    [Senate Prints 109-72]
    [From the U.S. Government Publishing Office]

    109th Congress
     2d Session                 COMMITTEE PRINT                     S. Prt.
                                                                    109-072
    _______________________________________________________________________

                                TAX EXPENDITURES

           Compendium of Background Material on Individual Provisions

                                   ----------

                            COMMITTEE ON THE BUDGET

                              UNITED STATES SENATE

    [GRAPHIC] [TIFF OMITTED] TONGRESS.#13

                                 DECEMBER 2006

                                PREPARED BY THE

                         Congressional Research Service

          Prepared for the use of the Committee on the Budget by the
     Congressional Research Service. This document has not been officially
    approved by the Committee and may not reflect the views of its members.

       TAX EXPENDITURES--Compendium of Background Material on Individual
                                   Provisions

    109th Congress
     2d Session                 COMMITTEE PRINT                     S. Prt.
                                                                    109-072
    _______________________________________________________________________

                                TAX EXPENDITURES

           Compendium of Background Material on Individual Provisions

                                   __________

                            COMMITTEE ON THE BUDGET

                              UNITED STATES SENATE

    [GRAPHIC] [TIFF OMITTED] TONGRESS.#13

                                 DECEMBER 2006

                                PREPARED BY THE

                         Congressional Research Service

          Prepared for the use of the Committee on the Budget by the
     Congressional Research Service. This document has not been officially
    approved by the Committee and may not reflect the views of its members.

                        U.S. GOVERNMENT PRINTING OFFICE
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                            COMMITTEE ON THE BUDGET

                      JUDD GREGG, New Hampshire, Chairman
    PETE V. DOMENICI, New Mexico         KENT CONRAD, North Dakota
    CHARLES E. GRASSLEY, Iowa            PAUL S. SARBANES, Maryland
    WAYNE ALLARD, Colorado               PATTY MURRAY, Washington
    CONRAD BURNS, Montana                RON WYDEN, Oregon
    MICHAEL ENZI, Wyoming                RUSSELL D. FEINGOLD, Wisconsin
    JEFF SESSIONS, Alabama               TIM JOHNSON, South Dakota
    JIM BUNNING, Kentucky                ROBERT C. BYRD, West Virginia
    MIKE CRAPO, Idaho                    BILL NELSON, Florida
    JOHN ENSIGN, Nevada                  DEBBIE STABENOW, Michigan
    JOHN CORNYN, Texas                   JON S. CORZINE, New Jersey
    LAMAR ALEXANDER, Tennessee
    LINDSEY O. GRAHAM, South Carolina
                      Scott Gudes, Majority Staff Director
                        Mary Ann Naylor, Staff Director

    LETTER OF TRANSMITTAL

    	December 20, 2006

    UNITED STATES SENATE
    COMMITTEE ON THE BUDGET
    WASHINGTON, DC

    To the Members of the Committee on the Budget:

    The Congressional Budget and Impoundment and Control Act of 1974
    (as amended) requires the Budget Committees to examine tax expenditures
    as they develop the Congressional Budget Resolution.  There are over 160
    separate tax expenditures in current law.  Section 3(3) of the Budget Act of
    1974 defines tax expenditures as those revenue losses attributable to
    provisions of the Federal tax laws which allow a special exclusion,
    exemption, or deduction from gross income or provide a special credit, a
    preferential rate of tax, or a deferral of tax liability.

    Tax expenditures are becoming increasingly important when
    considering the budget.  They are often enacted as permanent legislation and
    can be compared to direct spending on entitlement programs.  Both tax
    expenditures and entitlement spending have received, as they should in the
    current budget environment, increased scrutiny.

    This print was prepared by the Congressional Research Service (CRS)
    and was coordinated by Daniel Brandt and Cheri Reidy of the Senate Budget
    Committee staff.  All tax code changes through the end of the 109th
    Congress are included.

    The CRS has produced an extraordinarily useful document which
    incorporates not only a description of each provision and an estimate of its
    revenue cost, but also a discussion of its impact, a review of its underlying
    rationale, an assessment which addresses the arguments for and against the
    provision, and a set of bibliographic references.  Nothing in this print should
    be interpreted as representing the views or recommendations of the Senate
    Budget Committee or any of its members.

    Judd Gregg
    Chairman

    	LETTER OF SUBMITTAL

    	CONGRESSIONAL RESEARCH SERVICE
    	THE LIBRARY OF CONGRESS
    	Washington, D.C., December 15, 2006

    Honorable Judd Gregg
    Chairman, Committee on the Budget
    U.S. Senate
    Washington, DC 20510.

    Dear Mr. Chairman:

    I am pleased to submit a revision of the December 2004 Committee
    Print on Tax Expenditures.

    As in earlier versions, each entry includes an estimate of each tax
    expenditure's revenue cost, its legal authorization, a description of the tax
    provision and its impact, the rationale at the time of adoption, an assessment,
    and bibliographic citations.  The impact section includes quantitative data on
    the distribution of tax expenditures across income classes where such data
    are relevant and available.  The rationale section contains some detail about
    the historical development of each provision.  The assessment section
    summarizes major issues surrounding each tax expenditure.

    The revision was written under the general direction of Jane G.
    Gravelle, Senior Specialist in Economic Policy.  Contributors of individual
    entries include Andrew Austin, James M. Bickley, David L. Brumbaugh,
    Gregg A. Esenwein, Jane G. Gravelle, Gary Guenther, Thomas Hungerford,
    Pamela Jackson, Steven Maguire, Nonna Noto, and Maxim Shvedov of the
    Government and Finance Division;  Linda Levine, Robert F. Lyke,  Edward
    B. Rappaport, Christine Scott, and David Smole of the Domestic Social
    Policy Division; and Salvatore Lazzari of the Resources, Science and
    Industry Division.  Dee Gray, Rosslyn Richardson, and LaTanya Winston
    provided editorial assistance and prepared the document for publication.

