral Provisions

1. Expansion of requirement that involuntarily converted property be 
        replaced with property from an unrelated person

                               Present Law

    Gain realized by a taxpayer from certain involuntary 
conversions of property is deferred to the extent the taxpayer 
purchases property similar or related in service or use to the 
converted property within a specified replacement period of 
time (sec. 1033). Pursuant to a provision of H.R. 831, as 
passed by the Congress and signed by the President on April 11, 
1995 (P.L.104-7), subchapter C corporations (and certain 
partnerships with corporate partners) are not entitled to defer 
gain under section 1033 if the replacement property or stock is 
purchased from a related person.

                        Description of Proposal

    The proposal would expand the present-law denial of the 
application of section 1033 to any other taxpayer (including an 
individual) that acquires replacement property from a related 
party (as defined by secs. 267(b) and 707(b)(1)) unless the 
taxpayer has aggregate realized gain of $100,000 or less for 
the taxable year with respect to converted property with 
aggregate realized gains. In the case of a partnership (or S 
corporation), the annual $100,000 limitation would apply to 
both the partnership (or S corporation) and each partner (or 
shareholder).

                             Effective Date

    The proposal would apply to involuntary conversions 
occurring after the first date of committee action.

2. Further restrict like-kind exchanges involving foreign personal 
        property

                               Present Law

Like-kind exchanges

    An exchange of property, like a sale, generally is a 
taxable event. However, no gain or loss is recognized if 
property held for productive use in a trade or business or for 
investment is exchanged for property of a ``like-kind'' which 
is to be held for productive use in a trade or business or for 
investment (sec. 1031). In general, any kind of real estate is 
treated as of a like-kind with other real property as long as 
the properties are both located either within or both outside 
the United States. In addition, certain types of property, such 
as inventory, stocks and bonds, and partnership interests, are 
not eligible for nonrecognition treatment under section 1031.
    If section 1031 applies to an exchange of properties, the 
basis of the property received in the exchange is equal to the 
basis of the property transferred, decreased by any money 
received by the taxpayer, and further adjusted for any gain or 
loss recognized on the exchange.

Application of depreciation rules

    Tangible personal property that is used predominantly 
outside the United States generally is accorded a less 
favorable depreciation regime than is property that is used 
predominantly within the United States. Thus, under present 
law, if a taxpayer exchanges depreciable U.S. property with a 
low adjusted basis (relative to its fair market value) for 
similar property situated outside the United States, the 
adjusted basis of the acquired property will be the same as the 
adjusted basis of the relinquished property, but the 
depreciation rules applied to such acquired property generally 
will be different than the rules that were applied to the 
relinquished property.

                        Description of Proposal

    The proposal would provide that personal property 
predominantly used within the United States and personal 
property predominantly used outside the United States are not 
``like-kind'' properties. For this purpose, the use of the 
property surrendered in the exchange will be determined based 
upon the use during the 24 months immediately prior to the 
exchange. Similarly, for section 1031 to apply, property 
received in the exchange must continue in the same use (i.e., 
foreign or domestic) for the 24 months immediately after the 
exchange. In addition, for purposes of the proposal, property 
used outside the United States but not subject to the 
depreciation rules applicable to such property would be treated 
as property used in the United States.

                             Effective Date

    The proposal would be effective for transfers after the 
date of first committee action.

                      F. Administrative Provisions

1. Registration of confidential corporate tax shelters

                               Present Law

    An organizer of a tax shelter is required to register the 
shelter with the Internal Revenue Service (IRS) (sec. 6111). If 
the principal organizer does not do so, the duty may fall upon 
any other participant in the organization of the shelter or any 
person participating in its sale or management. The shelter's 
identification number must be furnished to each investor who 
purchases or acquires an interest in the shelter. Failure to 
furnish this number to the tax shelter investors will subject 
the organizer to a $100 penalty for each such failure (sec. 
6707(b)).
    A penalty may be imposed against an organizer who fails 
without reasonable cause to timely register the shelter or who 
provides false or incomplete information with respect to it. 
The penalty is the greater of 1 percent of the aggregate amount 
invested in the shelter or $500. Any person claiming any tax 
benefit with respect to a shelter must report its registration 
number on her return. Failure to do so without reasonable cause 
will subject that person to a $250 penalty (sec. 6707(b)(2)).
    A person who organizes or sells an interest in a tax 
shelter subject to the registration rule or in any other 
potentially abusive plan or arrangement must maintain a list of 
the investors (sec. 6112). A $50 penalty may be assessed for 
each name omitted from the list. The maximum penalty per year 
is $100,000 (sec. 6708).
    For this purpose, a tax shelter is defined as any 
investment that meets two requirements. First, the investment 
must be (1) required to be registered under a Federal or State 
law regulating securities, (2) sold pursuant to an exemption 
from registration requiring the filing of a notice with a 
Federal or State agency regulating the offering or sale of 
securities, or (3) a substantial investment. Second, it must be 
reasonable to infer that the ratio of deductions and 350 
percent of credits to investment for any investor (i.e., the 
tax shelter ratio) may be greater than two to one as of the 
close of any of the first five years ending after the date on 
which the investment is offered for sale. An investment that 
meets these requirements will be considered a tax shelter 
regardless of whether it is marketed or customarily designated 
as a tax shelter (sec. 6111(c)(1)).

                        Description of Proposal

    The proposal would require a promoter of a corporate tax 
shelter to register the shelter with the Secretary. 
Registration would be required not later than the next business 
day after the day when the tax shelter is first offered to 
potential users. If the promoter is not a U.S. person, or if a 
required registration is not otherwise made, then any U.S. 
participant would be required to register the shelter. An 
exception to this special rule provides that registration would 
not be required if the U.S. participant notifies the promoter 
in writing not later than 90 days after discussions began that 
the U.S. participant will not participate in the shelter and 
the U.S. person does not in fact participate in the shelter.
    A corporate tax shelter is any investment, plan, 
arrangement or transaction (1) a significant purpose of the 
structure of which is tax avoidance or evasion by a corporate 
participant, (2) that is offered to any potential participant 
under conditions of confidentiality, and (3) for which the tax 
shelter promoters may receive total fees in excess of $100,000.
    A transaction is offered under conditions of 
confidentiality if: (1) an offeree (or any person acting on its 
behalf) has an understanding or agreement with or for the 
benefit of any promoter to restrict or limit its disclosure of 
the transaction or any significant tax features of the 
transaction; or (2) the promoter claims, knows or has reason to 
know (or the promoter causes another person to claim or 
otherwise knows or has reason to know that a party other than 
the potential offeree claims) that the transaction (or one or 
more aspects of its structure) is proprietary to the promoter 
or any party other than the offeree, or is otherwise protected 
from disclosure or use. The promoter includes specified related 
parties.
    Registration will require the submission of information 
identifying and describing the tax shelter and the tax benefits 
of the tax shelter, as well as such other information as the 
Treasury Department may require.
    Tax shelter promoters are required to maintain lists of 
those who have signed confidentiality agreements, or otherwise 
have been subjected to nondisclosure requirements, with respect 
to particular tax shelters. In addition, promoters must retain 
lists of those paying fees with respect to plans or 
arrangements that have previously been registered (even though 
the particular party may not have been subject to 
confidentiality restrictions).
    All registrations will be treated as taxpayer information 
under the provisions of section 6103 and will therefore not be 
subject to any public disclosure.
    The penalty for failing to timely register a corporate tax 
shelter is the greater of $10,000 or 50 percent of the fees 
payable to any promoter with respect to offerings prior to the 
date of late registration (i.e., this part of the penalty does 
not apply to fee payments with respect to offerings after late 
registration). A similar penalty is applicable to actual 
participants in any corporate tax shelter who were required to 
register the tax shelter but did not. With respect to 
participants, however, the 50-percent penalty is based only on 
fees paid by that participant. Intentional disregard of the 
requirement to register by either a promoter or a participant 
increases the 50-percent penalty to 75 percent of the 
applicable fees.

                             Effective Date

    The proposal would apply to any tax shelter offered to 
potential participants after the date the Treasury Department 
issues guidance with respect to the filing requirements.

2. Information reporting on persons receiving contract payments from 
        certain Federal agencies

                               Present Law

    A service recipient (i.e., a person for whom services are 
performed) engaged in a trade or business who makes payments of 
remuneration in the course of that trade or business to any 
person for services performed must file with the IRS an 
information return reporting such payments (and the name, 
address, and taxpayer identification number of the recipient) 
if the remuneration paid to the person during the calendar year 
is $600 or more (sec. 6041A(a)). A similar statement must also 
be furnished to the person to whom such payments were made 
(sec. 6041A(e)). Treasury regulations explicitly exempt from 
this reporting requirement payments made to a corporation 
(Treas. Reg. 1.6041A-1(d)(2)).
    The head of each Federal executive agency must file an 
information return indicating the name, address, and taxpayer 
identification number (TIN) of each person (including 
corporations) with which the agency enters into a contract 
(sec. 6050M). The Secretary of the Treasury has the authority 
to require that the returns be in such form and be made at such 
time as is necessary to make the returns useful as a source of 
information for collection purposes. The Secretary is given the 
authority both to establish minimum amounts for which no 
reporting is necessary as well as to extend the reporting 
requirements to Federal license grantors and subcontractors of 
Federal contracts. Treasury regulations provide that no 
reporting is required if the contract is for $25,000 or less 
(Treas. Reg. 1.6050M-1(c)(1)(i)).

                        Description of Proposal

    The proposal would require reporting of all payments of 
$600 or more made by a Federal executive agency to any person 
(including a corporation) for services. In addition, the 
proposal would require that a copy of the information return be 
sent by the Federal agency to the recipient of the payment. An 
exception would be provided for certain classified or 
confidential contracts.

                             Effective Date

    The proposal would be effective for returns the due date 
for which (without regard to extensions) is more than 90 days 
after the date of enactment.

3. Increased information reporting penalties

                               Present Law

    Any person who fails to file a correct information return 
with the IRS on or before the prescribed filing date is subject 
to a penalty that varies based on when, if at all, the correct 
information return is filed. If a person files a correct 
information return after the prescribed filing date but on or 
before the date that is 30 days after the prescribed filing 
date, the penalty is $15 per return, with a maximum penalty of 
$75,000 per calendar year. If a person files a correct 
information return after the date that is 30 days after the 
prescribed filing date but on or before August 1 of that year, 
the penalty is $30 per return, with a maximum penalty of 
$150,000 per calendar year. If a correct information return is 
not filed on or before August 1, the amount of the penalty is 
$50 per return, with a maximum penalty of $250,000 per calendar 
year.
    There is a special rule for de minimis failures to include 
the required, correct information. This exception applies to 
incorrect information returns that are corrected on or before 
August 1. Under the exception, if an information return is 
originally filed without all the required information or with 
incorrect information and the return is corrected on or before 
August 1, then the original return is treated as having been 
filed with all of the correct required information. The number 
of information returns that may qualify for this exception for 
any calendar year is limited to the greater of (1) 10 returns 
or (2) one-half of 1 percent of the total number of information 
returns that are required to be filed by the person during the 
calendar year.
    In addition, there are special, lower maximum levels for 
this penalty for small businesses. For this purpose, a small 
business is any person having average annual gross receipts for 
the most recent three taxable years ending before the calendar 
year that do not exceed $5 million. The maximum penalties for 
small businesses are: $25,000 (instead of $75,000) if the 
failures are corrected on or before 30 days after the 
prescribed filing date; $50,000 (instead of $150,000) if the 
failures are corrected on or before August 1; and $100,000 
(instead of $250,000) if the failures are not corrected on or 
before August 1.
    If a failure to file a correct information return with the 
IRS is due to intentional disregard of the filing requirement, 
the penalty for each such failure is generally increased to the 
greater of $100 or ten percent of the amount required to be 
reported correctly, with no limitation on the maximum penalty 
per calendar year (sec. 6721(e)). The increase in the penalty 
applies regardless of whether a corrected information return is 
filed, the failure is de minimis, or the person subject to the 
penalty is a small business.

                        Description of Proposal

    The proposal would increase the penalty for failure to file 
information returns correctly on or before August 1 from $50 
for each return to the greater of $50 or 5 percent of the 
amount required to be reported correctly but not so reported. 
The $250,000 maximum penalty for failure to file correct 
information returns during any calendar year ($100,000 with 
respect to small businesses) would continue to apply under the 
proposal.
    The proposal also would provide for an exception to this 
increase where substantial compliance has occurred. The 
proposal would provide that this exception would apply with 
respect to a calendar year if the aggregate amount that is 
timely and correctly reported for that calendar year is at 
least 97 percent of the aggregate amount required to be 
reported under that section of the Code for that calendar year. 
If this exception applies, the present-law penalty of $50 for 
each return would continue to apply.
    The proposal would not affect the following provisions of 
present law: (1) the reduction in the $50 penalty where 
correction is made within a specified period; (2) the exception 
for de minimis failures; (3) the lower limitations for persons 
with gross receipts of not more than $5,000,000; (4) the 
increase in the penalty in cases of intentional disregard of 
the filing requirement; (5) the penalty for failure to furnish 
correct payee statements under section 6722; (6) the penalty 
for failure to comply with other information reporting 
requirements under section 6723; and (7) the reasonable cause 
and other special rules under section 6724.

                             Effective Date

    The proposal would apply to information returns the due 
date for which (without regard to extensions) is more than 90 
days after the date of enactment.

4. Disclosure of tax return information for administration of certain 
        veterans' programs

                               Present Law

    The Internal Revenue Code prohibits disclosure of tax 
returns and return information, except to the extent 
specifically authorized by the Internal Revenue Code (sec. 
6103). Unauthorized disclosure is a felony punishable by a fine 
not exceeding $5,000 or imprisonment of not more than five 
years, or both (sec. 7213). An action for civil damages also 
may be brought for unauthorized disclosure (sec. 7431). No tax 
information may be furnished by the Internal Revenue Service 
(IRS) to another agency unless the other agency establishes 
procedures satisfactory to the IRS for safeguarding the tax 
information it receives (sec. 6103(p)).
    Among the disclosures permitted under the Code is 
disclosure to the Department of Veterans Affairs (DVA) of self-
employment tax information and certain tax information supplied 
to the Internal Revenue Service and Social Security 
Administration by third parties. Disclosure is permitted to 
assist DVA in determining eligibility for, and establishing 
correct benefit amounts under, certain of its needs-based 
pension, health care, and other programs (sec. 
6103(1)(7)(D)(viii)). The income tax returns filed by the 
veterans themselves are not disclosed to DVA.
    The DVA is required to comply with the safeguards currently 
contained in the Code and in section 1137(c) of the Social 
Security Act (governing the use of disclosed tax information). 
These safeguards include independent verification of tax data, 
notification to the individual concerned, and the opportunity 
to contest agency findings based on such information.
    The DVA disclosure provision is scheduled to expire after 
September 30, 1998.

                        Description of Proposal

    The proposal would extend the DVA disclosure provision 
through September 30, 2002.

                             Effective Date

    The proposal would be effective on the date of enactment.

5. Extension of withholding to certain gambling winnings

                               Present Law

    In general, proceeds from a wagering transaction are 
subject to withholding at a rate of 28 percent if the proceeds 
exceed $5,000 and are at least 300 times as large as the amount 
wagered. The proceeds from a wagering transaction are 
determined by subtracting the amount wagered from the amount 
received. No withholding tax is imposed on winnings from bingo 
or keno.

                        Description of Proposal

    The proposal would impose withholding on proceeds from 
bingo or keno wagering transactions at a rate of 28 percent if 
such proceeds exceed $5,000, regardless of the odds of the 
wager.

                             Effective Date

    The proposal would be effective for payments made after the 
beginning of the first month that begins at least 10 days after 
the date of enactment.

6. Reporting of certain payments made to attorneys

                               Present Law

    Information reporting is required by persons engaged in a 
trade or business and making payments in the course of that 
trade or business of ``rent, salaries, wages, . . . or other 
fixed or determinable gains, profits, and income'' (Code sec. 
6041(a)). Treas. Reg. sec. 1.6041-1(d)(2) provides that 
attorney's fees are required to be reported if they are paid by 
a person in a trade or business in the course of a trade or 
business. Reporting is required to be done on Form 1099-Misc. 
If, on the other hand, the payment is a gross amount and it is 
not known what portion is the attorney's fee, no reporting is 
required on any portion of the payment.

                        Description of Proposal

    The proposal would require gross proceeds reporting on all 
payments to attorneys made by a trade or business in the course 
of that trade or business. It is anticipated that gross 
proceeds reporting would be required on Form 1099-B (currently 
used by brokers to report gross proceeds). The only exception 
to this new reporting requirement would be for any payments 
reported on either Form 1099-Misc under section 6041 (reports 
of payment of income) or on Form W-2 under section 6051 
(payments of wages).
    In addition, the present exception in the regulations 
exempting from reporting any payments made to corporations 
would not apply to payments made to attorneys. Treas. Reg. sec. 
1.6041-3(c) exempts payments to corporations generally 
(although payments to most corporations providing medical 
services must be reported). Reporting would be required under 
both Code sections 6041 and 6045 (as proposed) for payments to 
corporations that provide legal services. The exception of 
Treas. Reg. sec. 1.6041-3(g) exempting from reporting payments 
of salaries or profits paid or distributed by a partnership to 
the individual partners would continue to apply to both 
sections (since these amounts are required to reported on Form 
K-1).
    First, the proposal would apply to payments made to 
attorneys regardless of whether the attorney is the exclusive 
payee. Second, payments to law firms are payments to attorneys, 
and therefore would be subject to this reporting provision. 
Third, attorneys would be required to promptly supply their 
TINs to persons required to file these information reports, 
pursuant to section 6109. Failure to do so could result in the 
attorney being subject to penalty under section 6723 and the 
payments being subject to backup withholding under section 
3406. Fourth, the IRS should administer this provision so that 
there is no overlap between reporting under section 6041 and 
reporting under section 6045. For example, if two payments are 
simultaneously made to an attorney, one of which represents the 
attorney's fee and the second of which represents the 
settlement with the attorney's client, the first payment would 
be reported under section 6041 and the second payment would not 
be reported under either section 6041 or section 6045, since it 
is known that the entire payment represents the settlement with 
the client (and therefore no portion of it represents income to 
the attorney).

                             Effective Date

    The proposal would be effective for payments made after 
December 31, 1997. Consequently, the first information reports 
would be filed with the IRS (and copies will be provided to 
recipients of the payments) in 1999, with respect to payments 
made in 1998.

7. Modify the substantial understatement penalty

                               Present Law

    A 20-percent penalty applies to any portion of an 
underpayment of income tax required to be shown on a return 
that is attributable to a substantial understatement of income 
tax. For this purpose, an understatement is considered 
``substantial'' if it exceeds the greater of (1) 10 percent of 
the tax required to be shown on the return, and (2) $5,000 
($10,000 in the case of a corporation other than an S 
corporation or a personal holding company). Generally, the 
amount of an ``understatement'' of income tax is the excess of 
the tax required to be shown on the return, over the tax shown 
on the return (reduced by any rebates of tax). The substantial 
understatement penalty does not apply if there was a reasonable 
cause for the understatement and the taxpayer acted in good 
faith with respect to the understatement (the ``reasonable 
cause exception''). The determination as to whether the 
taxpayer acted with reasonable cause and in good faith is made 
on a case-by-case basis, taking into account all pertinent 
facts and circumstances.

                        Description of Proposal

    The proposal would treat a corporation's deficiency of more 
than $10 million as substantial for purposes of the substantial 
understatement penalty, regardless of whether it exceeds 10 
percent of the taxpayer's total tax liability.

                             Effective Date

    The proposal would be effective for taxable years beginning 
after the date of enactment.

8. Establish IRS continuous levy and improve debt collection

    a. Continuous levy

                               Present Law

    If any person is liable for any internal revenue tax and 
does not pay it within 10 days after notice and demand 
47 by the IRS, the IRS may then collect the tax by 
levy upon all property and rights to property belonging to the 
person, 48 unless there is an explicit statutory 
restriction on doing so. A levy is the seizure of the person's 
property or rights to property. Property that is not cash is 
sold pursuant to statutory requirements.49
---------------------------------------------------------------------------
    \47\ Notice and demand is the notice given to a person liable for 
tax stating that the tax has been assessed and demanding that payment 
be made. The notice and demand must be mailed to the person's last 
known address or left at the person's dwelling or usual place of 
business. Code sec. 6303.
    \48\ Code sec. 6331.
    \49\ Code secs. 6335-6343.
---------------------------------------------------------------------------
    In general, a levy does not apply to property acquired 
after the date of the levy, 50 regardless of whether 
the property is held by the taxpayer or by a third party (such 
as a bank) on behalf of a taxpayer. Successive seizures may be 
necessary if the initial seizure is insufficient to satisfy the 
liability.51 The only exception to this rule is for 
salary and wages.52 A levy on salary and wages is 
continuous from the date it is first made until the date it is 
fully paid or becomes unenforceable.
---------------------------------------------------------------------------
    \50\ Code sec. 6331(b).
    \51\ Code sec. 6331(c).
    \52\ Code sec. 6331(e).
---------------------------------------------------------------------------
    A minimum exemption is provided for salary and 
wages.53 It is computed on a weekly basis by adding 
the value of the standard deduction plus the aggregate value of 
personal exemptions to which the taxpayer is entitled, divided 
by 52.54 For a family of four for taxable year 1996, 
the weekly minimum exemption is $325.55
---------------------------------------------------------------------------
    \53\ Code sec. 6334(a)(9).
    \54\ Code sec. 6334(d).
    \55\ Standard deduction of $6,700 plus four personal exemptions at 
$2,550 each equals $16,900, which when divided by 52 equals $325.
---------------------------------------------------------------------------

                        Description of Proposal

    The proposal would amend the Code to provide that a 
continuous levy is also applicable to non-means tested 
recurring Federal payments. This is defined as a Federal 
payment for which eligibility is not based on the income and/or 
assets of a payee. For example, Social Security payments would 
be subject to continuous levy.
    In addition, the proposal would provide that this levy 
would attach up to 15 percent of any salary or pension payment 
due the taxpayer. This rule would explicitly replace the other 
specifically enumerated exemptions from levy in the Code. Under 
the proposal, the continuous levy could apply to the entire 
amount of a Federal payment that is not salary or a pension 
payment.