    	DANIEL P. MULHOLLAN, Director

                                 CONTENTS

    Letter of Transmittal	III
    Letter of Submittal	V
    Introduction	1
    National Defense
    Exclusion of Benefits and Allowances to
    Armed Forces Personnel	13
    Exclusion of Military Disability Benefits	19
    Deduction for Overnight-Travel Expenses of National
    Guard and Reserve Members	23
    International Affairs
    Exclusion of Income Earned Abroad by U.S. Citizens	27
    Exclusion of Certain Allowances for Federal Employees
    Abroad	33
    Exclusion of Extraterritorial Income	37
    Deferral of Active Income of Controlled Foreign
    Corporations	43
    Inventory Property Sales Source Rule Exception	49
    Deferral of Certain Financing Income	53
    General Science, Space, and Technology
    Tax Credit for Increasing Research Expenditures	57
    Expensing of Research and Experimental Expenditures	65
    Energy
    Expensing of Exploration and Development Costs;
    Amortization of Geological and Geophysical Costs:
    Oil, Gas, and Other Fuels	69
    Excess of Percentage over Cost Depletion: Oil, Gas, and
    Other Fuels	75
    Tax Credit for Production of Non-Conventional Fuels	83
    Tax Credits for Alcohol and Biodiesel Fuels	91
    Exclusion of Interest on State and Local Government
    Qualified Private Activity Bonds for Energy
    Production Facilities	101
    Exclusion of Energy Conservation Subsidies Provided
    by Public Utilities 	105
    Tax Credit for Investments in Solar, Geothermal,
    Fuel Cells, and Microturbines	109
    Tax Credits for Electricity Production from Renewable
    Resources	117
    Tax Credit and Deduction for Small Refiners with
    Capital Costs Associated with EPA Sulfur
    Regulation Compliance	125
    Deferral of Gain from the Disposition of Electric
    Transmission Property to Implement Federal
    Energy Regulatory Commission Restructuring Policy 	129
    Tax Credit for Holders of Clean Renewable Energy Bonds 	133
    Tax Credits For Investments In Clean Coal Power
    Generation Facilities	137
    Expensing of the Cost of Property Used in the Refiners
    of Liquid Fuels 	141
    Deduction of Expenditures on Energy-Efficient
    Commercial Building Property 	145
            Tax Credit for the Purchase of Qualified Energy
    Efficiency Improvements to Homes  151
           	Tax Credit for the Production of Energy-Efficient
    Appliances 	157
    Tax Credits for Alternative Technology Vehicles 163
    	Tax Credit for Clean Fuel Vehicle Refueling Property 173
    Five-Year Carryback Period for Certain Net Operating
    Losses of Electric Utility Companies 179
    Natural Resources and Environment
    Excess of Percentage Over Cost Depletion: Nonfuel
    Minerals	183
    Expensing of Multiperiod Timber-Growing Costs;
    Amortization and Expensing of Reforestation
    Expenses	189
    Expensing of Exploration and Development Costs:
    Nonfuel Minerals	193
    Exclusion of Interest on State and Local Government
    Sewage, Water, and Hazardous Waste
    Facilities Bonds	197
    Special Rules for Mining Reclamation Reserves	201
    Special Tax Rate for Nuclear Decommissioning
    Reserve Fund	203
    Exclusion of Contributions in Aid of Construction
    for Water and Sewer Utilities	207
    Amortization of Certified Pollution Control Facilities	211
    Agriculture
    Exclusion of Cost-Sharing Payments	215
    Exclusion of Cancellation of Indebtedness Income
    of Farmers	219
    Cash Accounting for Agriculture	223
    Income Averaging for Farmers and Fishermen	227
    Five-Year Carryback Period for Net Operating Losses
    	Attributable to Farming	231
    Commerce and Housing
    Exemption of Credit Union Income	235
    Exclusion of Investment Income on Life Insurance and
    Annuity Contracts	239
    Small Life Insurance Company Taxable Income
    Adjustment	245
    Special Treatment of Life Insurance Company Reserves	249
    Deduction of Unpaid Property Loss Reserves for
    Property and Casualty Insurance Companies	253
    Special Deduction for Blue Cross and Blue Shield
    Companies	257
    Deduction for Mortgage Interest on Owner-Occupied
    Residences	261
    Deduction for Property Taxes on Owner-Occupied
    Residences	267
    Exclusion of Capital Gains on Sales of Principal
    Residences	273
    Exclusion of Interest on State and Local
    Government Bonds for Owner-Occupied Housing	277
    Exclusion of Interest on State and Local
    Government Bonds for Rental Housing	281
    Tax Credit for First-Time Homebuyers in the
    District of Columbia	285
    Additional Exemption for Housing Provided to
    Individuals Displaced by Hurricane Katrina	289
    Employer Housing for Individuals Affected by
    Hurricane Katrina	293
    Depreciation of Rental Housing in Excess of
    Alternative Depreciation System	297
    Tax Credit for Low-Income Housing	303
    Tax Credit for Rehabilitation of Historic Structures	309
    Investment Credit for Rehabilitation of Structures
    Other Than Historic Structures	313
    Reduced Rates of Tax on Dividends and Long-Term
    Capital Gains	317
    Exclusion of Capital Gains at Death Carryover Basis of
    Capital Gains on Gifts	325
    Deferral of Gain on Non-Dealer Installment Sales	331
    Deferral of Gain on Like-Kind Exchanges	335
    Depreciation of Buildings Other than Rental Housing
    in Excess of Alternative Depreciation System	339
    Depreciation on Equipment in Excess of Alternative
    Depreciation System	345
    Expensing of Depreciable Business Property	351
    Amortization of Business Start-Up Costs	357
    Reduced Rates on First $10,000,000 of Corporate
    Taxable Income	361
    Permanent Exemption from Imputed Interest Rules	365
    Expensing of Magazine Circulation Expenditures	369
    Special Rules for Magazine, Paperback Book, and
    Record Returns	373
    Completed Contract Rules	377
    Cash Accounting, Other than Agriculture	381
    Exclusion of Interest on State and Local Government
    Small-Issue Qualified Private Activity Bonds	385
    Exception from Net Operating Loss Limitations for
    Corporations in Bankruptcy Proceedings	389
    Tax Credit for Employer-Paid FICA Taxes on Tips	393
    Production Activity Reduction	397
    Deduction for Certain Film and Television Production Costs	401
    Tax Credit for the Cost of Carrying Tax-Paid Distilled
    Spirits in Wholesale Inventories . . . . . . . . . . . . . . . . . . . . . .405
    Tax Benefits Related to 2005 Hurricane Disaster Costs:
    Expensing of Clean-up Costs, Additional First Year
    	Depreciation, Carryback of Losses, Tax Credit for
    Employee Retention	409
     Transportation
    Exclusion of Interest on State and Local Government Bonds
    for Highway Projects and Rail-Truck Transfer Facilities 	413
    Tax Credit for Certain Railroad Track Maintenance	417
    Deferral of Tax on Capital Construction Funds of Shipping 			Companies	421
    Exclusion of Employer-Paid Transportation Benefits	425
    Community and Regional Development
    New York City Liberty Zone Tax Incentives	429
    Empowerment Zone Tax Incentives, District of Columbia Tax
    Incentives, and Indian Reservation Tax Incentives	433
    New Markets Tax Credit and Renewal Community Tax
    Incentives	439
    Expensing of Redevelopment Costs in Certain Environmentally
     Contaminated Areas ("Brownfields")	443
    Exclusion of Interest on State and Local Government Bonds
    for Private Airports, Docks, and Mass Commuting
    Facilities	447
    Qualified Green Building and Sustainable Design Project
    Bonds	451
    Education, Training, Employment, and Social Services
    Exclusion of Income Attributable to the Discharge of
    Certain Student Loan Debt and NHSC Educational
    Loan Repayments	455
    Deduction for Classroom Expenses of Elementary and
    Secondary School Educators	459
    Tax Credits for Tuition for Post-Secondary Education	463
    Deduction for Interest on Student Loans	467
    Exclusion of Earnings of Coverdell Educational
    Savings Accounts	471
    Exclusion of Interest on Education Savings Bonds	475
    Deduction for Higher Education Expenses	479
    Exclusion of Tax on Earnings of Qualified Tuition Programs	483
    Exclusion of Scholarship and Fellowship Income	487
    Exclusion of Employer-Provided Education Assistance
    Benefits	491
    Exclusion of Employer-Provided Tuition Reduction 493
    Parental Personal Exemption for Students Age 19-23	497
    Exclusion of Interest on State and Local Government
    Student Loan Bonds	501
    Exclusion of Interest on State and Local Government
    Bonds for Private Nonprofit and Qualified Public
    Educational Facilities	507
    Tax Credit for Holders of Qualified Zone Academy Bonds	 511
    Deduction for Charitable Contributions to Educational
    Institutions	515
    Exclusion of Employee Meals and Lodging (Other
    than Military)	523
    Exclusion of Benefits Provided under Cafeteria Plans	527
    Exclusion of Housing Allowances for Ministers	533
    Exclusion of Miscellaneous Fringe Benefits	539
    Exclusion of Employee Awards	543
    Exclusion of Income Earned by Voluntary Employees'
    Beneficiary Associations	547
    Special Tax Provisions for Employee Stock Ownership
    Plans (ESOPs)	555
    Work Opportunity Tax Credit	561
    Welfare-to-Work Tax Credit	565
    Deferral of Taxation on Spread on Acquisition of Stock
    Under Incentive Stock Option Plans and Employee
    Stock Purchase Plans	569
    Tax Credit for Children Under Age 17	573
    Tax Credit for Child and Dependent Care and Exclusion
    of Employer-Provided Child Care	577
    Tax Credit for Employer-Provided Child Care	585
    Exclusion of Certain Foster Care Payments	589
    Adoption Credit and Employee Adoption Benefits Exclusion	593
    Deduction for Charitable Contributions, Other than for
    Education and Health	599
    Tax Credit for Disabled Access Expenditures	607
    Health
    Exclusion of Employer Contributions for Health Care,
    Health Insurance Premiums, and Long-Term Care
    Insurance Premiums	611
    Exclusion of Medical Care and CHAMPUS/TRICARE,
    Medical Insurance for Military Dependents, Retirees,
    and Retiree Dependents	619
    Deduction for Health Insurance Premiums and Long-Term
    Care Insurance Premiums Paid by the Self-Employed	623
    Deduction for Medical Expenses and Long-Term
    Care Expenses	629
    Exclusion of Workers' Compensation Benefits
    (Medical Benefits)	637
    Health Savings Accounts	641
    Exclusion of Interest on State and Local Government Bonds
    for Private Nonprofit Hospital Facilities	647
    Deduction for Charitable Contributions to Health
    Organizations	651
    Tax Credit for Orphan Drug Research	659
    Tax Credit for Purchase of Health Insurance by Certain
    Displaced Persons	665
    Medicare
    Exclusion of Untaxed Medicare Benefits: Hospital Insurance	671
    Exclusion of Medicare Benefits: Supplementary Medical
    Insurance	675
    Exclusion of Subsidy Payments to Employers Offering
    Certain Prescription Drug Benefits to Retirees Eligible
    for Medicare	679
    Income Security
    Exclusion of Workers' Compensation Benefits
    (Disability and Survivors Payments)	685
    Exclusion of Damages on Account of Personal Physical
    Injuries or Physical Sickness	689
    Exclusion of Special Benefits for Disabled Coal Miners	693
    Exclusion of Cash Public Assistance Benefits	697
    Net Exclusion of Pension Contributions and Earnings Plans
    for Employees and Self-Employed Individuals (Keoghs)	701
    Net Exclusion of Pension Contributions and Earnings:
    Individual Retirement Plans	709
    Tax Credit for Certain Individuals for Elective Deferrals
    and IRA Contributions	715
    Tax Credit for New Retirement Plan Expenses of Small
    Businesses	719
    Exclusion of Other Employee Benefits: Premiums on
    Group Term Life Insurance	723
    Exclusion of Other Employee Benefits: Premiums on
    Accident and Disability Insurance	727
    Additional Standard Deduction for the Blind and the Elderly	729
    Tax Credit for the Elderly and Disabled	733
    Deductibility for Casualty and Theft Losses	737
    Earned Income Credit (EIC)	741
    Exclusion of Cancellation of Indebtedness Income of
    Hurricane Katrina Victims	747
    Social Security and Railroad Retirement
    Exclusion of Untaxed Social Security and Railroad
    Retirement Benefits	749
    Veterans' Benefits and Services
    Exclusion of Veterans' Benefits and Services:
    (1) Exclusion of Veterans' Disability Compensation;
    (2) Exclusion of Veterans' Pensions;
    (3) Exclusion of Readjustment Benefits	755
    Exclusion of Interest on State and Local Government Bonds
    for Veterans' Housing	759
    General Purpose Fiscal Assistance
    Exclusion of Interest on Public Purpose State and Local 				Government Debt	763
    Deduction of Nonbusiness State and Local Government
    Income and Personal Property Taxes	769
    Tax Credit for Puerto Rico and Possession Income and
    Puerto Rico Economic Activity 773
    Interest
    Deferral of Interest on Savings Bonds	779
    Appendixes