                             Effective Date

    The proposal would be effective for levies issued after the 
date of enactment.

    b. Modifications of levy exemptions

                               Present Law

    The Code exempts from levy workmen's compensation payments 
56 and annuity or pension payments under the 
Railroad Retirement Act and benefits under the Railroad 
Unemployment Insurance Act 57 described above.
---------------------------------------------------------------------------
    \56\ Code sec. 6334(a)(7).
    \57\ Code sec. 6334(a)(6).
---------------------------------------------------------------------------

                        Description of Proposal

    The proposal would provide that the following property is 
not exempt from levy if the Secretary of the Treasury (or his 
delegate) approves the levy of such property:

        (1) workmen's compensation payments,58 and
---------------------------------------------------------------------------
    \58\ Many workmen's compensation payments are made by States. The 
heading of the new subsection of the Code (but not the text of the 
subsection itself) refers to ``Federal'' payments. A clarification of 
this matter may be desirable.
---------------------------------------------------------------------------
    (2) annuity or pension payments under the Railroad 
            Retirement Act and benefits under the Railroad 
            Unemployment Insurance Act.

                             Effective Date

    The proposal would apply to levies issued after the date of 
enactment.

                          G. Employment Taxes

1. Extension of Federal unemployment tax

                               Present Law

    The Federal Unemployment Tax Act (FUTA) imposes a 6.2 
percent gross tax rate on the first $7,000 paid annually by 
covered employers to each employee. Employers in States with 
programs approved by the Federal Government and with no 
delinquent Federal loans may credit 5.4 percentage points 
against the 6.2 percent tax rate, making the minimum, net 
Federal unemployment tax rate 0.8 percent. Since all States 
have approved programs, 0.8 percent is the Federal tax rate 
that generally applies. This Federal revenue finances 
administration of the system, half of the Federal-State 
extended benefits program, and a Federal account for State 
loans. The States are supposed to use the revenue turned back 
to them by the 5.4 percent credit to finance their regular 
State programs and half of the Federal-State extended benefits 
program.
    In 1976, Congress passed a temporary surtax of 0.2 percent 
of taxable wages to be added to the permanent FUTA tax rate. 
Thus, the current 0.8 percent FUTA tax rate has two components: 
a permanent tax rate of 0.6 percent, and a temporary surtax 
rate of 0.2 percent. The temporary surtax has been subsequently 
extended through 1998.

                        Description of Proposal

    The proposal would extend the temporary surtax rate through 
December 31, 2007.

                             Effective Date

    The proposal would be effective for labor performed on or 
after January 1, 1999.

2. Deposit requirement for Federal unemployment taxes

                               Present Law

    If an employer's liability for FUTA taxes is over $100 for 
any quarter, it must be deposited by the last day of the first 
month after the end of the quarter. Smaller amounts are subject 
to less frequent deposit rules.

                        Description of Proposal

    The proposal would require an employer to pay Federal and 
State unemployment taxes on a monthly basis in a given year if 
the employer's FUTA tax liability in the prior year was $1,100 
or more. The deposit with respect to wages paid during a month 
would be required to be made by the last day of the following 
month. A safe harbor would be provided for the required 
deposits for the first two months of each calendar quarter. For 
the first month in each quarter, the payment would be required 
to be the lesser of 30 percent of the actual FUTA liability for 
the quarter or 90 percent of the actual FUTA liability for the 
month. The cumulative deposits paid in the first two months of 
each quarter would be required to be the lesser of 60 percent 
of the actual FUTA liability for the quarter or 90 percent of 
the actual FUTA liability for the two months. The employer 
would be required to pay the balance of the actual FUTA 
liability for each quarter by the last day of the month 
following the quarter. States would be required to establish a 
monthly deposit mechanism but would be permitted to adopt a 
similar safe harbor mechanism for paying State unemployment 
taxes.

                             Effective Date

    The proposal would be effective for months beginning after 
December 31, 2001.

                            H. Excise Taxes

1. Reinstate Airport and Airway Trust Fund excise taxes

                               Present Law

     Before January 1, 1997, excise taxes were imposed on 
commercial air passenger and freight transportation and on 
fuels used in general aviation (i.e., transportation on non-
common carrier aircraft which is not for hire) to fund the 
Airport and Airway Trust Fund (the ``Airport Trust Fund''). The 
Airport Trust Fund was established in 1970 to finance a major 
portion of the costs of Federal Aviation Administration (the 
``FAA'') services and grant programs for State and local 
government airports. Before establishment of the Airport Trust 
Fund, Federal aviation expenditures were financed from general 
revenues; General Fund domestic air passenger and fuels taxes 
were imposed during this period. The structure of the Airport 
Trust Fund excise taxes has remained generally unchanged, 
except for rates, since 1970.
    Before 1997, the Airport Trust Fund excise taxes included 
three taxes on commercial air transportation:

  (1)  a 10-percent excise tax on domestic air passenger 
            transportation;
  (2)  a $6 per person international air passenger departure 
            tax; and
  (3)  a 6.25-percent domestic air freight excise tax.

     During the same period, general aviation (e.g., corporate 
aircraft) was subject to Airport Trust Fund excise taxes on the 
fuels it used rather than the commercial aviation passenger 
ticket and freight excise taxes. The Airport Trust Fund rates 
for these excise taxes were 17.5 cents per gallon for jet fuel 
and 15 cents per gallon for aviation gasoline.
    The Airport Trust Fund receives gross receipts attributable 
to the excise taxes described above. Present law provides that 
taxes received by the Treasury Department through the end of 
the period when the taxes were last imposed (i.e., through 
December 31, 1996) are deposited in the Airport Trust Fund. 
Taxes received after December 31, 1996, may not be transferred 
to the Airport Trust Fund under present law.

                        Description of Proposal

    The aviation excises taxes would be reimposed through 
September 30, 2007, at the same rates as in effect before 
January 1, 1997. Revenues from reinstatement of these taxes 
(and from taxes imposed during 1996 that were received by the 
Treasury after December 31, 1996) would be deposited in the 
Airport Trust Fund.
    The President's budget states that the Administration 
intends to propose legislation to replace these taxes, 
effective October 1, 1998, with cost-based user fees, as part 
of the Administration's effort to place the operation of and 
funding for the FAA on a more business-like basis. The revised 
charges would be governmental receipts made available in 
appropriations acts to fund discretionary spending.

                             Effective Date

    The reinstated excise taxes on air passenger transportation 
(including international departures) and freight waybills would 
apply to transportation during the period beginning seven days 
after the date of the proposal's enactment, but only with 
respect to amounts paid on and after that date.
    The reinstated portion of noncommercial aviation fuels 
taxes would apply to aviation fuel sold and aviation gasoline 
removed during the period beginning seven days after the date 
of the proposal's enactment.

2. Reinstate Leaking Underground Storage Tank Trust Fund excise tax

                               Present Law

    Before January 1, 1996, a 0.1-cent-per-gallon tax was 
imposed on gasoline, diesel fuel, special motor fuels, and 
fuels used on inland waterways. Revenues from this tax were 
deposited in the Leaking Underground Storage Tank (``LUST'') 
Trust Fund.

                        Description of Proposal

    The President's budget proposal would reinstate the LUST 
excise tax during the period after the date of the proposal's 
enactment and before October 1, 2007.
    Revenues from reinstatement of the tax would be deposited 
in the LUST Trust Fund.

                             Effective Date

    The proposal would be effective on the date of enactment.

3. Reinstate Superfund excise taxes and corporate environmental income 
        tax

                               Present Law

    Before January 1, 1996, four taxes were imposed to fund the 
Hazardous Substance Superfund Trust Fund (``Superfund'') 
program:

  (1)  an excise tax on petroleum and imported refined 
            products;
  (2)  an excise tax on certain hazardous chemicals, imposed at 
            rates that varied from $0.22 to $4.87 per ton;
  (3)  an excise tax on imported substances made with the 
            chemicals subject to the tax in (2), above; and
  (4)  an income tax on corporations calculated using the 
            alternative minimum tax rules.

                        Description of Proposal

     The President's budget proposal would reinstate the three 
Superfund excise taxes during the period after the date of the 
proposal's enactment and before October 1, 2007. The corporate 
environmental income tax would be reinstated for taxable years 
beginning after December 31, 1996, and before January 1, 2008.
     Revenues from reinstatement of these taxes would be 
deposited in the Superfund Trust Fund.

                             Effective Date

     The proposal would be effective on the date of enactment.

4. Reinstate Oil Spill Liability Trust Fund excise tax

                               Present Law

     A 5-cents-per-barrel excise tax was imposed before January 
1, 1995. Revenues from this tax were deposited in the Oil Spill 
Liability Trust Fund. The tax did not apply during any calendar 
quarter when the Treasury Department determined that the 
unobligated balance in this Trust Fund exceeded $1 billion.

                        Description of Proposal

     The President's budget proposal would reinstate the Oil 
Spill Liability Trust Fund tax during the period after the date 
of the proposal's enactment and before October 1, 2007. The 
proposal also would increase the $1 billion limit on the 
unobligated balance in this Oil Spill Liability Trust Fund to 
$2.5 billion.

                             Effective Date

     The proposal would be effective on the date of enactment.

5. Kerosene taxed as diesel fuel

                               Present Law

     Diesel fuel used as a transportation motor fuel generally 
is taxed at 24.3 cents per gallon. This tax is collected on all 
diesel fuel upon removal from a pipeline or barge terminal 
unless the fuel is indelibly dyed and is destined for a 
nontaxable use. Diesel fuel also commonly is used as heating 
oil; diesel fuel used as heating oil is not subject to tax. 
Certain other uses also are exempt from tax, and some 
transportation uses (e.g., rail and intercity buses) are taxed 
at reduced rates. Both exemptions and reduced-rates are 
realized through refund claims if undyed diesel fuel is used in 
a qualifying use.
     Aviation gasoline and jet fuel (both commercial and 
noncommercial use) currently are taxed at a rate of 4.3 cents 
per gallon. Before January 1, 1997, this aviation fuel was 
taxed at rates of 4.3 cents per gallon (commercial aviation); 
21.8 cents per gallon (noncommercial aviation jet fuel); and, 
19.3 cents per gallon (noncommercial aviation gasoline). Also, 
before January 1, 1996, an additional 0.1-cent-per-gallon tax 
was imposed to fund the Leaking Underground Storage Tank Trust 
Fund. Separate provisions of the President's budget proposal 
would reinstate those expired tax rates. The tax on non-
gasoline aviation fuel is imposed on the sale of the fuel by a 
``producer,'' typically a wholesale distributor. Thus, this tax 
is imposed at a point in the fuel distribution chain subsequent 
to removal from a terminal facility.
     Kerosene is used both as a transportation fuel and as an 
aviation fuel. Kerosene also is blended with diesel fuel 
destined both for taxable (highway) and nontaxable (heating 
oil) uses to, among other things, prevent gelling of the diesel 
fuel in cold temperatures. Under present law, kerosene is not 
subject to tax unless it is blended with taxable diesel fuel or 
is sold for use as aviation fuel. When kerosene is blended with 
dyed diesel fuel to be used in a nontaxable use, the dye 
concentration of the fuel mixture must be adjusted to ensure 
that it meets Treasury Department requirements for untaxed, 
dyed diesel fuel.
     Clear, low-sulphur kerosene (K-1) also is used in space 
heaters, and often is sold for this purpose at retail service 
stations. As with other heating oil uses, kerosene used in 
space heaters, is not subject to Federal excise tax. Although 
heating oil often has minor amounts of kerosene blended with it 
in colder weather, this blending typically occurs before 
removal of the fuel from the terminal facilities where Federal 
excise taxes are imposed. However, it may be necessary during 
periods of extreme or unseasonable cold to add kerosene to 
heating oil after its removal from the terminal. Other 
nontaxable uses of kerosene include feedstock use in the 
petrochemical industry.

                        Description of Proposal

     Kerosene would be subject to the same excise tax rules as 
diesel fuel. Thus, kerosene would be taxed when it is removed 
from a registered terminal unless it is indelibly dyed and 
destined for a nontaxable use. However, aviation-grade kerosene 
that is removed from the terminal by a registered producer of 
aviation fuel would not be subject to the dyeing requirement 
and would be taxed under the present law rules applicable to 
aviation fuel. Feedstock kerosene that a registered industrial 
user receives by pipeline or vessel also would be exempt from 
the dyeing requirement. Other feedstock kerosene would be 
exempt from the dyeing requirement to the extent and under 
conditions (including satisfaction of registration and 
certification requirements) prescribed by regulation. To 
accommodate State safety regulations that require the use of 
clear (K-1) kerosene in certain space heaters, a refund 
procedure would be provided under which registered ultimate 
vendors could claim refunds of the tax paid on kerosene sold 
for that use. In addition, the Internal Revenue Service would 
be given discretion to refund to a registered ultimate vendor 
the tax paid on kerosene that is blended with heating oil for 
use during periods of extreme or unseasonable cold.

                             Effective Date

     The proposal would be effective for kerosene removed from 
terminal facilities after June 30, 1998. Appropriate floor 
stocks taxes would be imposed on kerosene held beyond the point 
of taxation on July 1, 1998.

6. Exempt Federal vaccine purchases from vaccine excise tax for one 
        year

                               Present Law

     Under present law, a manufacturer's excise tax is imposed 
on the following vaccines routinely recommended for 
administration to children: DPT, $4.56 per dose; DT, $0.06 per 
dose; MMR, $4.44 per dose; and polio, $0.29 per dose. Any 
component vaccine of MMR (measles, mumps, or rubella) is taxed 
at the same rate as the MMR combined vaccine.
     Amounts equal to net revenues from this excise tax are 
deposited in the Vaccine Injury Compensation Trust Fund to 
finance compensation awards under the Federal Vaccine Injury 
Compensation Program for individuals who suffer certain 
injuries following administration of the taxable vaccines. This 
program provides a substitute Federal, ``no fault'' insurance 
system for the State-law tort and private liability insurance 
systems otherwise applicable to vaccine manufacturers. All 
persons immunized after September 30, 1988, with covered 
vaccines must pursue compensation under this Federal program 
before bringing civil tort actions under State law.

                        Description of Proposal

     The proposal would exempt vaccine purchases paid through 
grants from the Centers for Disease Control and Prevention and 
the Health Care Financing Administration from the vaccine 
excise tax for a 1-year period.

                             Effective Date

     The proposal would be effective for vaccine purchases 
after September 30, 1997, and before September 30, 1998.
      

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


       Estimated Budget Effects of the Revenue Provisions in the

              President's Fiscal Year 1998 Budget Proposal

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

                        EXPLANATION OF ESTIMATES

    This section contains two revenue tables prepared by the 
staff of the Joint Committee on Taxation and a Department of 
the Treasury table showing the effect of the President's 
proposal on receipts. The first Joint Committee revenue table 
provides the estimated budget effects of the revenue provisions 
contained in the President's fiscal year 1998 budget proposal. 
The second Joint Committee revenue table contains the estimated 
budget effects of the revenue provisions contained in the 
President's fiscal year 1998 budget proposal, based on the 
hypothetical assumption that such provisions will be enacted on 
a permanent basis (i.e., that such provisions will not be 
subject to the so-called ``tax cut sunset'' mechanism contained 
in the President's budget proposal).
    The sections describing the President's budget proposal 
that were transmitted to the Congress on Thursday, February 6, 
1997, indicated that a mechanism would apply to ensure that the 
budget is balanced in 2002 under both Office of Management and 
Budget (``OMB'') and Congressional Budget Office (``CBO'') 
economic assumptions. Specifically, the President's budget 
document states the following:

        ``The Administration is confident that its own 
        assumptions will continue to prove the more accurate.

        ``Nevertheless, the budget includes a mechanism to 
        ensure that the President's plan reaches balance in 
        2002 under OMB or CBO assumptions. If OMB's assumptions 
        prove correct, as we expect, then the mechanism would 
        not take effect. If, however, CBO proves correct--and 
        the President and Congress cannot agree on how to close 
        the gap through expedited procedures--then most of the 
        President's tax cuts would sunset, and discretionary 
        budget authority and identified entitlement programs 
        would face an across-the-board limit.'' \1\ (Emphasis 
        added.)
---------------------------------------------------------------------------
    \1\ Office of Management and Budget, Budget of the United States 
Government, Fiscal Year 1998, at p. 16.

    The February 6, 1997, budget documents published by the 
Administration contain no additional detail with respect to the 
sunset mechanism as it relates to the President's tax 
proposals. Subsequent to transmittal of these documents, 
however, the Administration has provided additional detail 
concerning certain of its tax reduction provisions.
    First, the Administration has provided specific statutory 
language relating to the following provisions: (1) the tax 
credit for families with young children, (2) the HOPE 
scholarship tuition tax credit, (3) the education and job 
training deduction, (4) the expanded Individual Retirement 
Arrangement (``IRA'') provisions, and (5) the deduction for 
environmental remediation expenses (``Brownfields'').\2\ Under 
that language, these provisions are to terminate or ``sunset'' 
for taxable years beginning after December 31, 2000.
---------------------------------------------------------------------------
    \2\ Memorandum for Ken Kies, Joint Committee on Taxation, from the 
Deputy Director of the Office of Management and Budget (February 26, 
1997).
---------------------------------------------------------------------------
    Second, the Administration provided an OMB outline 
description including certain conditions under which it is 
contemplated Congress could consider subsequent legislation 
after October 2000 to reinstate the tax reduction provisions 
that the Administration is proposing to sunset after December 
31, 2000. This outline indicates that if certain deficit 
targets are achieved for fiscal year 2000, as determined 
pursuant to a Treasury Department report to be made in October 
2000, ``. . . a legislative fast track is provided for 
reenactment of the tax cuts that had been sunset. . . .'' \3\ A 
similar possible reenactment scenario is contemplated for 
fiscal year 2001.
---------------------------------------------------------------------------
    \3\ Office of Management and Budget, Mechanism to Assure Balance on 
CBO Assumptions, Received February 10, 1997.
---------------------------------------------------------------------------
    Based on the information supplied by the Administration, 
the statutory language for the sunset mechanism provides that 
the specified tax cut provisions would be sunsetted after 
December 31, 2000. Contrary to language contained in the 
February 6, 1997, budget documents, this would be the case 
under either OMB or CBO economic assumptions.
    The first revenue table contains the estimates of the staff 
of the Joint Committee on Taxation of the revenue provisions in 
the President's budget proposal taking account of the sunset of 
certain of the tax cut provisions as specified in the statutory 
draft provided by the OMB.
    The second Joint Committee revenue table reflects a 
hypothetical revenue estimate of the revenue provisions in the 
President's budget as if those revenue provisions subject to 
sunset are permanent. This is a hypothetical estimate because 
subsequent congressional action after October 2000 would be 
required to make these provisions permanent.
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=======================================================================


                                MEDICARE

The President's FY1998 budget includes proposed savings in 
Medicare which, based on the Administration's estimates, would 
save a net $106.1 billion over the 5-year period, FY1998-
FY2002. The Congressional Budget Office (CBO) has estimated the 
savings at a net $81.6 billion for the same period. The 
following section summarizes the major Medicare provisions.

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

                                 PART A

                               Hospitals

Annual hospital payment updates 

                              Present Law

    Medicare pays most acute care hospitals under a prospective 
payment system (PPS). A fixed predetermined amount is paid 
according to the patient's diagnosis. Certain types of 
hospitals and distinct-part units of hospitals are exempt from 
PPS (psychiatric, rehabilitation, long-term care, cancer and 
children's hospitals). A PPS-exempt hospital is paid the lower 
of its current Medicare allowable inpatient operating costs per 
discharge or a target amount. Payments to PPS hospitals and 
PPS-exempt hospitals and distinct-part units are updated 
annually using an update factor which is determined in part by 
the projected increase in the hospital market basket index 
(MBI) which measures the cost of goods and services purchased 
by hospitals.

                        Description of Proposal

    The proposal would reduce the annual update by 1 percent 
for PPS hospitals for each year from FY1998-FY2002. PPS-exempt 
hospital and distinct-part unit updates would be reduced by 1.5 
percent for each year from FY1998-FY2002.

Hospital-capital payments

                              Present Law

    Medicare pays its proportionate share of certain hospital 
capital-related costs. Capital-related costs primarily include 
interest and depreciation related to construction of facilities 
and purchase of equipment. A 10-year transition to fully 
prospective payments for capital costs began in FY1992, during 
which capital payments are paid prospectively based on average 
capital costs per case in FY1989, updated for inflation and 
other cost changes.
     From FY1992 through FY1995, Health Care Financing 
Administration (HCFA) updated base payment rates using a moving 
average of capital cost increases in previous years. During 
this period, the Congress required HCFA to adjust the payment 
rates in each year so that anticipated aggregate capital 
payments would equal 90 percent of anticipated aggregate costs. 
This provision expired on September 30, 1995, resulting in a 
20.6 percent increase in the Federal capital payment rate for 
FY1996.