    A. Forms of Tax Expenditures	783
    B. Relationship Between Tax Expenditures and
    Limited Tax Benefits Subject to Line Item Veto	787

    INTRODUCTION

    This compendium gathers basic information concerning 160 Federal tax
    provisions currently treated as tax expenditures.  They include those listed in
    Tax Expenditure Budgets prepared for fiscal years 2006-2010 by the Joint
    Committee on Taxation,  although certain separate items that are closely
    related and are within a major function may be combined.

    With respect to each tax expenditure, this compendium provides:

    The estimated Federal revenue loss associated with the provision
    for individual and corporate taxpayers, for fiscal years 2006-2010,
    as estimated by the Joint Committee on Taxation;

    The legal authorization for the provision (e.g., Internal Revenue
    Code section, Treasury Department regulation, or Treasury
    ruling);

    A description of the tax expenditure, including an example of its
    operation where this is useful;

    A brief analysis of the impact of the provision, including
    information on the distribution of benefits where data are
    available;

    A brief statement of the rationale for the adoption of the tax
    expenditure where it is known, including relevant legislative
    history;

    An assessment, which addresses the arguments for and against the
    provision; and

    References to selected bibliography.

    The information presented for each tax expenditure is not intended to be
    exhaustive or definitive.  Rather, it is intended to provide an introductory
    understanding of the nature, effect, and background of each provision.  Good
    starting points for further research are listed in the selected bibliography
    following each provision.

    	Defining Tax Expenditures

    Tax expenditures are revenue losses resulting from Federal tax
    provisions that grant special tax relief designed to encourage certain kinds of
    behavior by taxpayers or to aid taxpayers in special circumstances.  These
    provisions may, in effect, be viewed as spending programs channeled through
    the tax system.  They are, in fact, classified in the same functional categories
    as the U.S. budget.

    Section 3(3) of the Congressional Budget and Impoundment Control
    Act of 1974 specifically defines tax expenditures as:

    . . . those revenue losses attributable to provisions of the Federal tax laws which
    allow a special exclusion, exemption, or deduction from gross income or which
    provide a special credit, a preferential rate of tax, or a deferral of tax liability; . . .

    In the legislative history of the Congressional Budget Act, provisions
    classified as tax expenditures are contrasted with those provisions which are
    part of the "normal structure" of the individual and corporate income tax
    necessary to collect government revenues.

    The listing of a provision as a tax expenditure in no way implies any
    judgment about its desirability or effectiveness relative to other tax or non-tax
    provisions that provide benefits to specific classes of individuals and
    corporations.  Rather, the listing of tax expenditures, taken in conjunction
    with the listing of direct spending programs, is intended to allow Congress to
    scrutinize all Federal programs relating to the same goals--both non-tax and
    tax--when developing its annual budget.  Only when tax expenditures are
    considered will congressional budget decisions take into account the full
    spectrum of Federal programs.

    Because any qualified taxpayer may reduce tax liability through use of a
    tax expenditure, such provisions are comparable to entitlement programs
    under which benefits are paid to all eligible persons.  Since tax expenditures
    are generally enacted as permanent legislation, it is important that, as
    entitlement programs, they be given thorough periodic consideration to see
    whether they are efficiently meeting the national needs and goals for which
    they were established.

    Tax expenditure budgets which list the estimated annual revenue losses
    associated with each tax expenditure first were required to be published in
    1975 as part of the Administration budget for fiscal year 1976, and have been
    required to be published by the Budget Committees since 1976.  The tax
    expenditure concept is still being refined, and therefore the classification of
    certain provisions as tax expenditures continues to be discussed.
    Nevertheless, there has been widespread agreement for the treatment as tax
    expenditures of most of the provisions included in this compendium.

    As defined in the Congressional Budget Act, the concept of tax
    expenditure refers to the corporation and individual income taxes.  Other
    parts of the Internal Revenue Code--excise taxes, employment taxes, estate
    and gift taxes--also have exceptions, exclusions, refunds and credits (such as
    a gasoline tax exemptions for non-highway uses) which are not included here
    because they are not parts of the income tax.

    Administration Fiscal Year 2007 Expenditure Budget

    There are several differences between the tax expenditures shown in this
    publication and the tax expenditure budget found in the Administration's
    FY2007 budget document.  In some cases tax expenditures are combined in
    one list, but not in the other.

    	Major Types of Tax Expenditures

    Tax expenditures may take any of the following forms:

    (1) exclusions, exemptions, and deductions, which reduce taxable
    income;

    (2) preferential tax rates, which apply lower rates to part or all of a
    taxpayer's income;

    (3) credits, which are subtracted from taxes as ordinarily computed;

    (4) deferrals of tax, which result from delayed recognition of income or
    from allowing in the current year deductions that are properly attributable to a
    future year.

    The amount of tax relief per dollar of each exclusion, exemption, and
    deduction increases with the taxpayer's tax rate.  A tax credit is subtracted
    directly from the tax liability that would otherwise be due; thus the amount of
    tax reduction is the amount of the credit--which does not depend on the
    marginal tax rate.  (See Appendix A for further explanation.)

    	Order of Presentation

    The tax expenditures are presented in an order which generally parallels
    the budget functional categories used in the congressional budget, i.e., tax
    expenditures related to "national defense" are listed first, and those related to
    "international affairs" are listed next.  In a few instances, two or three closely
    related tax expenditures derived from the same Internal Revenue Code
    provision have been combined in a single summary to avoid repetitive
    references even though the tax expenditures are related to different functional
    categories.  This parallel format is consistent with the requirement of section
    301(d)(6) of the Budget Act, which requires the tax expenditure budgets
    published by the Budget Committees as parts of their April 15 reports to
    present the estimated levels of tax expenditures "by major functional
    categories."

    Impact (Including Distribution)

    The impact section includes information on the direct effect of the
    provisions and, where available, the distributional effect across individuals.
    Unless otherwise specified, distributional tables showing the share of the tax
    expenditure received by income class are calculated from data in the Joint
    Committee on Taxation's committee print on tax expenditures for 2006-2010.
     This distribution uses an expanded income concept that is composed of
    adjusted gross income (AGI), plus (1) tax-exempt interest, (2) employer
    contributions for health plans and life insurance, (3) employee share of FICA
    tax, (4) worker's compensation, (5) nontaxable Social Security benefits, (6)
    insurance value of Medicare benefits, (7) corporate income tax liability
    passed on to shareholders, (8) alternative minimum tax preferences, and (9)
    excluded income of U.S. citizens abroad.

    The following table shows the estimated distribution of returns by
    income class, for comparison with those tax expenditure distributions:

    Distribution by Income Class of Tax Returns at 2005
    Income Levels

    Income Class
    (in thousands of $)

    Percentage
    Distribution

    Below $10

    15.0

    $10 to $20

    13.9

    $20 to $30

    12.2

    $30 to $40

    10.7

    $40 to $50

    9.1

    $50 to $75

    15.5

    $75 to $100

    9.4

    $100 to $200

    11.3

    $200 and over

    2.9

    These estimates were made for nine tax expenditures.  For other tax
    expenditures, a distributional estimate or information on distributional impact
    is provided, when such information could be obtained.

    Many tax expenditures are corporate and thus do not directly affect the
    taxes of individuals.  Most analyses of capital income taxation suggest that
    such taxes are likely to be borne by capital given reasonable behavioral
    assumptions.   Capital income is heavily concentrated in the upper-income
    levels.  For example, the Congressional Budget Office  reports in 2001 that
    52 percent of capital income was received by the top 1 percent of the
    population, 68 percent was received by the top 5 percent, 75 percent was
    received by the top 10 percent, and 83 percent was received by the top 20
    percent.  The distribution across the first four quintiles was 1, 2, 5, and 8
    percent.  Corporate tax expenditures would, therefore, tend to benefit higher-
    income individuals.

    Rationale

    Each tax expenditure item contains a brief statement of the rationale for
    the adoption of the expenditure, where it is known.  They are the principal
    rationales publicly given at the time the provisions were enacted.  The
    rationale also chronicles subsequent major changes in the provisions and the
    reasons for the changes.

    	Assessment

    The assessment section summarizes the arguments for and against the
    tax expenditures and the issues they raise.  These issues include effects on
    economic efficiency, on fairness and equity, and on simplicity and tax
    administration.  Further information can be found in the bibliographic
    citations.

    	Estimating Tax Expenditures

    The revenue losses for all the listed tax expenditures are those estimated
    by the Joint Committee on Taxation.

    In calculating the revenue loss from each tax expenditure, it is assumed
    that only the provision in question is deleted and that all other aspects of the
    tax system remain the same.  In using the tax expenditure estimates, several
    points should be noted.

    First, in some cases, if two or more items were eliminated, the
    combination of changes would probably produce a lesser or greater revenue
    effect than the sum of the amounts shown for the individual items.  Thus, the
    arithmetical sum of all tax expenditures (reported below) may be different
    from the actual revenue consequences of eliminating all tax expenditures.

    Second, the amounts shown for the various tax expenditure items do not
    take into account any effects that the removal of one or more of the items
    might have on investment and consumption patterns or on any other aspects
    of individual taxpayer behavior, general economic activity, or decisions
    regarding other Federal budget outlays or receipts.

    Finally, the revenue effect of new tax expenditure items added to the tax
    law may not be fully felt for several years.  As a result, the eventual annual
    cost of some provisions is not fully reflected until some time after enactment.
     Similarly, if items now in the law were eliminated, it is unlikely that the full
    revenue effects would be immediately realized.

    These tax expenditure estimating considerations are, however, similar to
    estimating considerations involving entitlement programs.  Like tax
    expenditures, annual budget estimates for each transfer and income-security
    program are computed separately.  However, if one program, such as veterans
    pensions, were either terminated or increased, this would affect the level of
    payments under other programs, such as welfare payments.