                        Description of Proposal

    The proposal would reduce the 1998 hospital capital payment 
rate by 15.7 percent, which would effectively limit payments 
for capital to 90 percent of what they would have been under a 
reasonable cost system. In addition, the proposal would pay 85 
percent of capital costs for PPS-exempt hospitals and distinct 
units.

Definition of hospital ``transfer''

                              Present Law

     PPS hospitals that move patients to PPS-exempt hospitals 
and distinct-part units, or skilled nursing facilities (SNFs) 
are currently considered to have ``discharged'' the patient and 
receive a full diagnosis related group (DRG) payment.

                        Description of Proposal

     The proposal would define the moving of a patient as a 
``transfer'' rather than as a ``discharge'' from the acute care 
hospital, and the PPS hospital payment would be determined on a 
per diem basis instead of the DRG payment.

Rural health provisions

                              Present Law

     The Medicare program includes special payments for certain 
rural hospitals in order to maintain beneficiary access to 
health care services and providers.

                        Description of Proposal

     The proposal would: (1) extend the Rural Referral Center 
program; (2) improve the Sole Community Hospital program; (3) 
expand the Rural Primary Care Hospital program; and (4) extend 
the Medicare Dependent Hospital program.

Graduate medical education payments

                              Present Law

     Medicare pays teaching hospitals for its share of the 
costs of providing graduate medical education. Direct graduate 
medical education payments (direct GME) are based on a 
hospital's per resident costs (i.e., resident and faculty 
salaries and fringe benefits, and overhead costs related to 
teaching activities) and the number of full-time-equivalent 
residents the hospital employs. The indirect costs are 
reimbursed through the indirect medical education (IME) payment 
adjustment. This adjustment is designed to compensate teaching 
hospitals for their relatively higher costs attributable to the 
involvement of residents in patient care and the severity of 
illness of patients requiring specialized services available 
only in teaching hospitals. The IME adjustment to Medicare's 
hospital payments is currently increased approximately 7.7 
percent for each 10 percent increase in a hospital's ratio of 
interns and residents to beds.

                        Description of Proposal

     The proposal would: (1) cap the total number of residents 
and the number of non-primary care residency positions 
reimbursed under Medicare at the current level; (2) count work 
in non-hospital settings for the IME adjustment; and (3) allow 
direct GME payments to certain non-hospitals (e.g., Federally 
Qualified Health Centers) for primary care residents in those 
settings, when a hospital is not paying for the resident's 
salary in that setting.
     In addition, the proposal would reduce the IME adjustment 
from its current level of about 7.7 percent to 7.4 percent in 
FY1998; 7.1 percent in FY1999; 6.8 percent in FY2000; 6.6 
percent in FY2001; and 5.5 percent in FY2002 and years 
thereafter.

Disproportionate Share Hospital (DSH) payments

                              Present Law

     Additional payments are made to hospitals that serve a 
disproportionate share of low-income patients. A hospital's 
disproportionate patient percentage is defined as the 
hospital's total number of inpatient days attributable to 
Federal Supplemental Security Income (SSI) Medicare 
beneficiaries divided by the total number of Medicare patient 
days, plus the number of Medicaid patient days divided by the 
total patient days.

                        Description of Proposal

     The proposal would freeze hospital-specific 
disproportionate share hospital (DSH) adjustments at current 
levels for FY1998 and FY1999. The Secretary would be required 
to submit a legislative proposal to Congress by April 1, 1999 
for revising the qualifying criteria and payment methodology 
for hospitals that incur higher Medicare costs because they 
serve a disproportionate share of low-income patients. If no 
action is taken by FY2000, the old (current law) formula would 
be reinstated.

Payment to teaching and disproportionate share hospitals
    from managed care rates

                              Present Law

    In its calculation of payment rates to Medicare risk-
contract HMOs, Medicare includes payments to teaching hospitals 
operating residency training programs and DSH that serve a 
disproportionate share of low-income persons.

                        Description of Proposal

     The proposal would remove from amounts paid to Medicare 
risk-contract HMOs, the direct GME, IME and DSH payments. These 
amounts would then be distributed directly to teaching and DSH 
hospitals for Medicare managed care enrollees. These funds 
would also be available for managed care plans that run their 
own teaching programs. (See Medicare Managed Care, Payment Rate 
Changes.)

Other hospital proposals

                              Present Law

     Long-term hospitals are exempt from PPS and instead are 
paid the lower of their current Medicare allowable inpatient 
operating costs per discharge, or a target amount. Medicare 
makes additional ``outlier'' payments to hospitals for 
beneficiaries whose care has been exceptionally costly or 
required an unusually long hospital stay. Under PPS, a separate 
standardized amount is set for determining Medicare payments to 
hospitals located in Puerto Rico (based on a 25 percent 
Federal/75 percent local blended rate).

                        Description of Proposal

     The proposal would (1) make new long-term care hospitals 
subject to the PPS for acute care hospitals; (2) eliminate 
increased IME and DSH payments that are attributable to 
``outlier'' payments, but allow hospitals to count IME and DSH 
as part of costs that trigger outlier payments, effective in 
FY1998; and (3) adjust the Puerto Rico payment rate to a 
blended amount of 50 percent Federal/50 percent local rate.

                   Skilled Nursing Facilities (SNFs)

Payment reform

                              Present Law

     Currently, Medicare reimburses the great bulk of SNF care 
on a retrospective cost-based basis. This means that SNFs are 
paid after services are delivered for the reasonable costs (as 
defined by the program) they have incurred for the care they 
provide. For Medicare reimbursement purposes, the costs SNFs 
incur for providing services to beneficiaries can be divided 
into three major categories: (1) routine services costs that 
include nursing, room and board, administration, and other 
overhead; (2) ancillary services, such as physical and 
occupational therapy and speech language pathology, laboratory 
services, drugs, supplies and other equipment; and (3) capital-
related costs.
     Routine costs are subject to national average per diem 
limits. Separate per diem routine cost limits are established 
for freestanding and hospital-based SNFs. Freestanding SNF 
routine limits are set at 112 percent of the average per diem 
labor-related and nonlabor-related costs. Hospital-based SNF 
limits are set at the limit for freestanding SNFs, plus 50 
percent of the difference between the freestanding limits and 
112 percent of the average per diem routine services costs of 
hospital-based SNFs. Routine cost limits for SNF care are 
required to be updated every 2 years. In the interim, the 
Secretary applies a SNF market basket developed by HCFA to 
reflect changes in the price of goods and services purchased by 
SNFs. OBRA93 eliminated updates in SNF routine cost limits for 
cost reporting periods beginning in FY1994 and FY1995.
     Ancillary service and capital costs are both paid on the 
basis of reasonable costs and neither are subject to limits.
     Cost-based reimbursement has been cited as one of the 
reasons for significant growth in SNF spending since 1989. 
Spending has increased from $3.5 billion in 1989 to $11.7 
billion in 1996, for an average annual rate of growth of 19 
percent. Growth in SNF spending can be explained largely by the 
increasing number of persons qualifying for the benefit and 
increases in reimbursements per day of care. The number of 
persons served has nearly doubled since 1989, reaching 1.15 
million persons in 1996. Average payments for care have grown 
from $117 per day in 1989 to $292 per day in 1996. Increases in 
ancillary service reimbursements explain much of this per diem 
payment growth.

                        Description of Proposal

     The President's budget would implement a SNF prospective 
payment system beginning in July 1, 1998. A single payment 
would cover routine, ancillary, and capital-related SNF costs 
and would be case-mix adjusted to reflect patients' varying 
service needs. The PPS payment would be made on a per diem 
basis. Rates would be set to capture permanently the savings 
from the OBRA93 freeze on SNF cost limits.

                            Part A Premiums

Enrollment

                              Present Law

     Most persons turning age 65 are automatically entitled to 
Medicare Part A based on their own or their spouse's work in 
covered employment. Most persons not automatically covered 
under Part A have coverage through a former government 
employer.
     However, some persons may need Part A protection. If such 
an individual does not establish eligibility during his or her 
initial enrollment period (i.e. when he or she turns 65), that 
individual must wait until the next general enrollment period. 
A person who terminates coverage must also wait till the next 
general enrollment period, to reenroll. There is a general 
enrollment period from January 1 to March 31 of each year. 
Coverage does not begin until July 1 of that year. Persons 
wishing to buy into Part A must pay a monthly premium of $311 
per month.

                        Description of Proposal

     The proposal would establish a continuous open enrollment 
period for persons not enrolling during their initial 
enrollment period. Coverage for these persons would begin 6-
months later.

Working disabled

                              Present Law

     Certain disabled persons may purchase Part A coverage 
under the voluntary enrollment provisions. These are 
beneficiaries who continue to be disabled, but who are no 
longer entitled to cash benefits solely because they have 
earnings in excess of the amount permitted.

                        Description of Proposal

     The proposal would establish a 4-year demonstration 
project under which social security disability beneficiaries 
(SSDI) who return to work would receive free Part A coverage.

                                 PART B

                     Physicians and Other Suppliers

Establish single conversion factor and reform method for
    updating physician fees

                              Present Law

     Medicare pays for physicians services on the basis of a 
fee schedule. The fee schedule assigns relative values to 
services. Relative values reflect three factors: physician work 
(time, skill, and intensity involved in the service), practice 
expenses, and malpractice costs. These relative values are 
adjusted for geographic variations in the costs of practicing 
medicine. Geographically-adjusted relative values are converted 
into a dollar payment amount by a dollar figure known as the 
conversion factor. There are three conversion factors--one for 
surgical services, one for primary care services, and one for 
other services. The conversion factors in 1997 are $40.96 for 
surgical services, $35.77 for primary care services, and $33.85 
for other services.
     The conversion factors are updated each year by a formula 
specified in the law. The update equals inflation plus or minus 
actual spending growth in a prior period compared to a target 
known as the Medicare volume performance standard (MVPS). (For 
example, fiscal year 1995 data were used in calculating the 
calendar 1997 update.) However, regardless of actual 
performance during a base period, there is a 5 percentage point 
limit on the amount of the reduction. There is no limit on the 
amount of the increase.

                        Description of Proposal

     The President's proposal would set a single conversion 
factor beginning in 1998, based on the 1997 primary care 
conversion factor, updated to 1998 by a single average fee 
update. The proposal would replace the MVPS with a cumulative 
``sustainable growth rate'' based on real gross domestic 
product (GDP) growth. This new target would begin affecting 
updates in 1999. The proposal would also place an upper limit 
on allowable fee increases--3 percentage points above 
inflation. The lower limit on decreases would change from 
inflation minus 5 percentage points to inflation minus 8.25 
percentage points.
     The Physician Payment Review Commission (PPRC), a 
congressional advisory body, has recommended use of a single 
conversion factor and replacing the MVPS with a sustainable 
growth rate. There are, however, a number of technical 
differences. PPRC has recommended using GDP plus 1 or 2 
percentage points in calculation of the sustainable growth 
rate; it has also recommended the use of the same limits on fee 
increases and decreases.

Make single payment for surgery

                              Present Law

     Under certain conditions, Medicare will make an additional 
payment when a physician or physician assistant serves as an 
assistant-at-surgery to a primary physician. Where payment is 
allowed, the fee schedule amount for a physician cannot exceed 
16 percent of the amount otherwise determined as the global fee 
for the service. When the service is provided by a physician 
assistant, payments equal 65 percent of the fee schedule amount 
that would be paid if a physician served as the assistant.

                        Description of Proposal

     The proposal would make the same payment for surgery, 
regardless of whether or not the primary surgeon elects to use 
an assistant-at-surgery.

Create incentives to control high-volume physician services

                              Present Law

     In general, current law does not include a specific limit 
on the number or mix of physicians services provided in 
connection with an inpatient hospital stay. (However, the law 
does require that certain services provided in connection with 
a surgery be included in a global surgical package and not 
billed for separately.)

                        Description of Proposal

     The proposal would establish limits on Medicare payments 
to groups of physicians practicing in hospitals whose volume 
and intensity of services per admission exceeded 125 percent of 
the national median for urban hospitals (120 percent beginning 
in 2002) and 140 percent for rural hospitals. There is an 
adjustment for teaching and disproportionate share hospitals. 
The Secretary would be required to provide for a withhold of 15 
percent in payment amounts for physicians services to a 
hospital's medical staff if, for any year (beginning in 2000) 
the medical staff's relative value units for a year is 
projected to exceed the national limit. After the close of the 
year, the Secretary would compare actual relative value units 
per admission with the limit. For staffs above the limit, none 
or a portion of the withhold would be refunded, as appropriate. 
For staffs below the limit, the full amount would be refunded.

Direct payment to physician assistants, nurse practitioners,
     and clinical nurse specialists

                              Present Law

     Medicare makes direct payments to physician assistants, 
nurse practitioners and clinical nurse specialists under 
limited circumstances. Physician assistants are paid directly 
when services are provided under the supervision of a 
physician: (i) in a hospital, skilled nursing or nursing 
facility; (ii) as an assistant at surgery; or (iii) in a rural 
area designated as a health manpower shortage area. Nurse 
practitioners are paid for services provided in collaboration 
with a physician when such services are furnished in a nursing 
facility. Nurse practitioners and clinical nurse specialists 
are paid directly for services provided in collaboration with a 
physician in a rural area. Payments for these services equal 
specified percentages of payments which would be made to 
physicians for the service under the physician fee schedule.

                        Description of Proposal

     The proposal would authorize direct payment to these 
practitioners when services were provided in home and 
ambulatory settings, provided no separate facility or provider 
fee was charged. The proposal would be effective January 1, 
1998.

Payment of acquisition costs for drugs

                              Present Law

     Medicare does not pay for most outpatient prescription 
drugs. The program will, however, pay for certain drugs 
including drugs used in connection with home infusion or 
inhalation equipment, drugs prescribed for dialysis or 
transplant patients, and certain oral cancer drugs. Payment is 
generally based on the charge submitted by the physician or 
pharmacist.

                        Description of Proposal

     Beginning January 1, 1998, the proposal would base 
Medicare's payment on the provider's acquisition cost of the 
drug. Payment could not exceed the national median cost of the 
drug.

Chiropractic services

                              Present Law

     Medicare covers chiropractic treatment services; however 
the coverage is limited to treatment by means of manual 
manipulation of the spine. In addition, a chiropractor's 
services are covered only if the treatment is to correct a 
subluxation (i.e., misalignment) demonstrated to exist by X-
ray; however, program regulations do not permit Medicare to pay 
for X-rays ordered by a chiropractor.

                        Description of Proposal

     Effective January 1, 1998, the pre-treatment X-ray 
requirement would be eliminated.

                 Hospital Outpatient Departments (OPDs)

Payment for hospital outpatient departments (OPDs)

                              Present Law

     Medicare's payment to hospital OPDs and hospital-operated 
ambulatory surgical centers (ASCs) for covered ASC procedures 
is equal to the lesser of the following two amounts: (1) the 
lower of the hospital's reasonable costs or customary charges 
less beneficiary deductibles and coinsurance, or (2) the amount 
determined based on a blend of the lower of the hospital's 
reasonable costs or customary charges, less beneficiary 
deductibles and coinsurance, and the amount that would be paid 
to a free-standing ASC in the same area for the same 
procedures. For cost reporting periods beginning on or after 
January 1, 1991, the hospital cost portion and the ASC cost 
portion are 42 percent and 58 percent, respectively.

                        Description of Proposal

     The proposal would move to a prospective payment system 
(PPS) for hospital OPD services effective January 1, 1999. 
Rates would be established so that total payments to a hospital 
for OPD services would be equal to projected FY1999 hospital 
revenue (consisting of Medicare's payments and beneficiary 
coinsurance payments), less savings from eliminating a flaw in 
the current payment methodology (described below) and assuming 
extension of certain policies (primarily payment reductions 
extended by OBRA 1993) set to expire at the end of 1998.

Formula driven overpayment for hospital outpatient department care

                              Present Law

     Medicare's share of the payment for certain ambulatory 
surgeries, radiology services, and some diagnostic services is 
supposed to be the total amount Medicare allows for payment 
minus beneficiary copayments. For facilities paid the blended 
amount, however, program payments are not reduced by the entire 
beneficiary copayment. This results in higher payments to 
hospital OPDs than the Congress intended.

                        Description of Proposal

     The proposal would eliminate the flaw in the current 
payment methodology for hospital OPDs as a part of the move to 
a prospective payment system (PPS) for such services.

Beneficiary coinsurance for hospital outpatient department care

                              Present Law

     OPDs are reimbursed by Medicare, in part, on the basis of 
reasonable cost, and because the facility's cost is not known 
at the time of service delivery, beneficiary coinsurance is 
calculated as 20 percent of the facility's charges. Because 
charges are almost always higher than the outpatient costs 
recognized by Medicare, beneficiary coinsurance for OPD 
services amounts to significantly more than 20 percent of 
Medicare's payment to the OPD.

                        Description of Proposal

     The proposal would ``buy-down'' beneficiary coinsurance to 
20 percent by the year 2007, as a part of the proposal to 
implement a prospective payment system for OPD services.

                            Other Providers

Ambulatory surgical centers (ASCs)

                              Present Law

     Medicare pays for ASC services on the basis of 
prospectively determined rates. These rates are updated 
annually for inflation using the CPI-U. OBRA 1993 eliminated 
updates for ASCs for FY1994 and FY1995.

                        Description of Proposal

     The proposal would reduce the annual CPI-U update for ASC 
fees by 2 percentage points for each year between FY1998 and 
FY2002.

Competitive bidding for laboratories, durable medical equipment and 
        other items

                              Present Law

     Medicare does not use competitive bidding for the 
selection of providers authorized to provide covered services 
to beneficiaries. Any provider meeting program requirements and 
agreeing to the program's payment rules may receive 
reimbursement for services.

                        Description of Proposal

     The proposal would permit the Secretary of HHS to bid 
competitively for laboratory services, durable medical 
equipment, and other medical items and supplies covered under 
Part B. The items included in a bidding process, and the 
geographic areas selected for bidding, would be determined by 
the Secretary based on the availability of entities able to 
furnish the services and the potential for savings. Entities 
would have to meet specified quality standards. The Secretary 
would be permitted to exclude suppliers whose bid was above the 
cutoff bid determined sufficient to maintain access. An 
automatic reduction in rates would be triggered for clinical 
lab services, durable medical equipment, and prosthetic and 
orthotic devices if a 20 percent reduction had not been 
achieved by 2001.

Payment for automated laboratory tests

                              Present Law

     Medicare currently pays individually for several common 
laboratory tests that are typically performed as a group (or 
``panel'' of tests) on automated equipment. As a result, 
Medicare pays more for some common tests than most private 
insurers pay.

                        Description of Proposal

     The proposal would add several chemistry tests to the 
existing list of tests that are classified and paid as 
automated tests.

Payment for ambulance services

                              Present Law

     Medicare generally pays for ambulance services on a 
reasonable charge basis. Hospital-based services are paid on 
the basis of reasonable costs.

                        Description of Proposal

     The proposal would create budget neutral fee schedules for 
the payment of all ambulance services.

                                Premiums

Part B premiums

                              Present Law

     When Medicare was established in 1965, the Part B monthly 
premium was intended to equal 50 percent of program costs. The 
remainder was to be financed by Federal general revenues, i.e., 
tax dollars. Legislation enacted in 1972 limited the annual 
percentage increase in the premium to the same percentage by 
which social security benefits were adjusted for the cost-of-
living (i.e., cost-of-living or COLA adjustments). As a result, 
revenues dropped to below 25 percent of program costs in the 
early 1980s. Since the early 1980s, Congress has regularly 
voted to set the premium equal to 25 percent of costs. Under 
current law, the 25 percent provision is extended through 1998; 
the COLA limitation would again apply in 1999.

                        Description of Proposal

     The proposal would permanently set the Part B premium 
equal to 25 percent of program costs.

Part B enrollment and penalties for delayed enrollment

                              Present Law

     People generally enroll in Part B when they turn 65. If an 
individual does not establish eligibility during his or her 
initial enrollment period, that individual must wait until the 
next general enrollment period. A person who terminates 
coverage must also wait until the next general enrollment 
period to reenroll. There is a general enrollment period from 
January 1 to March 31 of each year. Coverage does not begin 
until July 1 of that year.
     Persons who delay enrollment after their initial 
enrollment period are subject to a premium penalty. This 
penalty is a surcharge equal to 10 percent of the premium 
amount for each 12 months of delayed enrollment. There is no 
upper limit on the amount of the surcharge that may apply. 
Further, the penalty continues to apply for the entire time the 
individual is enrolled in Part B.

                        Description of Proposal

     The proposal would establish a continuous open enrollment 
period for persons not enrolling during their initial 
enrollment period. Coverage for these persons would begin 6 
months after enrollment. The delayed enrollment penalty would 
be based on the actuarially determined cost of late enrollment.

                                Benefits

Mammography services

                              Present Law

     Medicare provides coverage for screening mammograms. 
Frequency of coverage is dependent on the age and risk factors 
of the woman. For women ages 34-39, one test is authorized. For 
women ages 40-49, a test is covered every 24 months, except, an 
annual test is authorized for women at high risk. Annual tests 
are covered for women ages 50-64. For women aged 65 and over, 
the program covers one test every 24 months. Medicare's Part B 
deductible and coinsurance apply for these services.