    Also, like tax expenditure estimates, the elimination or curtailment of a
    spending program, such as military spending or unemployment benefits,
    would have substantial effects on consumption patterns and economic activity
    that would directly affect the levels of other spending programs.  Finally, like
    tax expenditures, the budgetary effect of terminating certain entitlement
    programs would not be fully reflected until several years later because the
    termination of benefits is usually only for new recipients, with persons already
    receiving benefits continued under "grandfather" provisions.
    All revenue loss estimates are based upon the tax law enacted through the end
    of the 109th Congress.

    The expenditure table below shows an initial declining amount for
    corporations.  This decline is due to the temporary first year depreciation for
    equipment enacted in 2002 that expires in 2004 and largely involves a timing
    shift: a loss of revenue in the short run offset by a long run gain.

    Sum of Tax Expenditure Estimates by Type of Taxpayer, Fiscal
    Years 2006-2010

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    868.5

    74.9

    943.4

    2007

    906.8

     86.6

    993.4

    2008

    951.6

    91.3

    1,042.9

    2009

    1,011.0

     98.5

    1,109.4

    2010

    1,049.3

    105.9

    1,155.2

    Note: These totals are the mathematical sum of the estimated fiscal year effect
    of each of the tax expenditure items included in this publication as appearing the
    Joint Committee on Taxation's April , 2006 list.  Legislation passed in the remainder
    of 2006 would increase them by a small percentage.

    Selected Bibliography

    Bartlett, Bruce.  "The Flawed Concept of Tax Expenditures." National
    Center for Policy Analysis (http:/www.ncpa.org).
    Bosworth, Barry P.  Tax Incentives and Economic Growth.
    Washington, DC: The Brookings Institution, 1984.
    Brannon, Gerard M. "Tax Expenditures and Income Distribution: A
    Theoretical Analysis of the Upside-Down Subsidy Argument," The
    Economics of Taxation, ed. Henry J. Aaron and Michael J. Boskin.
    Washington, DC: The Brookings Institution, 1980, pp. 87-98.
    Brixi, Hana Polackova, Christian M.A. Valenduc and Zhicheng Li
    Swift.  Shedding Light on Government Spending Through the Tax System:
    Lessons from Developed and Transition Economies.  Washington, DC, the
    World Bank, 2004.
    Browning, Jacqueline, M.  "Estimating the Welfare Cost of Tax
    Preferences," Public Finance Quarterly, v. 7, no. 2.  April 1979, pp. 199-219.
    Burman, Leonard E.  "Is the Tax Expenditure Concept Still
    Relevant?" National Tax Journal 56 (September 2003): 613-628.
    The Century Foundation, Bad Breaks All Around, Report of the
    Working Group on Tax Expenditures, New York: The Century Foundation
    Press, 2002.
    Craig, Jon and William Allan.  "Fiscal Transparency, Tax Expenditures
    and Budget Processes: An International Perspective," Proceedings of the 94th
    Annual Conference 2001, Washington, D.C.: National Tax Association,
    2002, 258-264.
    Edwards, Kimberly K.  "Reporting for Tax Expenditure and Tax
    Abatement," Government Finance Review, v. 4.  August 1988, pp. 13-17.
    Freeman, Roger A.  Tax Loopholes: The Legend and the Reality.
    Washington, DC: American Enterprise Institute for Public Policy Research,
    1973.
    Fox, John O.  "The Untold Story: Congress's Own Calculation of Its
    Revenue Losses from Special Provisions of the Tax Laws."  Chapter 5 in  If
    Americans Really Understood the Income Tax. Boulder, Colorado: Westview
    Press, 2001.
    Goode, Richard.  The Individual Income Tax.  Washington, DC: The
    Brookings Institution, 1976.
    Gravelle, Jane G. "Corporate Tax Welfare." Library of Congress,
    Congressional Research Service Report 97-308 E, Washington, DC: February
    28, 1998.
    -.  "Tax Expenditures."  The Encyclopedia of Taxation and Tax Policy,
    edited by Joseph J. Cordes, Robert O. Ebel, and Jane G. Gravelle.
    Washington, DC: Urban Institute Press, 1999, pp. 379-380.
    Hildred, William M., and James V. Pinto.  "Estimates of Passive Tax
    Expenditures, 1984," Journal of Economic Issues, v. 23.  March 1989,  pp.
    93-106.

    Howard, Christopher.  The Hidden Welfare State: Tax Expenditures and
    Social Policy in the United States.  Princeton, NJ: Princeton Univ. Press,
    1997.
    King, Ronald F.  "Tax Expenditures and Systematic Public Policy: An
    Essay on the Political Economy of the Federal Revenue Code," Public
    Budgeting and Finance, v. 4.  Spring 1984, pp. 14-31.
    Klimschot, JoAnn.  The Untouchables: A Common Cause Study of the
    Federal Tax Expenditure Budget.  Washington, DC: Common Cause, 1981.
    Ladd, Helen.  The Tax Expenditure Concept After 25 Years.
    Presidential Address to the National Tax Association.  Proceedings of the 86th
    Annual Conference 1994, Columbus, Ohio: National Tax Association, 1995,
    50-57.
    McLure, Charles E., Jr.  Must Corporate Income Be Taxed Twice?
    Washington, DC: The Brookings Institution, 1979.
    Mikesell, John L.  "The Tax Expenditure Concept at the State Level:
    Conflict Between Fiscal Control and Sound Tax Policy," Proceedings of the
    94th Annual Conference 2001, Washington, D.C.: National Tax Association,
    2002, 265-272.
    Neil, Bruce. "Tax Expenditures and Government Policy." Kingston,
    Ontario: John Deutsche Institute for the Study of Economic Policy, 1989.
    Noto, Nonna A.  "Tax Expenditures: The Link Between Economic
    Intent and the Distribution of Benefits Among High, Middle, and Low
    Income Groups."  Library of Congress, Congressional Research Service
    Multilith 80-99E.  Washington, DC: May 22, 1980.
    Pechman, Joseph A., ed.  Comprehensive Income Taxation.
    Washington, DC: The Brookings Institution, 1977.
    -. Federal Tax Policy: Revised Edition.  Washington, DC: The
    Brookings Institution, 1980.
    -. What Should Be Taxed: Income or Expenditures?  Washington, DC:
    The Brookings Institution, 1980.
    -. Who Paid the Taxes, 1966-85.  Washington, DC: The Brookings
    Institution, 1985.
    Schick, Allen.  "Controlling Nonconventional Expenditure: Tax
    Expenditures and Loans," Public Budgeting and Finance, v. 6.  Spring 1986,
    pp. 3-19.
    Schroeher, Kathy.  Gimme Shelters: A Common Cause Study of the
    Review of Tax Expenditures by the Congressional Tax Committees.
    Washington, DC: Common Cause, 1978.
    Simon, Karla,  "The Budget Process and the Tax Law," Tax Notes, v.
    40.  August 8, 1988, pp. 627-637.
    Steuerle, Eugene, and Michael Hartzmark.  "Individual Income
    Taxation, 1947-79," National Tax Journal, v. 34, no. 2.  June 1981, pp.
    145-166.
    Sugin, Linda.  "What is Happening to the Tax Expenditure Budget?"
    Tax Notes, August 16, 2004.
    Sunley, Emil M. "The Choice Between Deductions and Credits,"
    National Tax Journal, v. 30, no. 3.  September 1977, pp. 243-247.

    Surrey, Stanley S.  Pathways to Tax Reform.  Cambridge, MA: Harvard
    University Press, p. 3.

    This Page Left Blank
    Intentionally

    National Defense

    EXCLUSION OF BENEFITS AND ALLOWANCES
    TO ARMED FORCES PERSONNEL

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    2.8

     -

    2.8

    2007

    2.8

     -

    2.8

    2008

    2.9

     -

    2.9

    2009

    3.0

     -

    3.0

    2010

    3.0

     -

    3.0

    Authorization

    Sections 112 and 134, and court decisions [see Jones v. United States, 60
    Ct. Cl. 552 (1925)].

    	Description

    Military personnel are provided with a variety of in-kind benefits (or cash
    payments given in lieu of such benefits) that are not taxed.  These benefits
    include medical and dental benefits, group term life insurance, professional
    education and dependent education, moving and storage, premiums for
    survivor and retirement protection plans, subsistence allowances, uniform
    allowances, housing allowances, overseas cost-of-living allowances,
    evacuation allowances, family separation allowances, travel for consecutive
    overseas tours, emergency assistance, family counseling and defense counsel,
    burial and death services, travel of dependents to a burial site, and a number
    of less significant items.

    Other benefits include certain combat-zone compensation and combat-
    related benefits.  In addition, any member of the armed forces who dies while
    in active service in a combat zone or as a result of wounds, disease, or injury
    incurred while in service is excused from all tax liability.  Any unpaid tax due
    at the date of the member's death (including interest, additions to the tax, and
    additional amounts) is abated.  If collected, such amounts are credited or
    refunded as an overpayment.  (Medical benefits for dependents are discussed
    subsequently under the Health function.)  Families of members of the armed
    forces receive a $12,000 death gratuity payment for deceased members of the
    armed forces.  The full amount of the death gratuity payment is tax-exempt.

    The personal use of an automobile is not excludable as a qualified military
    benefit.

    The rule that the exclusion for qualified scholarships and qualified tuition
    reductions does not apply to amounts received that represent compensation
    for services no longer applies in the case of amounts received under the
    Armed Forces Health Professions Scholarship and Financial Assistance
    Program or the F. Edward Hebert Armed Forces Health Professions
    Scholarship and Financial Assistance Program.  Recipients of these
    scholarships are obligated to serve in the military at an armed forces medical
    facility.

    Impact

    Many military benefits qualify for tax exclusion.  That is to say, the value
    of the benefit (or cash payment made in lieu of the benefit) is not included in
    gross income.  Since these exclusions are not counted in income, the tax
    savings are a percentage of the amount excluded, dependent upon the
    marginal tax bracket of the recipient.

    An individual in the 10-percent tax bracket (the lowest income tax bracket)
    would not pay taxes equal to $10 for each $100 excluded.  Likewise, an
    individual in the 35-percent tax bracket (the highest income tax bracket)
    would not pay taxes of $35 for each $100 excluded.  Hence, the same
    exclusion can be worth different amounts to different military personnel,
    depending on their marginal tax bracket.  By providing military compensation
    in a form not subject to tax, the benefits have greater value for members of
    the armed services with high income than for those with low income.

    The exclusion of qualified medical scholarships will primarily benefit
    students, therefore most beneficiaries are likely to have low tax rates.  As
    noted earlier, the tax benefit of an exclusion varies according to the marginal
    tax rate of the individual.

    	Rationale

    In 1925, the United States Court of Claims in Jones v. United States, 60 Ct.
    Cl. 552 (1925), drew a distinction between the pay and allowances provided
    military personnel.  The court found that housing and housing allowances
    were reimbursements similar to other non-taxable expenses authorized for the
    executive and legislative branches.

    Prior to this court decision, the Treasury Department had held that the
    rental value of quarters, the value of subsistence, and monetary commutations
    were to be included in taxable income.  This view was supported by an earlier
    income tax law, the Act of August 27, 1894, (later ruled unconstitutional by
    the Courts) which provided a two- percent tax "on all salaries of officers, or
    payments to persons in the civil, military, naval, or other employment of the
    United States."

    The principle of exemption of armed forces benefits and allowances
    evolved from the precedent set by Jones v. United States, through subsequent
    statutes, regulations, or long-standing administrative practices.