                        Description of Proposal

     The proposal would authorize coverage for annual 
mammograms for all women ages 40 and over. It would also waive 
the coinsurance and deductible for screening mammograms. These 
provisions would be effective January 1, 1998.

Colorectal screening

                              Present Law

    Medicare does not cover preventive colorectal screening 
procedures. Such services are only covered as diagnostic 
services.

                        Description of Proposal

     The proposal would cover four common screening procedures 
for the detection of colorectal cancer. These are barium 
enemas, colonoscopy, sigmoidoscopy, and fecal-occult blood 
tests. Regular cost-sharing would apply for these procedures. 
The provision would be effective January 1, 1998.

Preventive injections

                              Present Law

     Medicare covers influenza vaccines, pneumococcal pneumonia 
vaccinations when prescribed by a doctor, and hepatitis B 
vaccinations for high or intermediate-risk beneficiaries. The 
benefit covers the reasonable cost of the vaccine and its 
administration. Cost sharing is waived for influenza and 
pneumococcal pneumonia vaccines.

                        Description of Proposal

     The proposal would increase the payment for the 
administration of these vaccines and waive the cost-sharing for 
hepatitis B vaccines. The proposal would be effective January 
1, 1998.

Diabetes self-management benefit

                              Present Law

     Medicare covers home blood-glucose monitors and associated 
testing strips for certain diabetes patients. Home blood 
glucose monitors enable diabetics to measure their blood 
glucose levels and then alter their diets or insulin dosages to 
ensure that they are maintaining an adequate blood glucose 
level. Home glucose monitors and testing strips are covered 
under Medicare's durable medical equipment benefit.
    Coverage of home blood glucose monitors is currently 
limited to certain diabetics, known as Type I diabetics, if: 
(1) the patient is an insulin-treated diabetic; (2) the patient 
exhibits poor diabetic control, as documented by a physician; 
(3) the patient is capable of being trained to use the monitor 
in an appropriate manner, or, in some cases, has a family 
member who can be trained; and (4) the device is designed for 
home rather than clinical use.

                        Description of Proposal

     The proposal would extend Medicare coverage of blood 
glucose monitors to Type II (non insulin-dependent) diabetics. 
The proposal would also reduce payment for testing strips by 10 
percent, based on evidence of overpayment for these items.

Respite benefit

                              Present Law

    No provision.

                        Description of Proposal

     Beginning in FY1998, the proposal would establish a 
Medicare respite benefit for families of beneficiaries with 
Alzheimer's disease or other irreversible dementia. Respite 
services provide relief to the caregivers of disabled persons. 
The benefit would cover up to 32 hours of care per year and 
would be administered through home health agencies or other 
entities, as determined by the Secretary of HHS.

                             PARTS A AND B

                          Home Health Services

Payment reform

                              Present Law

     Medicare reimburses home health agencies on a 
retrospective cost-based basis. This means that agencies are 
paid after services are delivered for the reasonable costs (as 
defined by the program) they have incurred for the care they 
provide to program beneficiaries, up to certain limits.
     Cost limits are determined separately for each type of 
covered home health service (skilled nursing care, physical 
therapy, speech pathology, occupational therapy, medical social 
services, and home health aide). Cost limits, however, are 
applied to aggregate agency payments; that is, an aggregate 
cost limit is set for each agency that equals the agency's 
limit for each type of service multiplied by the number of 
visits of each type provided by the agency. Limits for the 
individual services are set at 112 percent of the mean labor-
related and nonlabor per visit costs for freestanding agencies 
(i.e., agencies not affiliated with hospitals). To reflect 
differences in wage levels from area to area, the labor-related 
portion of a service limit is adjusted by the current hospital 
wage index. Cost limits are updated annually by applying a 
market basket index to base year data derived from home health 
agency cost reports.
     Cost-based reimbursement for home health has been 
criticized as providing few incentives for maximizing 
efficiency, minimizing costs, or controlling volume of 
services. It is cited as one of the reasons for the significant 
growth in home health spending since 1989. Spending has 
increased from $2.6 billion in 1989 to $18.1 billion in 1996, 
for an average annual rate of growth of 32 percent. Most of the 
growth in spending has been the result of an increasing volume 
of services being covered under the program, both in terms of 
increases in the numbers of users as well as the number of 
covered visits per user.

                        Description of Proposal

     The proposal would implement a home health prospective 
payment system (PPS) beginning October 1, 1999 (FY2000). 
Payments would be based on an episode of care for a time period 
as yet undefined. Budget neutral rates under the new PPS would 
be calculated after reducing expenditures that exist on the 
last day prior to implementation by 15 percent.
     In the interim, home health agencies would be paid the 
lesser of: (1) the actual costs (i.e., allowable reasonable 
costs); (2) the per visit cost limits, reduced to 105 percent 
of the national median; or (3) a new agency-specific per 
beneficiary annual limit calculated from 1994 reasonable costs. 
In addition, beginning January 1, 1998, payments would be based 
on the location where services are rendered, rather than where 
they are billed.

Extend savings from home health cost limits freeze

                              Present Law

    Home health limits are updated annually. The Omnibus Budget 
Reconciliation Act of 1993 (OBRA93) required that there be no 
updates in home health cost limits (including no adjustments 
for changes in the wage index or other updates of data) for 
cost reporting periods beginning on or after July 1, 1994, and 
before July 1, 1996.

                        Description of Proposal

     The proposal would permanently extend the savings stream, 
but not the freeze, in setting future home health limits, by 
not allowing for the inflation that occurred during the freeze 
years.

Clarification of the definition of ``homebound''

                              Present Law

     In order to be eligible for home health care, a Medicare 
beneficiary must be confined to his or her home. The law 
specifies that this ``homebound'' requirement is met when the 
beneficiary has a condition that restricts the ability of the 
individual to leave home, except with the assistance of another 
individual or with the aid of a supportive device (such as 
crutches, a cane, a wheelchair, or a walker), or if the 
individual has a condition such that leaving his or her home is 
medically contraindicated. The law further specifies that while 
an individual does not have to be bedridden to be considered 
confined to the home, the condition of the individual should be 
such that there exists a normal inability to leave home, that 
leaving home requires a considerable and taxing effort by the 
individual, and that absences from home are infrequent or of 
relatively short duration, or are attributable to the need to 
receive medical treatment.
     A March 1996 General Accounting Office (GAO) report on 
Medicare's home health benefit pointed to the law's broad 
criteria for defining ``homebound'' as resulting in few claims 
ever being denied on the basis that a beneficiary was not 
confined to home, and providing opportunities for abuse and 
overpayments.

                        Description of Proposal

     The proposal would redefine the ``homebound'' requirement 
by adding several calendar month benchmarks to emphasize that 
home health coverage is only available to those who are truly 
unable to leave the home.

Provide secretarial authority to make payment denials based on 
        normative service standards

                              Present Law

     As long as they remain eligible, home health users are 
entitled to an unlimited number of visits.

                        Description of Proposal

     The proposal would authorize the Secretary of HHS to 
establish a normative number of visits that would be covered 
for specific conditions or situations. Payments would be denied 
for visits that exceed the normative standard.

   Reallocate Financing of Part of the Home Health Benefit to Part B

                              Present Law

    Both Parts A and B of Medicare cover home health. Neither 
Part of the program applies deductibles or coinsurance to 
covered visits, and beneficiaries are entitled to an unlimited 
number of visits as long as they meet eligibility criteria. 
Section 1833(d) of Medicare law prohibits payments to be made 
under Part B for covered services to the extent that 
individuals are also covered under Part A for the same 
services. As a result, the comparatively few persons who have 
no Part A coverage are the only beneficiaries for whom payments 
are made under Part B.

                        Description of Proposal

     The proposal would transfer the majority of financing of 
the home health benefit from Part A to Part B. Effective in 
FY1998, the first 100 visits following a 3-day hospital stay 
would be reimbursed under Part A. All other visits would be 
reimbursed under part B. These would include visits for persons 
needing more than 100 visits following a hospitalization, 
visits for persons who have not had a 3-day prior 
hospitalization, and visits for those persons with Part B 
coverage only. For up to 18 months after enactment, Part A 
would pay what would otherwise be Part B costs for Part A-only 
individuals; subsequently, Part A-only individuals would only 
have payments made for the newly defined Part A services.
     The proposal has the effect of extending the solvency of 
the Part A trust fund by shifting some Part A costs to Part B. 
While Part B premiums generally equal 25 percent of total Part 
B costs, the premium would not be increased to reflect the cost 
of the additional Part B benefits.

                                Medigap

Medigap enrollment

                              Present Law

     Medigap is the term used to describe individually-
purchased Medicare supplement policies. In 1990, Congress 
provided for a standardization of Medigap policies; the 
intention was to enable consumers to better understand policy 
choices.
     All insurers offering Medigap policies are required to 
offer a 6-month open enrollment period for persons turning age 
65. This is known as guaranteed open enrollment. There is no 
guaranteed open enrollment provision for the under-65 disabled 
population (they must wait until they reach age 65).
     At the time insurers sell a Medigap policy, whether or not 
during an open enrollment period, they are permitted to limit 
or exclude coverage for services related to a preexisting 
health condition; such exclusions cannot be imposed for more 
than 6 months. An individual who has met the preexisting 
condition limitation in one Medigap policy does not have to 
meet the requirement under the new policy for previously 
covered benefits. However, an insurer could impose exclusions 
for newly covered benefits.
     Federal requirements for open enrollment and limits on 
preexisting condition exclusions are designed to insure 
beneficiaries have access to Medigap protection. However, 
persons who disenroll (or wish to disenroll) from managed care 
plans may not have the same access to Medigap coverage if they 
wish to move back into fee-for-service Medicare.
     Medigap insurers currently use three methods to price 
Medigap premiums. The first is community-rating under which all 
beneficiaries in an area pay the same price (except that a 
distinction may be made between the aged and the disabled). The 
second method uses age-at-issuance of the policy; future 
increases are limited to inflation and cost experience. The 
third method uses attained-age rating which factors in current 
age into the premium calculation. Younger beneficiaries may 
sign up at a relatively low cost but be unaware that the costs 
will increase substantially over their lifetimes. As a result, 
a number of States prohibit attained-age pricing.

                        Description of Proposal

     The proposal would establish an annual guaranteed open 
enrollment period for all beneficiaries during which 
beneficiaries would be guaranteed the opportunity to enroll in 
any Medigap plan. The current 6-month limit on coverage of pre-
existing conditions would not apply during a beneficiary's 
initial 6 month open enrollment period--but would apply during 
the annual enrollment periods. If an individual was previously 
covered by another Medigap policy or managed care plan (with no 
more than a 63-day lapse in coverage) the exclusion could only 
apply for the time period (if any) not met under the previous 
policy. Medigap plans would be required to be community-rated.
     The proposal would also require the Secretary (after 
consulting with the National Association of Insurance 
Commissioners (NAIC) and other interested parties) to develop 
standardized packages of supplemental benefits that may be 
offered by managed care organizations. The Secretary, after 
receiving recommendations from the NAIC would restructure 
standardized packages in order to permit comparisons among 
Medigap and managed care plans.

                         Purchasing Initiatives

Centers of excellence

                              Present Law

     HCFA is conducting a bundled payment demonstration project 
under which 10 facilities, considered ``centers of 
excellence,'' are paid a flat fee to provide cataract surgery 
or coronary artery bypass (CABG) surgery. The facilities were 
selected on the basis of their experience, outcomes, and 
efficiency in providing these services.

                        Description of Proposal

     The proposal would expand the demonstration to all urban 
areas by allowing Medicare to pay select facilities a single 
rate for all services associated with CABG surgery or other 
heart procedures, knee surgery, hip replacement surgery, and 
other procedures deemed appropriate by the Secretary. Selected 
facilities would have to meet special quality standards. The 
single rate paid to the center would have to represent a 
savings to the program. Beneficiaries would not be required to 
receive services at these facilities.

Other purchasing initiatives

                              Present Law

    Medicare generally pays for services on the basis of 
payment rules established by law for each service.

                        Description of Proposal

     The proposal would give the Secretary authority to pay on 
the basis of special arrangements. Two components of this plan, 
centers of excellence and competitive bidding, are discussed 
above. The proposal would also permit other payment 
arrangements. For example, the Secretary would be authorized to 
contract selectively with providers and suppliers to receive a 
global payment for a package of services directed at a specific 
condition or need of an individual (such as diabetes). Within 
the global payment, providers would have flexibility in 
determining how services are provided and could, subject to 
approval, offer additional benefits.

   Coordination of Benefits, Program Integrity and Other Management 
                              Initiatives

Medicare secondary payer

                              Present Law

     Generally, Medicare is the primary payer, that is, it pays 
health claims first, with an individual's private or other 
public plan filling in some or all of the coverage gaps. In 
certain cases, the individual's other coverage pays first, 
while Medicare is the secondary payer. This is known as the 
Medicare secondary payer (MSP) program. The MSP provisions 
apply to group health plans for the working aged, large group 
health plans for the disabled, and employer health plans 
(regardless of size) for the end-stage renal disease (ESRD) 
population.
     The law authorizes a data match program which is intended 
to identify potential secondary payer situations. Medicare 
beneficiaries are matched against data contained in the Social 
Security Administration and Internal Revenue Service files to 
identify cases where a working beneficiary (or working spouse) 
may have employer-based health insurance coverage. Recent court 
action has made recoveries more difficult in certain cases.

                        Description of Proposal

     The proposal would make permanent the provisions relating 
to the disabled, the ESRD population, and the data match 
program. The proposal would also require a beneficiary's other 
insurance to inform Medicare when that beneficiary is covered. 
The proposal would also clarify Medicare's recovery authority.

Consolidated billing for SNF services

                              Present Law

     Current law does not require nursing homes to bill for all 
Part A and Part B services provided within the SNF. The HHS 
Office of Inspector General reports that some Part B suppliers 
bill for services that are never delivered to nursing home 
residents.

                        Description of Proposal

     The proposal would require SNFs to bill Medicare for all 
of the services their residents receive, except for physicians 
services. Payments could not be made to other entities for 
services or supplies furnished to Medicare-covered 
beneficiaries.

Home health payments based on location of service

                              Present Law

     Some home health agencies (HHAs) are established with the 
home office in an urban area and branch offices in rural areas. 
Payment is based on the higher wage rate for the urban area, 
even if the service was delivered in a rural area.

                        Description of Proposal

    The proposal would base payment on the location where the 
service was rendered, not where the service was billed.

Periodic interim payments for home health

                              Present Law

     Medicare pays home health providers under the periodic 
interim payment (PIP) system. A set amount is paid on a bi-
weekly basis; at the end of the year, PIP is reconciled with 
actual expenditures.

                        Description of Proposal

     The proposal would eliminate PIP payments for home health 
services.

Survey and certification

                              Present Law

     HCFA's survey and certification budget has been held 
constant for several years, while the number of entities 
seeking entry continues to grow.

                        Description of Proposal

     The proposal would permit the Secretary to charge entities 
a fee for the initial survey required by the program.

                            Fraud and Abuse

Advisory opinions

                              Present Law

     P.L. 104-191, the Health Insurance Portability and 
Accountability Act, signed into law on August 21, 1996, added a 
number of new fraud and abuse provisions. Under the law, the 
Secretary of the HHS is directed to issue written advisory 
opinions regarding whether a proposed business transaction 
would violate certain Medicare and Medicaid statutory 
provisions. The opinions will be binding between the Secretary 
and the party requesting the opinion and will address issues 
such as what constitutes prohibited remuneration under the 
anti-kickback law; whether a proposed arrangement falls within 
one of the exceptions to the anti-kickback law; whether a 
proposed arrangement comes within an applicable safe harbor 
established by the Inspector General; what constitutes an 
inducement to reduce or limit services; and, whether a 
particular activity would be subject to penalties under the 
anti-kickback law, civil monetary law, or exclusion statutes. 
The Secretary is required to issue an advisory opinion within 
60 days after it is requested, and the advisory opinion 
provisions apply to requests made during a 4 year period 
beginning 6 months after enactment of this provision, i.e., 
February 21, 1997.

                        Description of Proposal

     The proposal would repeal this new provision.

Managed care exception in anti-kickback statute

                              Present Law

     P.L. 104-191 added a new exception to the Medicare and 
Medicaid anti-kickback provisions set forth in section 1128B(b) 
of the Social Security Act. The anti-kickback provisions 
generally prohibit persons from providing or offering to 
provide remuneration in cash or in kind in return for a patient 
referral whose treatment is paid for in whole or in part by 
Medicare or Medicaid. This new exception allows remuneration 
between certain managed care organizations and individuals or 
entities providing items or services pursuant to a written 
agreement with such organizations, if the arrangement places 
the individual or entity at substantial financial risk for the 
cost or utilization of the items or services. The Secretary of 
HHS, using a negotiated rulemaking process, is to issue 
standards relating to this new exception to the anti-kickback 
penalties.

                        Description of Proposal

     The proposal would repeal this new exception to the anti-
kickback provisions.

Reasonable diligence

                              Present Law

     Civil monetary penalties may be imposed under section 
1128A of the Social Security Act for various fraudulent 
activities relating to reimbursements under the Medicare or 
Medicaid programs. P.L. 104-191 changed the definition of the 
level of intent associated with such fraud violations. Under 
the new standard, similar to the False Claims Act standard, a 
person is subject to such civil monetary penalties if the 
person ``knowingly'' presents a claim that the person ``knows 
or should know'' falls into one of the prohibited categories. 
The term ``should know'' means that the person acted in 
deliberate ignorance of the truth or falsity of the information 
or acted in reckless disregard of the truth or falsity of the 
information.

                        Description of Proposal

     The proposal would repeal this amendment. The level of 
intent standard for civil monetary penalties under Medicare or 
Medicaid would return to the prior definition which did not 
require proof that the person ``knowingly'' or consciously 
engaged in the prohibited activity, only that the person knew 
that the prohibited activity occurred.

                         MEDICARE MANAGED CARE

                        Payments and Plan Choice

Payment changes

                              Present Law

     In 1983, Medicare began making payments to qualified 
``risk-contract'' HMOs or similar entities that enrolled 
Medicare beneficiaries. The intent was to give Medicare 
beneficiaries the opportunity to enroll in HMOs as a more cost 
efficient alternative to fee-for-service health care. Under the 
risk contract program, a beneficiary in an area served by a 
qualified organization may voluntarily choose to enroll in the 
organization. Medicare makes a single monthly capitation 
payment for each of the organization's Medicare enrollees. This 
payment equals 95 percent of the estimated adjusted average per 
capita cost (AAPCC) of providing Medicare services to a given 
beneficiary under the fee-for-service system.
     The AAPCC is Medicare's estimate of the average per capita 
amount it would spend for a given beneficiary (classified by 
certain demographic characteristics and county of residence) 
who was not enrolled in an HMO and who obtained services on the 
usual fee-for-service basis. The AAPCCs are further adjusted 
for enrollees on the basis of age, sex, whether they are in a 
nursing home or other institution, and whether they are also 
eligible for Medicaid, whether they are working and being 
covered under an employer plan, and the county of their 
residence. These AAPCC values are calculated in three basic 
steps:

   Medicare's national average calendar year per capita 
        costs are projected for the future year under 
        consideration. These numbers are known as the U.S. per 
        capita costs (USPCCs) and are estimated average 
        incurred benefit costs per Medicare enrollee and 
        adjusted to include program administration costs. 
        USPCCs are developed separately for Parts A and B of 
        Medicare, and for costs incurred by the aged, disabled, 
        and those with ESRD in those two parts of the program.
   Geographic adjustment factors that reflect the 
        historical relationships between the county's and the 
        Nation's per capita costs are used to convert the 
        national average per capita costs to the county level. 
        Expected Medicare per capita costs for the county count 
        only fee-for-service beneficiaries by removing both 
        reimbursement and enrollment attributable to Medicare 
        beneficiaries in prepaid plans.
   Once the county AAPCC is calculated, it is then 
        adjusted for the demographic variables described above 
        such as age, sex, and Medicaid status.

     For each Medicare beneficiary enrolled under a risk 
contract, Medicare will pay the HMO 95 percent of the rate 
corresponding to the demographic class to which the beneficiary 
is assigned. Wide variations exist in the AAPCC payments across 
counties. For example, payments in 1997 range from a low of 
$221 per month for two rural Nebraska counties to a high of 
$761 for Staten Island (Richmond County), New York or a 
difference of $540. In counties with small numbers of Medicare 
beneficiaries, the AAPCCs can fluctuate dramatically from year 
to year as a result of changes in Medicare fee-for-service 
expenditures. Participation of managed care plans in low paid 
counties, which are disproportionately in rural areas, is very 
limited, in part, because risk plans do not exist in these 
counties.
     Medicare fee-for-service payments for inpatient hospital 
stays include payments for indirect and direct graduate medical 
education costs (IME and direct GME respectively) incurred by 
teaching hospitals and extra payments to hospitals that serve a 
disproportionate share of low income beneficiaries (or DSH 
payments). These payments are retained in the expenditures used 
to calculate the AAPCCs paid to risk contract plans. As a 
result, the AAPCC reflects a county's average monthly per 
capita cost for fee-for-service graduate medical education and 
DSH. These amounts may not correspond with actual risk plan 
costs, however, because not all plans have medical education 
programs or use teaching or disproportionate share hospitals.

                        Description of Proposal

     The proposal would affect the AAPCCs in five major ways: 
(1) payments would be updated annually by a percentage rate of 
increase determined by the Secretary based on the national 
average per capita growth in Medicare expenditures; (2) savings 
would be achieved indirectly because the rise in fee-for-
service expenditures would be reduced as a result of provider 
payment changes in the Administration's plan; (3) the AAPCCs 
would be modified to correct for wide geographic disparities; 
(4) payments for direct graduate medical education (direct 
GME), indirect medical education (IME), and disproportionate 
share hospitals (DSH) would be eliminated from the AAPCCs; and 
(5) payments to plans would be reduced from 95 percent to 90 
percent of the AAPCC beginning in the year 2000.
    (1) Annual Updates. The AAPCCs would no longer be 
calculated each year based on area fee-for-service 
expenditures. The Secretary would establish an update each year 
based on the per capita growth of Medicare expenditures 
nationwide. Under the Administration's proposal, the annual 
update is estimated to be about 5 percent each year. This 
change would uncouple payment rates from Medicare's fee-for-
service expenditures in each county.
    (2) Savings From Fee-For-Service. Payments for Medicare 
managed care are defined as 95 percent of the amount that would 
have been spent for the beneficiary in an area if that 
beneficiary had been in Medicare fee-for-service. This means 
that the growth in managed care payments are directly linked to 
the growth in Medicare fee-for-service payments. Under the 
President's proposal, reductions would be made in the rate of 
growth of payments for Medicare fee-for-service. These 
reductions would be reflected in a reduced rate of growth in 
payments to Medicare managed care plans.
    (3) Eliminate Direct GME, IME, and DSH Payments from the 
AAPCCs. The proposal would eliminate (''carve out'') direct 
GME, IME and DSH payments from the AAPCCs. The resulting 
amounts would then be distributed directly to teaching and 
disproportionate share hospitals for managed care enrollees and 
to managed care plans that run their own residency programs. 
The carve-out would be done over a 2-year period. Fifty percent 
of the total amount would be carved out in the first year 
(1998) and the remainder would be eliminated in the second year 
(1999). (There would be no net savings; however, because about 
the same amount of direct GME, IME, and DSH expenditures would 
be paid directly to teaching hospitals and managed care 
teaching programs.) The Physician Payment Review Commission 
estimated that for 1995, direct medical education and DSH 
payments totaled about 5.5 percent of the AAPCCs nationally. 
However, significant variations exist across counties. For 
example, for the most urbanized counties, they averaged about 
8.4 percent whereas in the most rural counties, such payments 
averaged about 3.4 percent of the payments made to Medicare 
HMOs.
    (4) Modify the AAPCCs to Correct for Geographic 
Disparities. The proposal would modify the AAPCC payments to 
reduce the existing variation in payment rates across counties. 
In general, it would raise payment levels for current low-
payment counties. The proposal would also limit payment 
increases for counties whose rates have been inflated by high-
service utilization in the fee-for-service sector. 
Specifically, AAPCCs would be updated in the following manner. 
Each year, starting in 1998, the payment rate would be set at 
the highest of three amounts:

   A blend of the local payment rate for the county 
        (the AAPCC) and an input price adjusted national fee-
        for-service rate. (Input prices include such costs as 
        hospital wages and physician practice costs.) The blend 
        would start in 1998 at 90 percent of local costs and 10 
        percent of national Medicare fee-for-service costs. 
        Over 5 years, this blend would move to 70 percent of 
        local costs and 30 percent of national fee-for-service 
        costs. This modification would bring lower-paid and 
        higher-paid counties closer to the national payment 
        average.
   A minimum county payment rate (AAPCC) of $350 in 
        1998 (but no higher than 150 percent of the previous 
        year's rate). This new floor on payment rates is 
        intended to ensure increases in 1998 for the lowest 
        paid counties in the country. The floor would be 
        updated in each year by the annual update factor (as 
        described above).
   For 1998 and 1999, 100 percent of the 1997 AAPCC and 
        102 percent of the previous year's AAPCC thereafter. 
        This provision would ensure that plans which otherwise 
        might experience reductions in payments in 1998 and 
        1999 as a result of the carve out of GME, IME, and DSH 
        would get their 1997 rates. For the year 2000 and 
        thereafter, they would receive at least the previous 
        year's rate plus 2 percent. It should be noted that in 
        the year 2000, however, the rates would be reduced due 
        to the effect of the ``risk selection'' adjustment 
        described below.

     This proposal is designed to be budget neutral. No new 
spending would be required because increased AAPCC payments for 
low-paid areas would be redirected from high-paid areas. 
Because of the minimum floor for some counties and the preset 
rates of increase in others (i.e., the freeze in 1998 and 1999 
and 2 percent increase thereafter), budget neutrality would be 
achieved by reducing the amounts paid to plans in counties 
receiving blended rates.
    (5) Adjust Payments for Risk Selection by Reducing Payments 
to Plans to 90 percent of Fee-For-Service Payment. The proposal 
would reduce Medicare payments to managed care plans to 90 
percent of the AAPCC, beginning in the year 2000. The rationale 
for this change is that, on average, Medicare managed care 
plans experience favorable selection when compared to 
traditional Medicare. Some studies have shown that Medicare 
HMOs attract a healthier than average group of Medicare 
beneficiaries and as a result, cost HMOs less than 95 percent 
of what these beneficiaries would cost had they remained in 
Medicare fee-for-service. The Administration's proposal would 
delay implementation of the change from 95 percent to 90 
percent until the year 2000 to enable health plans the chance 
to prepare for the new payment methodology. The reduction of 
payments from 95 percent to 90 percent of the AAPCC effectively 
means a 5.3 percent reduction in rates for all counties. 
Therefore, whatever the payment rate would have been under the 
adjustments described above (i.e., the blended rate, the floor, 
or 2 percent increase) would be reduced by 5.3 percent.

Increased plan choice and consumer information

                              Present Law

     Under section 1876 of the Social Security Act, Medicare 
specifies requirements to be met by an organization seeking to 
become a managed care contractor with Medicare. In general, 
these include the following: (1) the entity must be organized 
under the laws of the State and be a federally qualified HMO or 
meet specified requirements (provide physician, inpatient, 
laboratory, and other services, and provide out-of-area 
coverage); (2) the organization is paid a predetermined amount 
without regard to the frequency, extent, or kind of services 
actually delivered to a member; (3) the entity provides 
physicians' services primarily through physicians who are 
either employees or partners of the organization or through 
contracts with individual physicians or physician groups; (4) 
the entity assumes full financial risk on a prospective basis 
for the provision of covered services, except that it may 
obtain stop loss coverage and other insurance for catastrophic 
and other specified costs; and (5) the entity has made adequate 
protection against the risk of insolvency.
    Provider Sponsored Organizations (PSOs) and Preferred 
Provider Organizations (PPOs) that are not organized under the 
laws of a State and are neither a federally qualified HMO or 
Competitive Medical Plan (CMP) are not eligible to contract 
with Medicare under the risk contract program. A PSO is a term 
used to describe a cooperative venture of a group of providers 
who control its health service delivery and financial 
arrangements. PPOs are generally groups of physicians and 
hospitals who contract with an insurer or employer to serve a 
group of enrollees on a fee-for-service basis at negotiated 
rates that are lower than those charged to nonenrollees. PPOs 
do not traditionally have primary care gatekeepers.
     Point-of-service (POS) plans combine features of HMOs and 
PPOs. They feature networks of providers who agree to provide 
health care services in a managed care environment at a reduced 
rate. However, enrollees can decide to use the defined managed 
care program, or can go out of plan for services, with cost 
sharing responsibilities varying with the choice of provider 
(the highest cost sharing associated with the use of non-
network providers). In 1995, HCFA issued guidelines to Medicare 
HMOs for operating, on an optional basis, a POS option. By 
early 1997, HCFA had approved POS options for about 30 plans. 
In an attempt to test additional types of managed care delivery 
and financing arrangements (including PPOs and PSOs), HCFA in 
April of 1996 selected 25 managed care plans in eight cities 
and five rural areas as final candidates for a new Medicare 
Choice demonstration program. As of December 1996, five plans 
had dropped out. In January 1997, the first six Medicare 
Choices demonstration plans began enrolling beneficiaries. An 
additional 13 plans are expected to begin enrollment in 1997.
     Medicare HMOs/CMPs must provide enrollees, at the time of 
enrollment and annually thereafter, an explanation of rights to 
benefits, restrictions on services provided through 
nonaffiliated providers, out-of-area coverage, coverage of 
emergency and urgently needed services, and appeal rights. They 
must enroll individuals and provide covered services to 
enrollees who live within the geographic area served by the 
organization. Enrollment is carried out by the participating 
HMOs/CMPs. These organizations are required to provide an 
annual open enrollment period of at least 30 days duration.

                        Description of Proposal

     The proposal would allow PPOs and PSOs that meet certain 
standards to participate as Medicare managed care plans. The 
proposal defines a PPO as an entity that provides at least 
physicians' services performed by physicians and meets the 
requirements specified in the proposal for fiscal soundness, 
assumption of risk, and minimum private enrollment. The 
proposal defines a PSO as an entity which is a hospital, a 
group of affiliated hospitals, or an affiliated group 
consisting of a hospital or hospitals and physicians or other 
entities that furnish health services. It must provide at least 
physicians' services performed by physicians and inpatient 
hospital services. Moreover, the entity must itself provide a 
substantial portion of Medicare services and only a limited 
amount of services through contract. It too has to meet the 
proposal's specific solvency, risk, and minimum private 
enrollment requirements. For entities meeting the PSO 
requirements, State licensing laws that vary from Federal 
requirements would be preempted. However, if the Secretary 
determined that a State had met the criteria for participation 
in an alternative certification and monitoring program, the 
Secretary would require the PSO to obtain a license from the 
State.
     Second, the proposal would improve information available 
to Medicare beneficiaries to enable them to make more informed 
choices about their insurance options. The Secretary would 
carry out the enrollment process, although plans with a good 
past record would be authorized to directly enroll individuals. 
The Secretary would develop and distribute standardized 
comparative materials about plans and Medicare supplemental 
policies to enable individuals to compare benefits, costs, and 
quality indicators. Plans would be assessed for a pro rata 
share of the costs associated with developing and disseminating 
this comparative information. Plan marketing materials would be 
subject to review by the Secretary. All plans would have to 
provide a 30-day open enrollment period during the month of 
November. Individuals would be able to enroll at other times, 
such as when they first enroll in Medicare Part B or when they 
move into a new service area. Special enrollment periods would 
apply for individuals losing coverage from another entity. 
Plans could not deny enrollment, or fail to re-enroll 
individuals, because of an individual's health status or need 
for health care services. PPOs would be required to provide a 
POS option. (PSOs would be prohibited from providing such an 
option.)
     Third, the proposal would change Medigap law to enable 
beneficiaries that switch from an HMO to Medicare fee-for-
service to obtain Medigap coverage without being subject to 
preexisting condition exclusions and without being charged a 
higher premium because of their medical history or health 
status. (See discussion of Medigap enrollment, above.)

                          Additional Proposals

Permit enrollment of ESRD beneficiaries

                              Present Law

     Under current law, a beneficiary in a Medicare managed 
care plan who develops ESRD may remain in the plan but one who 
already has ESRD is prohibited from enrolling.

                        Description of Proposal

     The proposal would allow a beneficiary with ESRD to enroll 
in a Medicare managed care plan.

Limits on charges for out-of-network services

                              Present Law

     No provision.

                        Description of Proposal

     The proposal would impose limits on charges for 
unauthorized, out-of-network services.

Coverage of out-of-area dialysis services

                              Present Law

     Today, Medicare HMOs are only required to pay for out-of-
area services in the event of emergency care and urgent care. 
Dialysis services are considered foreseeable and Medicare HMOs 
have no obligation to pay for them.

                        Description of Proposal

     The proposal would require Medicare managed care plans to 
pay for out-of-area dialysis when an enrollee is temporarily 
out of a plan's service area so that an enrollee with ESRD is 
not prevented from leaving their home area.

Clarification of coverage for emergency services

                              Present Law

     Currently, payment disputes have arisen where the plan has 
denied payment for an emergency room visit because of its view 
that the care sought was not for an actual medical emergency. 
The beneficiary, on the other hand, sought emergency room care 
because he or she believed the problem required emergency 
medical attention.

                        Description of Proposal

     The proposal would clarify that Medicare managed care 
plans must pay for emergency services in cases where a 
``prudent layperson'' would reasonably believe that such 
services were needed immediately to prevent serious harm to his 
or her health.

Permit States with programs approved by the Secretary to
    have primary oversight responsibility

                              Present Law

     HMOs/CMPs that contract with Medicare generally have to be 
organized and licensed under State laws. However, it is up to 
the Secretary of HHS (through HCFA) to determine whether an 
HMO/CMP can contract with Medicare.

                        Description of Proposal

     The proposal would authorize those States with approved 
programs to certify whether a plan is eligible to contract with 
Medicare and to monitor aspects of plan performance. Such 
certification and monitoring would be subject to Federal 
standards. User fees would be collected from plans for both the 
certification and monitoring activities.

Modify termination and sanction authority

                              Present Law

     Current law requires that there first be a hearing prior 
to termination of a contract.

                        Description of Proposal

     The proposal would authorize the Secretary to terminate a 
contract with an organization prior to a hearing in cases where 
the health and safety of Medicare beneficiaries are at risk. 
The proposal would also eliminate the current law requirement 
for corrective actions plans and for hearing and appeals prior 
to imposing intermediate sanctions.

Deem privately accredited plans to meet internal quality
    assurance standards

                              Present Law

     No provision.

                        Description of Proposal

     The proposal would authorize the Secretary to deem plans 
with private accreditation as meeting Medicare's requirement 
for an internal quality assurance program.

Replace 50/50 rule with quality measurement system

                              Present Law

     Currently, no more than 50 percent of a Medicare HMO's 
enrollees may be Medicare or Medicaid beneficiaries; the rest 
must be privately funded (typically through employer groups). 
The requirement may be waived by the Secretary for certain 
specified reasons. Only a few waivers have ever been granted. 
This reflects the view that an organization which must compete 
in the private market is likely to provide services of higher 
quality than one formed solely for the purpose of obtaining 
government contracts.

                        Description of Proposal

     The proposal would replace the 50/50 requirement once the 
Secretary, in consultation with consumers and the managed care 
industry, developed a system for quality measurement. The 
Secretary would be authorized to terminate contracts that do 
not meet standards under the quality measurement system. In the 
interim, the proposal would expand the Secretary's authority to 
waive the 50/50 requirement for plans with good track records.
      

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         CBO and OMB Estimates of the President's FY1998 Budget

                         Proposals for Medicare

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                                MEDICAID

Medicaid is a Federal-State program providing medical 
assistance for specified groups of low-income persons who are 
aged, blind, disabled, or members of families with children. 
Within Federal guidelines, each State designs and administers 
its own program. Thus, there is substantial variation among the 
States in terms of persons covered, types of benefits provided, 
and payment rates for covered services.

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

                            Federal Payments

Limitations on per capita rate of growth in Federal financial 
        participation

                              Present Law

    The Federal Government has an open-ended commitment to 
match each State's spending for Medicaid at the Federal 
matching rate for the State. In other words, the Federal 
Government shares in the cost of all allowable Medicaid 
expenses for eligible individuals. Federal Medicaid payments 
are based on quarterly reports that States submit to the 
Secretary of DHHS. States which, through section 1115 waivers, 
offer Medicaid to persons not otherwise eligible for benefits 
under the program, receive Federal payments at their regular 
matching rates.

                        Description of Proposal

    The proposal establishes a limit in the annual growth in 
Federal Medicaid spending per beneficiary for each State, based 
on a specified growth index. For each State, the growth limit 
would apply to a per capita base for each of four beneficiary 
groups: non-disabled child, non-disabled adult, elderly, and 
disabled beneficiaries. Each State's group base rate would be 
the State's total 1996 Medicaid expenditures calculated on a 
per beneficiary basis. That is, for each State, the Secretary 
would determine the amount attributable to items and services 
furnished to individuals in each of the groups specified, and 
apportion the State's FY1996 administrative expenditures to 
each group according to the State's expenditures for items and 
services for the group. The State's total amount spent for each 
group would be divided by the number of full-year equivalent 
individuals in the group who were enrolled in the State's 
Medicaid program in FY1996 to arrive at the per capita base 
rate for each group. The annual Federal payment limit for each 
group would be the product of (1) the per capita base rate for 
the group, (2) the actual number of full-year equivalent 
individuals in the group in the year, (3) the State's Federal 
matching rate as under current law, and the allowable Medicaid 
growth multiplier for FY1997 and succeeding years.
     For FY1998 and succeeding years, the limit on Federal 
Medicaid payments to a State would be an aggregate amount equal 
to the sum of the State's group limits except for certain items 
that would not be subject to the per capita cap. Spending for 
State fraud control units; payments for disproportionate share 
adjustments, for Medicare cost sharing and to Indian Health 
Service and other Indian health providers; expenditures for the 
Vaccines for Children program; spending for nursing facility 
certification; and amounts attributable to the immigration 
status verification system would be excluded from the cap.
     In their quarterly reports, each State would be required 
to indicate the share of total Medicaid expenditures 
attributable to each beneficiary group. The number of full-year 
equivalent enrollees in each group would be determined by the 
Secretary (based on State reports) taking into account the 
numbers of individuals who were not enrolled in a State's 
program for the entire fiscal year, or were within a group of 
individuals for only part of a fiscal year. A State that had a 
section 1115 waiver in effect during FY1996 would have the 
option of counting only the enrollees who would have been 
eligible for Medicaid in the absence of a waiver in the cap 
calculation. Those eligible only through the qualified Medicare 
beneficiary program and related programs (SLMBs) are excluded 
from the cap.
    The allowable Medicaid growth multiplier would be used to 
update group limits from year to year. The multiplier for a 
fiscal year would be one plus the arithmetic average of the 
annual change in the nominal gross domestic product per capita 
for the five consecutive 12-month periods ending on June 30 of 
the preceding fiscal year, increased by two percentage points 
for each of fiscal years 1997 and 1998, and by one percentage 
point for each succeeding fiscal year.
    Prior to the beginning of FY1998 and each succeeding fiscal 
year, the Secretary would publish each State's average per 
capita limit for each beneficiary group. Federal matching 
payments for States' Medicaid expenditures made after September 
30, 1997 would be subject to per capita limits. For 
expenditures incurred before that date, States would be 
required to submit their claims for Federal matching funds by 
June 30, 1998.

                 Entitlement to Benefits Are Mantained

Reduction of disproportionate share payments

                              Present Law

     Since 1981, States have been required to make supplemental 
payments to hospitals that serve a disproportionate number of 
Medicaid recipients and low-income patients. These payments are 
referred to as disproportionate share hospital (DSH) payments. 
Each State determines which hospitals receive DSH payments and 
the payment to each. States that contract with health 
maintenance organizations (HMOs) or other prepaid capitation 
managed care providers may include DSH expenses in the payment 
rates to the contractors. A major factor behind the growth in 
Medicaid expenditures between 1989 and 1992 was States' use of 
DSH and related financing mechanisms such as provider taxes and 
donations to generate Federal dollars. Although legislation 
enacted in 1991 and 1993 curtailed these State practices, 
Federal spending for DSH is about $10 billion per year. Total 
annual Federal DSH spending and DSH spending in each State is 
limited to 12 percent of total annual Medicaid expenditures. 
The limit is being phased in through the use of State-specific 
DSH allotments.

                        Description of Proposal

     Federal DSH spending would be reduced. The proposal would 
require that each State pay hospitals directly for DSH instead 
of including DSH payments in prepaid capitation contracts. In 
addition, the proposal would establish new State-specific DSH 
allotments to freeze DSH payments in FY1998 at FY1995 spending 
levels and gradually reduce DSH payments. Finally, for fiscal 
years 1999-2002, the proposal would provide for supplemental 
payments for States and other entities to ease the transition 
to per capita limits and reductions to DSH payments.
    Beginning with FY1998, no Federal DSH payment would be made 
in excess of a State's new DSH allotment. For FY1998, each 
State's DSH allotment would be equal to the State's FY1995 DSH 
spending. For subsequent years, a State's DSH allotment would 
be a reduced portion of the State's FY1995 DSH spending. This 
proportional reduction applies to a State multiplier defined as 
the lesser of the State's FY1995 DSH spending, or 12 percent of 
the State's FY1995 Medicaid expenditures. For FY1999, a State's 
DSH allotment would be its FY1995 DSH spending minus 15 percent 
of the State multiplier. For FY2000 and each succeeding year, 
25 percent of the State multiplier would be deducted from the 
State's FY1995 DSH spending. In other words, each State's DSH 
spending is reduced proportionally with certain DSH spending 
amounts--above 12 percent of total spending--excluded from 
reductions.
    The proposal would authorize grants to States and other 
entities that the Secretary determines need grants to ease the 
transition from the current Medicaid program to a program 
operated with per capita caps and reductions in DSH payments. 
The Secretary would establish criteria for transition grants in 
regulations to be published by October 1, 1997. Amounts 
authorized for such grants would be $400 million for FY1999, 
$300 million for FY2000, $200 million for FY2001, and $100 
million for FY2002.
Medicaid eligibility quality control (MEQC) requirements

                              Present Law

    Under Medicaid quality control systems, each State monitors 
aspects of its own administrative performance. MEQC is the 
identification of eligibility errors that may result in 
improper Federal payments. If error rates exceed certain 
tolerances, Federal payment is disallowed.

                        Description of Proposal

    The proposal would modify the current MEQC system to 
accommodate population components of the per capita cap. 
Specifically, the system would examine for whether enrollees 
were reported in the proper beneficiary group.
Nursing home survey and certification

                              Present Law

    Nursing facilities participating in the Medicaid program 
are subject to survey and certification procedures. States are 
responsible for conducting inspections to determine whether 
providers can be certified as meeting the standards and 
conditions for Medicaid participation. The Federal matching 
rate to States for most administrative expenses is 50 percent; 
the rate for survey and certification activities is 75 percent.

                        Description of Proposal

    The Federal matching rate for nursing home survey and 
certification activities would be increased from 75 percent to 
85 percent.

                              Eligibility

Disabled children who lose SSI benefits

                              Present Law

    P.L. 104-193, the Personal Responsibility and Work 
Opportunity Act of 1996, established a definition of childhood 
disability for receipt of benefits under the Supplemental 
Security Income (SSI) program. Under the new definition, some 
children will lose their SSI benefits. Due to the loss of SSI, 
the children will lose their Medicaid eligibility as it is 
linked to SSI eligibility.

                        Description of Proposal

    The proposal would allow disabled children who are 
currently receiving Medicaid to retain their Medicaid coverage 
if they lose SSI because of the new definition.
State option to permit workers with disabilities to buy into Medicaid

                              Present Law

    States must continue Medicaid coverage for ``qualified 
severely impaired individuals under the age of 65.'' These are 
disabled and blind individuals whose earnings reach or exceed 
the SSI benefit standard. (The current law threshold for 
earnings is $1,053 per month.) This special eligibility status 
applies as long as the individual (1) continues to be blind or 
have a disabling impairment; (2) except for earnings, continues 
to meet all the other requirements for SSI eligibility; (3) 
would be seriously inhibited from continuing or obtaining 
employment if Medicaid eligibility were to end; and (4) has 
earnings that are not sufficient to provide a reasonable 
equivalent of benefits from SSI, State Supplementary Payments 
(if provided), Medicaid, and publicly funded attendant care 
that would have been available in the absence of those 
earnings. To implement the fourth criterion, the Social 
Security Administration compares the individual's gross 
earnings to a ``threshold'' amount that represents average 
expenditures for Medicaid benefits for disabled SSI cash 
recipients in the individual's State of residence.

                        Description of Proposal

    States would have the option of creating a new eligibility 
category for disabled SSI beneficiaries with higher incomes 
than current law allows. Beneficiaries would ``buy into'' 
Medicaid by paying a premium. Premium levels would be on a 
sliding scale, based on the individual's income as determined 
by the State.
Extension of coverage to additional individuals

                              Present Law

    Medicaid law limits eligibility to members of families with 
children, and to individuals who are elderly, blind, or 
disabled. Eligibility rules are linked to a State's rules for 
its Aid to Families with Dependent Children (AFDC) program, or 
to rules of the Federal SSI program. There is variation in the 
rules for the 50 potentially eligible groups that can be 
covered by Medicaid. Some States have obtained waivers of 
Federal law to expand Medicaid coverage to low-income uninsured 
people who do not fall into one of the eligibility categories 
and who have higher incomes than current law allows.

                        Description of Proposal

    At their option, States would be able to cover new groups 
of individuals with incomes up to 150 percent of the Federal 
poverty level without waivers. Expansions would be approved 
only if they were demonstrated to be cost neutral. 
Administration would be simplified so that instead of the many 
different rules for different groups, States could use the same 
rules for everyone eligible under the percent-of-poverty 
option. Individuals enrolled under this provision could not be 
counted in State reports of numbers enrolled or included in 
calculation of the Federal payment limit.
Elimination of authority for new statewide eligibility expansion 
        demonstrations

                              Present Law

    Section 1115(a) of the Social Security Act gives the 
Secretary authority to waive statutory requirements for 
Medicaid in order to conduct statewide demonstration projects 
``likely to assist in promoting the objectives'' of the 
program. Under 1115(a) waivers, some States have extended 
Medicaid eligibility to individuals who, in the absence of a 
waiver, would not be eligible for categorical or financial 
reasons.

                        Description of Proposal

    The proposal would amend section 1115 to eliminate the 
Secretary's authority to grant waivers that would expand the 
number of individuals eligible for Medicaid.
Continuous eligibility for children

                              Present Law

     In general, Medicaid coverage can be provided only to 
individuals who continue to meet all the requirements for 
eligibility. For some individuals and families, income 
fluctuates so that there are frequent interruptions in 
eligibility. Medicaid law makes an exception to provide 
continuous eligibility for pregnant women and infants 
regardless of changes in income. The law specifies that a 
pregnant recipient continues to be eligible for Medicaid until 
60 days after the pregnancy ends. Further, a child born to a 
woman receiving medical assistance remains eligible for medical 
assistance for 1 year so long as the child is a member of the 
woman's household and the woman remains (or would remain if 
pregnant) eligible for medical assistance.

                        Description of Proposal

    States would be permitted to provide a full continuous 12 
months of eligibility for children who are over age 1 and under 
18, 19, 20, or 21 as specified by the State.
Upper income limit on ``less restrictive'' eligibility methodologies

                              Present Law

    Under section 1902(r)(2) of the Social Security Act, States 
are allowed to use more liberal methodologies for determining 
income and resource eligibility than those used for the AFDC 
program to determine Medicaid financial eligibility. 
Disregarding additional amounts of income and resources, States 
can qualify certain categories of populations for Medicaid 
eligibility who are not entitled to benefits under categorical 
eligibility criteria. The provision has been used to expand 
eligibility for pregnant women and children with household 
incomes up to 300 percent of the Federal poverty line.

                        Description of Proposal

     The proposal would establish a 150 percent of poverty 
income eligibility limit on individuals who can be determined 
eligible through this provision. States can maintain their 
income eligibility limit in effect in FY1996 (including 1115 
demonstrations) if higher than the 150 percent limit.

                              Managed Care

                              Present Law

    Medicaid programs use three main types of managed care 
arrangements. These vary according to the comprehensiveness of 
the services they provide and the degree to which they accept 
risk. Under primary care case management (PCCM) a Medicaid 
beneficiary selects, or is assigned to a single primary care 
provider. Numerous provisions of current law apply to contracts 
between States and managed care organizations (MCOs). States 
may offer services through a MCO on a voluntary basis. However, 
to mandate that beneficiaries enroll in MCOs, or to limit MCO 
services to specific populations or geographic areas, States 
must obtain waivers of Federal laws. Generally, waivers of 
freedom-of-choice, comparability, and statewideness provisions 
are obtained under section 1915(b) of the Social Security Act. 
They are for 2 years and may be renewed. As of February 1997, 
42 States had 96 1915(b) waivers.
     States' payments under contracts with MCOs must be 
established on an actuarially sound basis. By regulation, 
payment rates may not exceed what the State would have paid for 
similar services for a beneficiary not enrolled in a MCO. This 
upper payment limit is known as the fee-for-service equivalent. 
States may pay less than the upper limit. However, some States 
argue that the upper limit is inadequate to attract plans to 
participate. All State contracts with MCOs must receive prior 
approval by the Secretary if expenditures are expected to be 
over $100,000. Cost-sharing charges such as deductibles or 
copayments, may not be imposed on Medicaid enrollees in HMOs 
(Note: not all MCOs are HMOs under the law). As a proxy for 
quality, Federal law requires that less than 75 percent of an 
MCO's enrollment must be Medicaid or Medicare beneficiaries. 
For some MCOs, the 75/25 rule has been bypassed through State 
demonstration waivers or through specific Federal legislation.

                        Description of Proposal

    The proposal establishes a definition of PCCM, sets 
contractual requirements for PCCM arrangements, adds PCCM 
services to the list of Medicaid covered services, and repeals 
waiver authorization for PCCM.
     States would be permitted to mandate enrollment in PCCM or 
other managed care arrangements if a Medicaid beneficiary had a 
choice of at least two entities or managers and other 
conditions were met. States would be permitted to require 
beneficiaries to remain in a managed care arrangement for up to 
6 months; States would also (as under current law) be permitted 
to guarantee 6 months of eligibility for enrollees. Prior to 
establishing a mandatory managed care enrollment requirement, a 
State would have to provide for public notice and comment.
     The payment limit and actuarial soundness standards would 
be modified to require that capitated payment amounts be set at 
rates that have been determined, by an actuary meeting the 
standards of qualification and practice established by the 
Actuarial Standards Board, to be sufficient and not excessive 
with respect to the estimated costs of services provided. The 
threshold for Federal review of contracts would be raised from 
$100,000 to $1 million. States would be permitted to impose 
nominal copayments on HMO enrollees.
     The 75/25 rule would be eliminated. The Secretary would be 
authorized to require reporting of detailed individual 
encounter data to monitor care furnished under managed care 
arrangements. States that have agreements with HMOs, PCCMs, and 
other managed care entities would be required to develop and 
implement quality assessment and improvement strategies 
consistent with standards established by the Secretary.

                                Benefits

Home and community-based services

                              Present Law

    Under 1915(c) waivers, States have the option of providing 
a broad range of home and community-based services to elderly, 
mentally retarded, and other disabled and chronically ill 
persons who would otherwise require nursing home care or other 
forms of institutional care. The 1915(c) authority is known as 
a waiver program because States must request, through a special 
application, that the Secretary waive certain requirements that 
would normally apply to services covered under their Medicaid 
plans.

                        Description of Proposal

    States would be able to create a home and community-based 
services program without a Federal waiver. Instead, a State 
would amend its State plan for Medicaid to include the program.
Elimination of requirement to pay for private insurance

                              Present Law

    States are required to identify cases in which it would be 
cost-effective to enroll a Medicaid-eligible individual in a 
private insurance plan and, as a condition of eligibility, 
require that the individual enroll in the plan. In case of 
enrollment, the Medicaid program would pay insurance premiums 
as well as cost-sharing obligations for items and services 
covered by Medicaid.

                        Description of Proposal

    Identification and enrollment requirements would be 
eliminated. States would have the option of purchasing private 
insurance.
Individuals covered during transition to work

                              Present Law

    Prior to enactment of the welfare reform law (P.L. 104-193) 
and the repeal of AFDC, an individual who increased earnings 
from employment faced the loss of AFDC and Medicaid coverage. 
Medicaid eligibility is still determined by AFDC rules. 
Medicaid law extends at least 6 months of coverage to families 
who would lose AFDC because of earnings. States are required to 
provide full Medicaid coverage or ``wrap-around'' coverage. 
Under the wrap-around option, States can pay expenses for 
insurance premiums, deductibles, and coinsurance for health 
care offered by the employer. States are permitted to extend 
Medicaid coverage for a second 6 months and to impose premiums 
for that period. Premiums may not exceed 3 percent of the 
family's average gross monthly earnings.

                        Description of Proposal

    The proposal specifies that under the wrap-around option, 
States would be permitted to limit the amount of payment for 
any deductible or coinsurance to what the State would pay if 
the item or service had been furnished by a provider 
participating in the State's Medicaid program. The premium 
limit would be eliminated.
Copayments in health maintenance organizations

                              Present Law

    Enrollment fees, coinsurance, or other cost-sharing charges 
may not be imposed on Medicaid recipients for services 
furnished by HMOs.

                        Description of Proposal

    The proposal would eliminate the prohibition on fees for 
services furnished by HMOs.

                Provider Participation and Payment Rates

Methods for establishing provider payment rates

                              Present Law

    Generally, States develop their own methods and standards 
for reimbursement of Medicaid services though there are Federal 
statutory requirements for some services. Among these are the 
so-called Boren amendments that require States to pay hospitals 
and nursing homes rates that are reasonable and adequate to 
cover the cost of efficient and economically operated 
facilities. States are required to receive and audit cost 
reports by hospitals, nursing facilities, and intermediate care 
facilities for the mentally retarded (ICFs/MR). States are 
required to pay federally qualified health centers (FQHCs) and 
rural health clinics (RHCs) rates that are equal to 100 percent 
of the facility's reasonable costs, subject to any 
reasonableness test developed for the same services under 
Medicare rules (or, for Medicaid services not covered under 
Medicare, as would be allowed under principles similar to 
Medicare's).

                        Description of Proposal

    The proposal would repeal the Boren amendments and 
establish a public notice process for setting payment rates for 
services provided by hospitals, nursing facilities, and 
intermediate care facilities for the mentally retarded. Not 
later than 4 years after enactment, the Secretary would be 
required to report to Congress on the effects of States' rate-
setting methods on access to and quality and safety of 
services. Beginning with FY1999, the requirement to pay RHCs 
and FQHCs at 100 percent of costs would be eliminated.
    The proposal would require the Secretary to make quarterly 
grants to eligible FQHCs and RHCs for each of fiscal years 
1999-2002. Such grants would be made according to criteria and 
payment methodology established by the Secretary and published 
in regulation by October 1, 1997. Amounts authorized for these 
grants would be $500 million for FY1999, $400 million for 
FY2000, $300 million for FY2001, and $200 million for FY2002.
Physician qualification requirements

                              Present Law

    Medicaid law establishes special minimum qualifications for 
a physician who furnishes services to a child under age 21 or 
to a pregnant woman.

                        Description of Proposal

    The provision would be repealed.
Elimination of obstetrical and pediatric payment rate requirements

                              Present Law

    Under section 1926 of the Social Security Act, States are 
required to assure adequate payment levels for obstetrical and 
pediatric services and provide annual reports on their payment 
rates for the services.

                        Description of Proposal

    Section 1926 would be repealed.
Program for all-inclusive care for the elderly (PACE)

                              Present Law

    OBRA 86 required the Secretary to grant waivers of certain 
Medicare and Medicaid requirements to not more than 10 public 
or non-profit private community-based organizations to provide 
health and long-term care services on a capitated basis to 
frail elderly persons at risk of institutionalization. These 
projects are known as the Programs for All-Inclusive Care for 
the Elderly, or PACE projects. OBRA 90 expanded the number of 
organizations eligible for waivers to 15.

                        Description of Proposal

    The proposal would establish PACE as a provider type and 
require sites to meet minimum requirements included in a PACE 
protocol.

                       State Plan Administration

Elimination of personnel requirements

                              Present Law

    For Medicaid, States are required to maintain personnel 
standards on a merit basis, and train and use subprofessional 
staff with emphasis on employment of recipients and other low-
income persons.

                        Description of Proposal

    Particular personnel requirements would be eliminated. A 
State would be required to provide methods of administration 
that the Secretary finds to be necessary for the proper and 
efficient operation of its Medicaid plan.
Elimination of duplicative inspection of care requirements for ICFs/MR 
        and mental hospitals

                              Present Law

    States that provide services in mental hospitals and in 
ICFs/MR must provide for periodic inspections of care for each 
Medicaid beneficiary who receives services in the institution. 
Inspections of care have been conducted to assure that persons 
are receiving the appropriate level of care of adequate 
quality. The DHHS has established a new survey outcome-oriented 
process for mental hospitals and ICFs/MR.

                        Description of Proposal

    Inspection of care reviews in mental hospitals and ICFs/MR 
would be eliminated. Survey and certification reviews for the 
facilities would remain in place.
Public process for developing state plan amendments

                              Present Law

    Each State is required to maintain a State Medicaid plan--a 
comprehensive statement that describes the nature and scope of 
the State's Medicaid program. State plans must be amended when 
necessary due to changes in laws, regulations, or policies. 
State plans and amendments are subject to approval of the 
Secretary. Current Medicaid law has no provisions for the 
development of State plan amendments.

                        Description of Proposal

    States would be required to establish a public notice and 
review process for the development of Medicaid State plan 
amendments.
Alternative sanctions for non-compliant ICFs/MR

                              Present Law

    ICFs/MR must meet certain requirements and standards for 
safety and for the proper provision of care. If a State finds 
that a facility is out of compliance with the requirements, the 
facility's participation in Medicaid can be terminated until 
the deficiencies have been corrected. States have limited 
sanctions available for the use of ICFs/MR that are found to 
have deficiencies.

                        Description of Proposal

    The proposal would provide for alternative sanctions 
similar to those that are available for nursing facilities.
Modification of MMIS requirements

                              Present Law

    Beginning October 1, 1986 States have been required to 
maintain mechanized claims processing and information retrieval 
systems better known as Medicaid Management Information Systems 
(MMIS). Failure to meet the 1986 deadline resulted reduced 
Federal Medicaid funds. An MMIS is reviewed at least once every 
3 years by the Health Care Financing Administration of DHHS. 
Failure to pass a systems performance review could result in 
reduction of the usual 75 percent Federal Medicaid match rate 
for operation of an approved MMIS.

                        Description of Proposal

    The proposal would delete the statutory language that 
related to 1980s requirements for MMIS. It would require each 
State to operate a system that is adequate to provide 
efficient, economical, and effective administration, is 
compatible with the claims processing and information retrieval 
systems that are used to administer the Medicare program, and 
provides for electronic transmission of claims data.
Nurse aide training and competency evaluation programs

                              Present Law

    Nursing facilities are prohibited from offering a nurse 
aide training program by or in the facility if within the 
previous 2 years it has had a waiver of the registered nurse 
staffing requirement, or has been subject to an extended 
survey, or has been subject to sanctions for noncompliance with 
requirements.

                        Description of Proposal

    This provision would allow otherwise prohibited nurse aid 
training programs, which are offered in (but not by) nursing 
facilities to do so, if the State determines that there would 
be no other program offered within a reasonable distance, 
provided notice of the approval to the State long-term care 
ombudsman, and assured through an oversight effort that an 
adequate environment exists for the program. The proposal would 
also clarify that a survey finding of substandard care, rather 
than the mere occurrence of an extended survey, would be the 
event that triggers the prohibition on nurse aide training.
Elimination of repayment requirement for States imposing alternative 
        remedies on non-compliant nursing facilities

                              Present Law

    States have available to them a range of sanctions they may 
take against nursing facilities found to be out of compliance 
with the requirements for participation in Medicaid. These 
include termination of participation in the program, denial of 
payment for new admissions, civil money penalties, appointment 
of temporary management; and authority to close the facility or 
transfer residents. For facilities that are not terminated and 
that are taking steps to eliminate deficiencies according to an 
approved plan of correction, the Secretary of DHHS is 
authorized to continue Federal Medicaid matching payments to 
the State for no longer than 6 months. States, however, are 
required to repay to the Federal Government any payments made 
to facilities that fail to take corrective action according to 
the approved plan and timetable.

                        Description of Proposal

    The proposal would eliminate the requirement for States to 
repay Federal funds for failure of a facility to correct 
deficiencies according to an approved plan of correction.

                        Miscellaneous Provisions

Commission on Medicaid

                              Present Law

    No provision.

                        Description of Proposal

    The proposal would establish a Commission on State Health 
Reform and Medicaid Equity. The Commission would monitor the 
status and progress of Medicaid, report to the public 
concerning progress made by States, provide for the promotion 
of information exchange between the States and the Federal 
Government, and recommend program improvements and other State 
health reform initiatives to the President and the Congress. 
Also, the Commission would review and recommend suggestions for 
achieving equity among the States in States' per capita base 
year and growth rates. The Commission will also review and 
recommend appropriate changes in the Federal Medicaid matching 
rate to reflect demographics, health care utilization changes, 
and economic differences.
     The Commission would be required to make a final report to 
the Secretary and the Congress 2 years after its initial 
meeting. For FY1998, $2 million would be authorized to be 
appropriated for the Commission.
Effective Date

                              Present Law

    No provision.

                        Description of Proposal

    Unless otherwise specified, the Medicaid amendments would 
take effect on and after October 1, 1997. The proposal provides 
for an extension in the case of a State that the Secretary 
determines requires State legislation to comply with the 
amendments.
Increase Federal payment cap for Puerto Rico

                              Present Law

    The Federal Government matches Puerto Rico's Medicaid 
spending at a 50 percent rate up to statutory limits that are 
specified in section 1108 of the Social Security Act. Beginning 
with $116,500,000 in FY1994, the Medicaid limit increases 
annually by the percentage increase in the medical care 
component of the consumer price index for all urban consumers, 
rounded to the nearest $100,000.

                        Description of Proposal

    The Federal Medicaid payment to Puerto Rico would be 
increased by $30 million in FY1998 and by an additional $10 
million in each of the succeeding fiscal years 1999-2002.
Increase Federal payment to the District of Columbia

                              Present Law

    Under Medicaid law, the District of Columbia is a State. 
States are required to pay at least 40 percent of the non-
Federal share of Medicaid costs. This means that States, by 
law, can require local jurisdictions to share Medicaid costs, 
up to a certain proportion, instead of bearing the entire non-
Federal share. The District's Federal Medicaid matching rate is 
50 percent.

                        Description of Proposal

    The District's share of Medicaid costs would be reduced to 
30 percent, the maximum amount that the District, as a local 
government, could be required to contribute if it were located 
within a State with a Federal matching rate of 50 percent (60 
percent of the non-Federal share--50 percent).
Medicaid eligibility for non-citizens

                              Present Law

    P.L. 104-193, the Personal Responsibility and Work 
Opportunity Act of 1996, bars most aliens from receiving 
benefits under the Supplemental Security Income (SSI) program 
for the elderly, blind, and disabled. Many people are eligible 
for Medicaid because they receive SSI benefits. Without SSI, an 
individual would not be eligible for Medicaid unless the State 
of residence could determine the individual eligible under one 
of the State's optional eligibility categories. States have the 
option of continuing Medicaid coverage to legal aliens in the 
country as of August 22, 1996 including those who lose Medicaid 
due to loss of SSI benefits. A State can continue coverage by 
determining eligibility under an existing optional eligibility 
category in the State's Medicaid program. However, some States 
have not chosen to exercise the optional Medicaid eligibility 
categories that would be appropriate for the population. A 
State that has no applicable category must deny coverage or 
expand its entire program.
     Under P.L. 104-193, aliens who enter the U.S. after the 
date of enactment are barred from Medicaid for 5 years after 
arrival except for certain aliens including refugees and 
asylees. Refugees and asylees who otherwise meet Medicaid 
eligibility requirements may be eligible for Medicaid for up to 
5 years. For aliens not exempted form the 5-year ban, States 
are permitted to provide Medicaid after the 5 years have 
passed.
     In general, the Immigration and Nationality Act excludes 
from entry aliens who appear ``likely at any time to become a 
public charge.'' Sponsors of prospective aliens must pledge 
support of aliens whom they sponsor. Amendments enacted in P.L. 
104-193 expand the use of sponsor-to-alien deeming. Under the 
deeming provisions, a sponsor's income and assets are taken 
into account when an alien applies for a means-tested benefit 
such as Medicaid.

                        Description of Proposal

    Immigrants who become disabled after entry to the United 
States, or who are children, would be exempted from the ban on 
SSI benefits and on Medicaid benefits. This applies to 
immigrants in the country before enactment and those arriving 
after that date--August 22, 1996. The 5-year period during 
which refugees and asylees can receive Medicaid benefits would 
be extended to 7 years. The sponsor-to-alien deeming 
requirements would not apply to disabled immigrants or to 
immigrant children.
      

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


                  CBO and OMB Estimates of the FY 1998

                 President's Budget Medicaid Proposals

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

[GRAPHIC] [TIFF OMITTED] TP018.021

[GRAPHIC] [TIFF OMITTED] TP018.022

[GRAPHIC] [TIFF OMITTED] TP018.023

      

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


                            HEALTH INSURANCE

In addition to the existing public programs which provide 
health care, the Administration's budget proposes to create 
three new programs to increase health insurance coverage. The 
Administration also proposes to extend Medicaid coverage of 
children.

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

          Initiative To Maintain and Expand Workers' Coverage

Temporary premium assistance for families between jobs

                              Present Law

     There is no provision in current law for direct subsidies 
of private health insurance premiums. (Title XIX of the Social 
Security Act authorizes State Medicaid programs to purchase 
private health insurance for certain individuals.) Some premium 
assistance is provided under the Internal Revenue Code, in the 
form of the individual medical expense deduction for 
unreimbursed medical expenses, the self-employed deduction for 
a portion of the cost of health insurance, and the exclusion 
from taxable income of employer contributions for health 
insurance.
     COBRA continuation coverage was established under the 
Internal Revenue Code, the Employee Retirement Income Security 
Act (ERISA), and the Public Health Service Act. It requires 
employer-sponsored group health plans with 20 or more employees 
to provide employees and their families the option of 
continuing under the group health plan for 18 to 36 months, 
depending on the qualifying event. Qualifying events include 
changes in job and family status that would otherwise result in 
the loss of the group health plan. The event of a job loss or 
reduction in hours entitles a COBRA-eligible individual up to 
18 months of continued coverage. Employers are allowed to 
charge COBRA enrollees up to 102 percent of the total plan 
premium. The requirement is known as COBRA after the 
Consolidated Omnibus Budget Reconciliation Act (P.L. 99-272), a 
law enacted in 1986 which included this provision.

                        Description of Proposal

     The proposal authorizes the Secretary of Health and Human 
Services (HHS) to establish a demonstration program of grants 
to the States for fiscal years 1998 through 2001, to enable 
them to provide temporary health insurance premium assistance 
for eligible unemployed workers and their families. The 
Secretary could operate (directly or through contract) a 
program in a State that failed to establish a federally 
approved program.
     The proposal would authorize $1.738 billion in FY1998. 
This amount would be increased annually by an amount linked to 
the growth in unemployment compensation and the growth in the 
economy. The program's authorization would sunset at the end of 
FY2001.
     To become eligible for a grant, a State would have to 
submit a plan providing specific information such as how it 
would use the funds, the plan's methodology for determining 
eligibility, and how the State would notify individuals of the 
availability of premium assistance. The plan would be approved 
unless the Secretary notified the State within 90 days that the 
plan was disapproved (and the reasons for such or that specific 
information was needed).
     The State program funded under the Federal grant would be 
required to provide premium assistance to eligible unemployed 
individuals and their eligible family members in obtaining 
health benefit coverage through payment of all or part of the 
premium cost for COBRA continuation coverage or coverage that 
(1) is equivalent to the Blue Cross/Blue Shield standard option 
under the Federal Employees Health Benefit program (FEHBP), or 
(2) meets the conditions of approval as specified by the 
Secretary. The coverage would have to be economical compared to 
other coverage options considered by the State and would have 
to comply with specified provisions of the Health Insurance 
Portability and Accountability Act of 1996 (P.L. 104-191).
     The amount of premium assistance would be related to 
income. It would be available for up to 6 months for those who 
had employer-based coverage in their prior job, are now 
receiving unemployment benefits, and have incomes below certain 
thresholds. A full subsidy would be provided up to 100 percent 
of the Federal poverty level; it would be phased out from 100 
percent to 240 percent of the poverty level. An individual 
would not be qualified if he or she was eligible for Medicaid 
or had an employed spouse with health insurance coverage. (An 
individual would be eligible if the spouse was not covered 
under group coverage and the spouse's employer did not offer 
family coverage or contributed less than 50 percent of the 
premium.) Federal subsidies would be limited to the amount of 
money authorized under the proposal. States would be allocated 
funds based on specific criteria (e.g., the different rates of 
unemployment and prices for health care among States).
     The proposal includes amendments to the Unemployment 
Compensation program. State agencies would be required to 
disclose to the relevant government officials, upon request and 
on a reasonable basis, wage and unemployment compensation 
claims information.
     The Secretary of HHS, in conjunction with the Secretary of 
Labor, would be required to study the effects of the premium 
assistance program on insurance coverage and on the unemployed 
and to report to the Senate Committee on Labor and Human 
Resources and the House Committees on Commerce and Education 
and the Workforce on the findings of the study.

                   Voluntary Purchasing Cooperatives

                              Present Law

    None.

                        Description of Proposal

    The proposal would establish a Federal grant program to 
States to encourage the development of voluntary health 
insurance purchasing cooperatives for employer groups of 1 to 
50 employees. The purposes of the cooperatives would be to 
enable small businesses to bargain collectively for lower 
premium rates and obtain a greater array of choices of plans 
for their employees than otherwise would be available. An 
amount of $25 million per year for 5 years (1998-2002) in 
grants would be available for technical assistance, for setting 
up voluntary purchasing cooperatives, and for allowing these 
purchasing cooperatives to access health plans sold through the 
FEHBP grant fund may not be used for operating costs after the 
first 6 months of operation.
     Entities eligible for grants would include State agencies, 
non-profit cooperatives, and for-profit cooperatives whose 
profits were shared on a pro-rata basis among cooperative 
members. Eligible cooperatives could not bear insurance risk 
and must ensure members are free of conflicts of interest. 
Eligible cooperatives could not deny membership to small 
employers on the basis of the health status of their employees 
and would have to offer multiple, competing health plans. The 
cooperatives must demonstrate financial liability and be 
capable of becoming self-sustaining.
     Under the FEHBP alternative, a State could request the 
Secretary of HHS to establish a cooperative in coordination 
with FEHBP. Such a cooperative would be a separately-rated 
group, distinct from any group of Federal employees. Grant 
funds from this proposal could be used by the Secretary to 
establish this cooperative. It could use the FEHBP name in 
marketing, and require FEHBP plan providers that sell coverage 
in the private market to offer appropriate health benefit 
coverage to the small group market, at prices negotiated with 
the cooperative. The cooperative also could negotiate with 
providers not participating in FEHBP to sell coverage to the 
small group market. These cooperatives coordinating with FEHBP 
cannot collect or distribute premiums.
     State laws restricting or prohibiting combinations of 
groups for the purchase of health insurance benefits would be 
preempted for cooperatives that meet the requirements of this 
bill. Also preempted for such cooperatives would be State laws 
imposing rate requirements that prohibit a health plan issuer 
from offering to a cooperative lower rates reflecting the 
issuer's administrative savings due to the size of the 
cooperative.

                      Children's Health Initiative

Grants to the States

                              Present Law

    None.

                        Description of Proposal

     The proposal would provide an appropriation of $750 
million for FY1998 and each succeeding fiscal year for grants 
to States to expand children's health insurance coverage. The 
intent of the program is to allow States to expand existing 
programs or to establish new programs providing access to 
health insurance for children who are not currently eligible 
for Medicaid, and who do not have access to adequate and 
affordable individual or family coverage.
     Each State would have to apply and obtain Secretarial 
approval of an initial application and of amendments to the 
application made annually and when the State made significant 
changes to its program. The Secretary could establish minimum 
standards for the specific health care benefits to be provided 
including quality standards. State applications would have to 
include the health insurance need in the State, descriptions of 
existing State efforts to insure uninsured children, new 
program design features including eligibility, benefits 
covered, and beneficiary cost sharing. The application also 
would have to include descriptions of the outreach activities 
the State planned to use, the public program development 
process, how the State intended to coordinate with other 
insurance programs, and the State's plans for annual 
assessment. A State plan would be considered approved unless 
the Secretary notified the State within 90 days that it had 
been disapproved (and why) or that specified additional 
information was needed. It would ensure that the insurance 
provided under the State program did not substitute for 
employment-related health insurance. The State must collect 
data and keep records. A State must submit an evaluation by 
March 31, 2000 that included specified elements such as an 
assessment of the State program in increasing the number of 
children with health insurance coverage. The Secretary would be 
required to submit a report to Congress and the public by 
December 31, 2000, based on the evaluations submitted by the 
States containing any conclusions and recommendations that the 
Secretary considered appropriate.
     Of the appropriation provided, 1.5 percent would be 
distributed among the territories with each receiving at least 
$100,000. Each State with an approved application would receive 
a base allotment of $1 million. The remaining funds would be 
allotted to each State having an approved application based on 
the States' allotment percentage.
     In FY1998, 1999, and 2000 the allotment percentage is 
defined as the average number of uninsured children in the 
State during 1993-1995 divided by the average number of 
uninsured children in all States during the same period based 
on Current Population Surveys of the Bureau of the Census for 
those years. In fiscal years after 2000 the allotment 
percentage is defined as the average number of uninsured 
children in the States during 1993-1995 divided by the average 
number of uninsured children in all States having approved 
applications during the same period. The Secretary would adjust 
the States' allotment for relative price differences among the 
States. In 2001, an additional allotment would be made of funds 
not allocated from the 1998, 1999 and 2000 authorizations. 
(There would presumably be funds remaining since not all States 
will immediately have approved applications.) Each State would 
be paid (from its allotment) an amount up to the Medicaid 
Federal medical assistance percentage of expenditures under the 
State's program for: (1) health insurance assistance for 
eligible children and (2) expenditures (which could not exceed 
10 percent of the total expenditures under the program) for 
outreach and for administrative costs. Expenditures under the 
State program for which Federal matching payments could be made 
could include any expenditures from State or local public 
funds, or from private funds, in excess of the amount spent by 
the State in calendar year 1995 for children's coverage.
Investments to expand Medicaid coverage

                              Present Law

     Medicaid provides health insurance coverage to over 21 
million low-income children whose family incomes fall below the 
eligibility thresholds in each of the State programs. GAO 
estimates that there are about 2.9 million Medicaid-eligible 
children that are not enrolled and are uninsured. Other 
Medicaid children may become uninsured during the year if their 
family income rises above the Medicaid eligibility thresholds.

                        Description of Proposal

     The President's plan includes proposals to encourage 
coverage of Medicaid-eligible children. States would be 
provided with an option to allow continuous coverage for 
current child beneficiaries, age 1 and older, for 1 year after 
eligibility is determined, regardless of whether they would 
otherwise lose coverage during the year (as described in the 
Medicaid section). The additional coverage, is estimated to 
reach about 1 million children and to cost $4.9 billion over 5 
years (CBO scoring under Medicaid).
     The plan includes a non-budget item intended to increase 
the effectiveness of Medicaid outreach. The focus of the 
enhanced outreach would be to increase enrollments among those 
eligible for Medicaid by identifying other Federal programs 
that conduct eligibility determinations for low-income children 
including the proposed new grant program for children's health. 
In addition, the President's plan proposes to identify ``best 
practices'' among States with respect to outreach activities.

                                            HEALTH INSURANCE PROVISIONS IN THE PRESIDENT'S FY 1998 BUDGET \1\                                           
                                                                (In millions of dollars)                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                        1998     1999     2000     2001     2002     2003     2004     2005     2006     2007     1998-02     1998-2007 
--------------------------------------------------------------------------------------------------------------------------------------------------------
Temporary premium assistance for                                                                                                                        
 families between jobs \2\..........   1,738    2,472    2,688    2,924        0        0        0        0        0        0       9,822         9,822 
Voluntary purchasing cooperatives...      25       25       25       25       25        0        0        0        0        0         125           125 
Grants to States for Children's                                                                                                                         
 Health Initiative..................     750      750      750      750      750      750      750      750      750      750       3,750         7,500 
--------------------------------------------------------------------------------------------------------------------------------------------------------
The OMB and CBO estimated cost of these programs are the same.                                                                                          
                                                                                                                                                        
\1\ Medicaid child health proposals are included in Medicaid scoring.                                                                                   
\2\ $1,738 billion is appropriated for FY 1998; funding for 1999, 2000, and 2001 is linked to the growth in unemployment compensation and the growth in 
  the economy. The Secretary's authority to conduct this program ceases at the end of FY 2001.                                                          

      

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


                  INCOME SECURITY AND SOCIAL SECURITY

The Administration's budget proposes to increase spending on 
income security programs, including restoring welfare benefits 
to certain individuals, a new vocational rehabilitation 
initiative for SSDI/SSI beneficiaries, and extending 
unemployment compensation taxes.

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

           A. SSI and Medicaid Benefits for Legal Immigrants

1. SSI eligibility for legal immigrants 1
---------------------------------------------------------------------------
    \1\ The term ``legal immigrants'' refers to ``qualified aliens,'' 
defined by P.L. 104-193 (as amended by P.L. 104-208) to include legal 
permanent residents, refugees, aliens paroled into the United States 
for at least 1 year, aliens granted asylum or related relief, and 
certain abused spouses and children. The restrictions on SSI and 
Medicaid noted here do not apply to ``qualified aliens'' who meet a 10-
year work requirement, or who are veterans, certain active duty 
personnel, and their families.
---------------------------------------------------------------------------

                              Present Law

    The Personal Responsibility and Work Opportunity Act of 
1996 (P.L. 104-193) bars legal immigrants from Supplemental 
Security Income (SSI). Current recipients will be screened 
during a 1-year period after enactment of the welfare law 
(August 22, 1996) for SSI eligibility. Legal immigrant children 
are ineligible for SSI on the same basis as other legal 
immigrants.
     Refugees and asylees are eligible for SSI for 5 years 
after entering as refugees or being granted asylum.

                        Description of Proposal

    The President's proposal would provide SSI eligibility for 
legal immigrants who become blind or disabled after their 
admission to the United States regardless of their date of 
entry. It would also make legal immigrant children (under 18) 
eligible for SSI. This would include currently disabled 
children as well as children who are disabled when they enter 
the country. Finally, it would extend the SSI eligibility 
period for refugees and asylees from 5 to 7 years.
2. Medicaid eligibility for legal immigrants

                              Present Law

    States may exclude legal aliens who entered the United 
States before August 22, 1996, from Medicaid beginning January 
1, 1997. Legal immigrants entering the United States after 
August 22, 1996, are barred for 5 years from all but emergency 
medical assistance. After 5 years, the Medicaid bar becomes a 
State option, subject to the ``deeming'' rule. In the case of 
immigrants entering with sponsors after enactment, the 
sponsor's income will be deemed to be available to them in 
determining their eligibility for Medicaid until they 
naturalize or meet the 10-year work requirement.
    Additionally, to the extent that legal immigrants' receipt 
of Medicaid is based only on their eligibility for SSI, they 
may lose Medicaid because of their ineligibility for SSI.
    Eligible refugees and asylees can qualify for full Medicaid 
benefits for 5 years after entering as refugees or being 
granted asylum.

                        Description of Proposal

    The President's proposal would make eligible legal 
immigrants who became blind or disabled after admission to 
qualify for Medicaid regardless of their date of entry and 
without regard to the ``deeming'' provision. This would cover 
both those immigrants who would lose their Medicaid eligibility 
because of the loss of SSI eligibility ($2.3 billion), and 
those immigrants (including children) who would be subject to 
the Medicaid bans and deeming requirements of the welfare law 
($2.5 billion). The President's proposal would also extend the 
Medicaid eligibility period for eligible refugees and asylees 
to 7 years ($25 million).

             B. Medicaid Eligibility for Disabled Children

                              Present Law

    In most States eligibility for SSI confers eligibility for 
Medicaid as well. The 1996 welfare reform law established a 
separate definition of childhood disability for SSI benefits. 
As a result, some children will lose their SSI benefits and 
automatic eligibility for Medicaid. Although some may qualify 
for Medicaid on other grounds, such as low income, some will 
not.

                        Description of Proposal

    The proposal would preserve Medicaid eligibility for 
children who had Medicaid coverage as disabled recipients of 
SSI but who lose SSI eligibility under the new definition.

                      C. Welfare-to-Work Measures

1. Welfare-to-work jobs challenge

                              Present Law

    The new welfare law has replaced AFDC, its education, work 
and training component, known as JOBS (Job Opportunities and 
Basic Skills Training Program), and Emergency Assistance with a 
fixed yearly block grant of $16.5 billion for Temporary 
Assistance to Needy Families (TANF), effective July 1, 1997 at 
the latest. State TANF grants equal Federal funding received in 
a recent year for the replaced programs and currently generally 
exceeds amounts they would have received from AFDC/JOBS, since 
welfare enrollment has declined from the base level. The law 
places heavy stress on moving welfare recipients to work. 
States must require recipients to engage in work, as defined by 
States, after a maximum of 24 months of TANF aid; they must 
achieve minimum rates of participation in creditable ``work 
activities'' specified in the law; and they must impose a 5-
year lifetime limit on TANF benefits. States may use TANF funds 
in any manner that they were authorized to use AFDC, EA, and 
JOBS funds, but no part of the TANF grant is earmarked for a 
specific function.

                        Description of Proposal

    The Administration proposes a ``performance-based Welfare-
to-Work Jobs Challenge'' to help States and cities create job 
opportunities for the ``hardest-to-employ'' welfare recipients. 
The proposal would provide $3 billion in mandatory funding 
designed to move a million recipients into jobs by the year 
2000. Funds could be used for job placement, job creation, 
subsidies and other incentives to private employers. The 
Administration said it also would encourage States and cities 
to use ``voucher-like'' arrangements to provide recipients with 
tools and choices that would help them get jobs and keep them.

 (Note: The Administration placed the Welfare-to-Work Jobs 
Challenge in the budget of the Labor Department.)
2. Work Opportunity Tax Credit

                              Present Law

    The Small Business Job Protection Act of 1996, signed into 
law as P.L. 104-188 on August 20, 1996, established the Work 
Opportunity Tax Credit (WOTC), effective for FY1997 only. It 
entitles employers to an income tax credit of 35 percent of the 
first $6,000 earned in a year (maximum credit, $2,100) by an 
eligible person in one of six groups. (There is a smaller 
credit for summer youth.) Eligible groups include members of 
families who received cash welfare benefits (from AFDC or its 
successor, TANF) for at least 9 months before being hired. Also 
eligible are some food stamp recipients: 18 to 24-year-olds who 
received food stamps for 6 months before being hired or who 
received benefits for at least 3 months out of the last 5 
before being hired (but who have been disqualified for 
continued food stamp benefits because of the program's new work 
requirement. Employers must retain all eligible hires except 
summer youth for at least 180 days or 400 hours in order to 
receive the WOTC. (The WOTC is a successor to the Targeted Jobs 
Tax Credit, which expired on January 1, 1995.)

                        Description of Proposal

    The FY1998 budget proposes ``a greatly-enhanced and 
targeted'' WOTC. The proposed credit would entitle employers to 
a credit of 50 percent of the first $10,000 earned in a year by 
persons who were ``long-term'' recipients of welfare (AFDC or 
TANF). Long-term recipients would include members of families 
who received aid for at least 18 months and those who lost 
eligibility for cash aid because of either Federal or State 
time limits. The credit could be claimed for up to 2 years; the 
maximum credit would be $5,000 per year. Employers who hired 
long-term cash welfare recipients could include some fringe 
benefits in ``wages'' eligible for the credit, namely, amounts 
paid for certain educational, health, and dependent care 
assistance. The proposal also would greatly expand coverage of 
the existing, smaller WOTC for food stamp recipients (for 
example, by extending the eligible age range to 50 years). 
Employers could claim credits for hiring members of these two 
groups--long-term cash welfare recipients and food stamp 
recipients subject to the new work rule--through FY2000. 
Finally, the proposal would extend the present WOTC for 1 year, 
through FY1998.
3. Transportation to jobs and other supportive services

                              Present Law

    As noted above, the TANF block grant does not earmark funds 
for specified purposes.

                        Description of Proposal

    The Administration proposes to establish an ``Access to 
Jobs and Training'' initiative in the Transportation Department 
``to help assure that efforts to reform welfare will be 
successful.'' State and local governments and non-profit 
organizations could apply for funds for new or modified 
transportation services that ensure access to work for low-
income persons, especially current welfare recipients. (For 
this initiative, funds from the mass transit account of the 
Highway Trust Fund would be used.)
    The Administration also proposes to expand an existing 
demonstration program of the Department of Housing and Urban 
Development known as ``Bridges to Work,'' which links low-
income persons in central cities to job opportunities in 
surrounding suburbs. The proposal would offer grants to units 
of local government, preferably for communities designated as 
Empowerment Zones or Enterprise Communities, to develop 
strategies for Bridges to Work programs, including assistance 
for transportation, job search, child care, and other 
supportive services to increase job opportunities.
    $110 million in FY1998 ($100 million for Access to Jobs and 
Training Initiative and $10 million for Bridges to Work).

        D. Unspecified Welfare Reform ``Technical Corrections''

    In addition to the above proposals, the budget proposes 
outlays of $40 million a year ($200 million in FY1998-FY2002) 
for unspecified welfare reform ``technical corrections.'' No 
details are available.

    E. Vocational Rehabilitation Services for SSDI/SSI Beneficiaries

                              Present Law

    Under current law, the Social Security Administration (SSA) 
refers Social Security disability insurance (SSDI) and disabled 
Supplemental Security Income (SSI) beneficiaries who might be 
expected to benefit from vocational rehabilitation (VR) 
services to State VR agencies. SSA may also refer a SSDI or 
disabled SSI beneficiary to an alternate public or private VR 
provider if a State VR agency declines to provide services to 
that individual. SSA reimburses for VR services provided to 
SSDI and disabled SSI beneficiaries only when these services 
contributed to the beneficiary's performance of substantial 
gainful activity for a continuous period of 9 months.

                        Description of Proposal

    This proposal would allow SSA to initiate a new VR services 
program, to be implemented as a 10-year phased-in pilot in 
selected States. Under the proposal, all SSDI and disabled SSI 
beneficiaries--except those expected to recover--would be 
issued a ``ticket'' when they begin receiving disability 
benefit payments. Beneficiaries may assign the ticket to a 
participating provider of his or her choice who is willing to 
accept assignment in exchange for providing VR or other 
employment services. If the SSDI or disabled SSI beneficiary 
returns to work and stops receiving disability benefit payments 
because of earnings, the VR service provider holding the ticket 
at the time the beneficiary returns to work would receive a 
percentage (e.g., 50 percent) of the disability benefit 
payments for a specified period (e.g., 5 years). At the end of 
the 10-year pilot, the Commissioner would recommend whether the 
pilot be terminated or expanded.

                    F. Railroad Retirement Benefits

                              Present Law

    Social Security old-age, survivors, and disability 
insurance (OASDI) and Railroad Retirement tier 1 benefits are 
generally equivalent; however, certain Social Security OASDI 
provisions are more generous than Railroad Retirement, and vice 
versa. For example, unlike Social Security, Railroad Retirement 
does not provide cash benefits for children of living retired 
or disabled railroad workers. Railroad Retirement permits a 
current spouse to take a lump-sum survivor's benefit; however, 
if this benefit is elected, no other survivor (i.e., divorced 
spouse or children) is allowed a survivor's benefit.

                        Description of Proposal

    This proposal would conform Railroad Retirement benefits to 
Social Security OASI provisions where Social Security is more 
generous. Specifically, this proposal would: (1) provide 
benefits to children of retired and disabled railroad workers; 
currently only children of deceased workers are eligible for 
benefits; (2) provide tier 1 benefits to survivors, even if a 
residual lump-sum benefit had been paid; (3) provide a new 
benefit for divorced spouses where the railroad worker is 
eligible but has not yet retired; (4) provide a new benefit for 
a spouse and a divorced spouse for a disabled railroad worker; 
and (5) allow an otherwise eligible individual (e.g., worker or 
spouse) to receive Railroad Retirement benefits even though 
that individual is engaged in rail service (currently, eligible 
individuals working in the railroad industry are not allowed 
Railroad Retirement benefits).

                      G. Unemployment Compensation

1. Extension of the FUTA surtax

                              Present Law

    A Federal payroll tax authorized by the Federal 
Unemployment Tax Act (FUTA) funds certain activities of the 
Federal-State unemployment compensation (UC) system. The FUTA 
tax is paid by private-sector employers for each employee in a 
job covered by the UC system. FUTA revenue is used to pay for 
Federal and State UC administration, operations of the U.S. 
Employment Service, the Federal share of extended UC benefits 
in States with high unemployment, and loans to States with 
insolvent benefit accounts in the Unemployment Trust Fund. The 
FUTA tax applies to the first $7,000 of annual wages of each 
covered worker. The permanent tax rate is 0.6 percent, but a 
temporary rate of 0.8 percent has applied every year since 
1977. The additional 0.2 percent tax, which has been extended 
four times, is scheduled to expire on January 1, 1999.

                        Description of Proposal

    The President's budget proposes that the 0.2 percent 
``surtax'' be extended again through December 31, 2007.

                             Estimated Cost

    This proposal would raise additional revenue as follows 
(OMB scoring):

                    FY1999......................$862 million
                    FY2000...................... 1,218 million
                    FY2001...................... 1,295 million
                    FY2002...................... 1,333 million

2. Monthly payment of unemployment taxes

                              Present Law

    Private-sector employers pay both the FUTA tax to the U.S. 
Treasury and a State UC tax, used to fund UC benefit payments, 
to their State's revenue agency. These taxes are generally paid 
on a quarterly basis.

                        Description of Proposal

    The President's budget would require private-sector 
employers with 20 or more full-time employees to pay these 
taxes on a monthly basis beginning after December 31, 2001.

                             Estimated Cost

    This proposal would raise additional revenue as follows 
(OMB scoring):

                    FY2002......................$1,333 million
                  

                                                                               INCOME SECURITY AND SOCIAL SECURITY                                                                              
                                                                            (By fiscal year, in millions of dollars)                                                                            
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                              1998       1999       2000       2001       2002       2003       2004       2005       2006       2007     1998-02     1998-2007 
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
As reestimated by CBO:                                                                                                                                                                          
  Railroad retirement (raise benefits to Social Security                                                                                                                                        
   levels)...............................................        31         46         46         47         47         48         48         49         49         50        217           461 
  FUBA (extend NAFTA program)............................  .........        28         29         30         30         31         32         33         34         36        117           283 
  UI (health insurance for unemployed)...................       200        210        220        230   .........  .........  .........  .........  .........  .........       860           860 
  UI (Reed Act legislation)..............................  .........  .........      -200       -208       -216   .........  .........  .........  .........  .........      -624          -624 
  SSI return-to-work demonstration.......................  .........  .........        -4         -4         -2   .........         2          2          1          1        -10            -4 
  SSI legal aliens (welfare reform rollback) \1\.........     1,925      1,875      1,925      1,550      1,800      1,950      2,075      2,350      2,300      2,225      9,075        19,975 
  Social Security return-to-work demonstration...........  .........         1   .........         5         12         20         28         30         31         31         18           158 
                                                          --------------------------------------------------------------------------------------------------------------------------------------
        Total............................................     2,156      2,160      2,016      1,650      1,671      2,049      2,185      2,464      2,415      2,343      9,653        21,109 
As estimated by Administration:                                                                                                                                                                 
  Railroad retirement (raise benefits to Social Security                                                                                                                                        
   levels)...............................................        31         46         46         47         47         48         48         49         49         50        217           461 
  FUBA (extend NAFTA program)............................  .........        17         24         25         26         27         28         30         31         32         92           240 
  UI (health insurance for unemployed)...................  .........  .........  .........  .........  .........  .........  .........  .........  .........  .........                         
  UI (Reed Act legislation)..............................  .........  .........      -200       -200       -200   .........  .........  .........  .........                 -600          -600 
  SSI return-to-work demonstration.......................        -4         -4         -4         -3         -3         -3         -4         -5         -5         -5        -18           -40 
  SSI legal aliens (welfare reform rollback) \2\.........     1,707      1,824      2,096      1,907      2,184      2,308      2,433      2,762      2,698      2,610      9,718        22,529 
  Social Security return-to-work demonstration...........  .........        -5          1          7         13         19         19         19         18         18         16           109 
                                                          --------------------------------------------------------------------------------------------------------------------------------------
        Total............................................     1,734      1,878      1,963      1,783      2,067      2,399      2,524      2,855      2,791      2,705      9,425        22,699 
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ Also estimated by CBO to have costs of $325 million in 1997.                                                                                                                                
\2\ Also estimated by Administration to have costs of $224 million in 1997.                                                                                                                     

      

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


                                 TRADE

The Administration's budget proposes total spending of $6.855 
billion over 10 years from fiscal year 1998 on three trade 
initiatives: (1) reauthorization of the Generalized System of 
Preferences; (2) extension of enhanced trade benefits to 
Caribbean Basin Initiative countries; and (3) implementation of 
the Agreement Respecting Normal Competitive Conditions in the 
Commercial Shipbuilding and Repair Industry (negotiated under 
the auspices of the Organization for Economic Cooperation and 
Development).

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

                        Administration Proposals

Generalized System of Preferences

                              Present Law

    The United States and other industrial countries 
established the Generalized System of Preferences (GSP) in the 
1970s to promote economic development in developing countries 
through increased trade. The U.S. program provides duty-free 
treatment to imports of specified products from designated 
beneficiary countries, to provide a competitive advantage for 
those imports. To obtain GSP benefits under U.S. law on over 
4,000 products (excluding certain import-sensitive items such 
as apparel and footwear), a developing country must satisfy 
certain criteria concerning its level of economic development, 
trade and foreign policy. Among the trade criteria considered 
are whether a country provides adequate and effective 
protection to U.S. intellectual property rights, and whether 
the country provides its citizens with certain internationally 
recognized worker rights. The President has authority to 
withdraw or suspend GSP benefits based on these criteria, as 
well as the authority to ``graduate'' advanced developing 
countries. GSP benefits may also be withdrawn if a country's 
imports of a particular product exceed a specified level--the 
so-called competitive need limit.
    The program is intended to give temporary assistance to 
developing countries until their exporters are able to compete 
on world markets without preferential treatment.
    The U.S. program expired on July 31, 1995. After more than 
a 1-year lapse, Congress passed and President Clinton signed 
legislation to renew GSP retroactively through May 31, 1997, 
when it will again expire.

                        Description of Proposals

    The Administration has requested a total of $4.134 billion 
for a 10-year reauthorization of the GSP program. The 
Administration will propose certain changes in eligibility 
under the GSP program, which may reduce the overall cost of the 
program while expanding the benefits available under GSP to the 
least-developed developing countries, particularly in Sub-
Saharan Africa.

Caribbean Basin Initiative

                              Present Law

    In February 1982, President Reagan proposed a comprehensive 
program--the Caribbean Basin Initiative (CBI)--``to promote 
economic revitalization and facilitate expansion of economic 
opportunity in the Caribbean Basin region.'' The centerpiece of 
the CBI program is the Caribbean Basin tariff preference. This 
preference and some other less comprehensive benefits were 
enacted in 1983 by the Caribbean Basin Economic Recovery Act 
(CBERA) and put into effect January 1, 1984. The CBERA has been 
amended several times, most substantively by the Caribbean 
Basin Economic Recovery Act of 1990 (``CBI II''), which added 
several improvements in the trade and tax benefits and made the 
program permanent.
    The CBERA authorizes unilateral duty-free treatment for 
eligible articles imported from 27 potentially eligible 
Caribbean countries. While most otherwise dutiable products are 
eligible for duty-free treatment under CBERA, the statute 
specifically excepts from the preference certain textiles, 
apparel and footwear, canned tuna, petroleum and its products, 
and watches and watch parts containing any material originating 
in countries denied Most Favored Nation (MFN) status.

                        Description of Proposals

    To prepare for a future free-trade agreement, the 
Administration has requested a total of $2.604 billion from 
fiscal year 1998 through fiscal year 2005 to phase in expanded 
trade benefits to Caribbean Basin countries. Under the 
Administration's proposal, the expanded trade benefits will 
include authorization of reduced and potentially duty-free 
treatment to products now excluded from the CBI program (e.g., 
textiles and apparel) for Caribbean Basin countries that 
satisfy new eligibility criteria. The proposed expanded program 
would expire on September 30, 2005.

OECD Shipbuilding Subsidies Agreement

                              Present Law

    After 5 years of negotiations under the auspices of the 
Organization for Economic Cooperation and Development (OECD), 
key shipbuilding nations (the United States, the European Union 
(EU), Japan, South Korea, and Norway) signed the Agreement 
Respecting Normal Competitive Conditions in the Commercial 
Shipbuilding and Repair Industry (Shipbuilding Agreement) on 
December 21, 1994.
    The Shipbuilding Agreement applies to construction and 
repair of self-propelled seagoing vessels of 100 gross tons and 
above and tugs of 365 kilowatts or more, and covers 
approximately 80 percent of world shipbuilding capacity for 
vessels engaged in worldwide shipping. It has four main 
provisions: (1) elimination of virtually all shipbuilding 
subsidies granted either directly to shipbuilders or indirectly 
through ship operators; (2) an injurious pricing code, modeled 
on the World Trade Organization (WTO) Antidumping Agreement, 
under which countries can fine foreign shipyards that sell 
ships at unfairly low (i.e., dumped) prices; (3) a 
comprehensive set of rules on government financing for export 
and domestic ship sales; and (4) binding dispute-settlement 
procedures in the OECD. The Shipbuilding Agreement also 
contains a ``standstill'' requirement, under which the 
signatories agree not to give their shipyards additional 
subsidies or to increase existing subsidies before the 
Agreement enters into force.
    For the United States to complete its ratification, 
legislation must be enacted by Congress to conform U.S. law to 
the obligations in the Agreement.

                        Description of Proposals

    The Administration has requested a total of $117 million 
from fiscal year 1998 through fiscal year 2007 for 
implementation of the OECD Shipbuilding Agreement.
      

                                          CBO REESTIMATE OF THE TRADE PROPOSALS IN THE 1998 PRESIDENT'S BUDGET                                          
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                  1998     1999     2000     2001     2002     2003     2004     2005     2006     2007 
--------------------------------------------------------------------------------------------------------------------------------------------------------
GSP:                                                                                                                                                    
  CBO.........................................................     -454     -318     -324     -343     -362     -383     -404     -430     -458     -489
  ADM.........................................................     -555     -361     -360     -364     -376     -391     -407     -423     -440     -457
    Total difference..........................................      101       43       36       21       14        8        3       -7      -18      -32
                                                                                                                                                        
CBI:                                                                                                                                                    
  CBO.........................................................      -83     -122     -227     -282     -311     -343     -377     -414        0        0
  ADM.........................................................     -101     -137     -277     -356     -383     -427     -452     -471        0        0
    Total difference..........................................       18       15       50       74       72       84       75       57        0        0
                                                                                                                                                        
OECDSHIP:                                                                                                                                               
  CBO.........................................................       -8       -8       -7       -7       -7       -7       -7       -7       -7       -7
  ADM.........................................................      -10      -11      -11      -11      -12      -12      -12      -12      -13      -13
    Total difference..........................................        2        3        4        4        5        5        5        5        6        6
                                                                                                                                                        
Total trade:                                                                                                                                            
  CBO.........................................................     -544     -448     -559     -631     -680     -732     -788     -851     -465     -496
  ADM.........................................................     -666     -509     -648     -731     -771     -830     -871     -906     -453     -470
    Total difference..........................................      122       61       89      100       91       98       83       55      -12      -26
--------------------------------------------------------------------------------------------------------------------------------------------------------

      

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


                      NET INTEREST AND DEBT LIMIT

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

                              NET INTEREST

    Interest costs are a significant portion of the Federal 
budget, currently representing 15 percent of all Federal 
outlays. Under CBO's assumption of stable interest rates 
throughout the projection period and assuming that 
discretionary spending rises with inflation, interest payments 
will decline to 13 percent of the budget by 2007. In dollar 
terms, net interest will rise from $241 billion in 1996 and 
increase steadily to an expected level of $340 billion in 2007. 
Debt held by the public is projected to rise during that period 
from $3.7 trillion to $6 trillion. As a percentage of GDP, 
interest costs are expected to decline slowly from 3.2 percent 
this year to 2.7 percent in 2007, and debt held by the public 
will stabilize at about 48 percent of GDP.
[GRAPHIC] [TIFF OMITTED] TP018.024


    Interest costs are generally not covered by the enforcement 
provisions of the Budget Enforcement Act because they are not 
directly controllable. Rather, interest depends on the 
outstanding amount of government debt and on interest rates. 
The Congress and the President influence the former by making 
decisions about taxes and spending and thus about borrowing. 
Beyond that, they exert no direct control over interest rates, 
which are determined by market forces and Federal Reserve 
policy.
    Net interest is the most useful measure of the government's 
current debt-service costs. Some budget-watchers stress gross 
interest (and its counterpart, the gross Federal debt) instead 
of net interest (and its counterpart, debt held by the public). 
But that choice exaggerates the government's debt-service 
burden because it overlooks billions of dollars in interest 
income received by the government.
    The government has sold more than $3.7 trillion in 
securities to finance deficits over the years. But it has also 
issued $1.4 trillion in securities to its own trust funds 
(mainly Social Security and the other retirement funds). Those 
securities represent the past surpluses of the trust funds, and 
their total amount grows approximately in step with the 
projected trust fund surpluses. The funds redeem the securities 
when needed to pay benefits; in the meantime, the government 
both pays and collects the interest on those securities. It 
also receives interest income from loans and cash balances. 
Broadly speaking, gross interest encompasses all interest paid 
by government (even to its own funds) and ignores all interest 
income. Net interest, by contrast, is the net flow to people 
and organizations outside the Federal Government.
    Net interest is only about two-thirds as large as gross 
interest. CBO estimates that the government will pay $360 
billion in gross interest costs this year. Of that amount, 
however, $106 billion is simply credited to trust funds and 
does not leave the government or add to the total deficit. The 
government also collects $6 billion in other interest income. 
Net interest costs therefore total $248 billion.

                               DEBT LIMIT

                         Raising the Debt Limit

    Since 1917, the Congress by statute has set an overall 
dollar ceiling on the amount of debt that the Treasury can 
issue. That ceiling is increased periodically, with each change 
giving the Treasury authority to issue debt for a couple of 
years before another increase is necessary. As fiscal year 1996 
began, the Treasury's authority to issue debt, last raised in 
August 1993 to $4.9 trillion, was once again becoming 
inadequate.
    Legislation increasing the debt limit has historically been 
viewed by the Congress as ``must pass'' legislation and has 
been used as a vehicle for enacting other measures important to 
the Congress. For example, the Balanced Budget and Emergency 
Deficit Control Act of 1985 was passed as  part of legislation 
raising the debt ceiling. In 1995 and 1996, the Congress also 
attempted to use such legislation to achieve deficit reduction. 
The resulting deadlock over measures to reduce the deficit led 
to the longest impasse ever regarding the debt limit, 
stretching from November 15, 1995 to March 28, 1996, a total of 
135 days.
[GRAPHIC] [TIFF OMITTED] TP018.025

    Because the debt limit covers both debt sold to the public 
and government securities held by trust funds and other 
government accounts, the Treasury can disinvest (convert to 
uninvested balances) holdings of government accounts and 
thereby create room under the debt limit to raise cash from the 
public. As negotiations on achieving a balanced budget 
continued past the start of the fiscal year, Treasury Secretary 
Robert E. Rubin authorized the use of that technique to ensue 
that the government would be able to make its November 15 
quarterly interest payment to holders of public debt 
securities. The Secretary disinvested holdings of the 
Government Securities Investment Fund of the Thrift Savings 
Fund (a tax-deferred savings plan for Federal employees) and 
the Civil Service Retirement and Disability Fund because 
statute permits it and provides that the funds be restored in 
full with interest.
    The continued inability of the President and the Congress 
to agree on legislation to balance the budget required the use 
of other techniques to allow the government to remain below the 
debt ceiling and continue borrowing. The Secretary withheld the 
semiannual interest payment to the Civil Service Retirement and 
Disability Fund, which is normally made in December, to prevent 
the debt ceiling from being reached (interest payments are 
invested in government account securities). Then, in order to 
make the February 15 quarterly interest payment to holders of 
public debt securities, the Secretary extended disinvestment of 
that fund, authorized withdrawals from the Exchange 
Stabilization Fund, and swapped agency securities of the Postal 
Service and the Tennessee Valley Authority held by the Federal 
Financing Bank with government accounts series securities held 
by the Civil Service Retirement and Disability Fund.
    As the Treasury Secretary warned that the continued impasse 
over the debt limit threatened the timely payment of Social 
Security benefits for the month of March, the Congress passed 
legislation enabling the Treasury to borrow about $29 billion 
(the size of the March Social Security benefits) that would not 
be counted against the debt limit until March 15. That 
legislative technique was new; in prior impasses, the Congress 
had generally enacted temporary increases in the debt ceiling. 
As March 15 approached, the temporary exemption was extended 
through March 30 and amended to exclude inflows to government 
accounts from the debt ceiling.
    Finally, on March 28, the Congress passed an increase in 
the debt limit to $5.5 billion. The bill also terminated 
Supplemental Security Income benefits for drug addicts and 
alcoholics and included an increase in the exempt earnings 
amount for Social Security beneficiaries who continue to work. 
Under the Congressional Budget Office's baseline projections, 
the new ceiling will be sufficient through the beginning of 
fiscal year 1998.
[GRAPHIC] [TIFF OMITTED] TP018.026