    The Tax Reform Act of 1986 (P.L. 99-514) consolidated these rules so that
    taxpayers and the Internal Revenue Service could clearly understand and
    administer the tax law consistent with fringe benefit treatment enacted as part
    of the Deficit Reduction Act of 1984 (P.L. 98-369).  Provisions added by the
    Military Family Tax Relief Act of 2004 (P.L. 108-121) in November 2003
    clarified uncertainty concerning the U.S. Treasury Department's authority to
    add dependent care assistance programs to the list of qualified military
    benefits.

    For some benefits, the rationale was a specific desire to reduce tax burdens
    of military personnel during wartime (as in the use of combat pay provisions);
    other allowances were apparently based on the belief that certain types of
    benefits were not strictly compensatory, but rather intrinsic elements in the
    military structure.

    The Economic Growth and Tax Reconciliation Relief Act (P.L. 107-16)
    simplified the definition of earned income by excluding nontaxable employee
    compensation, which included combat zone pay, from the definition of earned
    income.  The amount of earned income that armed forces members reported
    for tax purposes was reduced and caused a net loss in tax benefits for some
    low-income members of the armed forces.  The Working Families Tax Relief
    Act of 2004 (P.L. 108-311) provided that combat pay that was otherwise
    excluded from gross income could be treated as earned income for the
    purpose of calculating the earned income tax credit and the child tax credit,
    through 2006, a provision that was extended through 2007 by H.R. 6111,
    enacted at the end of December 2006.

    Assessment

    Some military benefits are akin to the "for the convenience of the
    employer" benefits provided by private enterprise, such as the allowances for
    housing, subsistence, payment for moving and storage expenses, overseas
    cost-of-living allowances, and uniforms.  Other benefits are equivalent to
    employer-provided fringe benefits such as medical and dental benefits,
    education assistance, group term life insurance, and disability and retirement
    benefits.

    Some see the provision of compensation in a tax-exempt form as an unfair
    substitute for additional taxable compensation.  The tax benefits that flow
    from an exclusion do provide the greatest benefits to high- rather than low-
    income military personnel.  Administrative difficulties and complications
    could be encountered in taxing some military benefits and allowances that
    currently have exempt status; for example, it could be difficult to value meals
    and lodging when the option to receive cash is not available.  By eliminating
    exclusions and adjusting military pay scales accordingly, a result might be to
    simplify decision-making about military pay levels and make "actual" salary
    more apparent and satisfying to armed forces personnel.  If military pay scales
    were to be adjusted upward, it could increase the retirement income of
    military personnel.  However, elimination of the tax exclusions could also
    lead service members to think their benefits were being cut, or provide an
    excuse in the "simplification" process to actually cut benefits, affecting
    recruiting and retention negatively.

    	Selected Bibliography

    Garrison, Larry R.  "Tax Planning for Armed Forces Personnel (Part I),"
    The Tax Advisor, v. 30, December 1999, pp. 838-843.
    -, "Tax Planning for Armed Forces Personnel (Part II)," The Tax Advisor,
    v. 31, January 2000, pp. 44-47.
    Kusiak, Patrick J.  "Income Tax Exclusion for Military Personnel During
    War: Examining the Historical Development, Discerning Underlying
    Principles, and Identifying Areas for Change," Federal Bar News and
    Journal, v. 39, February 1992, pp. 146-151.
    Ogloblin, Peter K.  Military Compensation Background Papers:
    Compensation Elements and Related Manpower Cost Items, Their Purposes
    and Legislative Backgrounds.  Washington, DC: Department of Defense,
    Office of the Secretary of Defense, September 1996, pp. 137-149.
    Poulson, Linda L. and Ananth Seetharaman.  "Taxes and the Armed
    Forces,"  The CPA Journal, April 1996, pp. 22-26.
    Rousseau, Richard W.  "Tax Benefits for Military Personnel in a Combat
    Zone or Qualified Hazardous Duty Area," The Army Lawyer, v. 1999,
    December 1999, pp. 1-29.

    Steurle, Gene.  "Tax Relief and Combat Pay," Tax Notes, v. 50, January
    28, 1991, pp. 405-406.
    U.S. Congress, Congressional Budget Office.  Military Family Housing in
    the United States., Washington, DC, September 1993. p. 67.
    U.S. Congress, House Committee on Veterans' Affairs, Subcommittee on
    Education, Training and Employment.  Transition Assistance Program,
    Hearing, 102nd Congress, 2nd session, Serial no. 102-31.  Washington, DC:
    U.S. Government Printing Office, March 19, 1992.
    -, House Committee on Ways and Means.  Tax Benefits for Individuals
    Performing Services in Certain Hazardous Duty Areas; Report to Accompany
    H.R. 2778 including Cost Estimate of the Congressional Budget Office, 104th
    Congress, 2nd Session.  Washington, DC: U.S. Government Printing Office,
    1996.  14pp.
    -, Joint Committee on Taxation.  General Explanation of the Tax Reform
    Act of 1986, H.R. 3838, 99th Congress, Public Law 99-514.  Washington,
    DC: U.S. Government Printing Office, 1987, pp. 828-830.
    -, Joint Committee on Taxation.  Technical Explanation of H.R. 3365, The
    Military Family Tax Relief Act of 2003," as Passed by the House of
    Representatives and the Senate.  Washington, DC: U.S. Government Printing
    Office, 2003, pp. 1-19.
    U.S. Dept. of Defense.  Report and Staff Analysis of the Seventh
    Quadrennial Review of Military Compensation.  Washington, DC: 7 volumes,
    August 21, 1992.
    U.S. Dept. of the Treasury, Office of the Secretary.  Tax Reform for
    Fairness, Simplicity, and Economic Growth; the Treasury Department
    Report to the President.  Washington, DC: November 1984, pp. 47-48.
    U.S. General Accounting Office, "Military Compensation: Active Duty
    Compensation and Its Tax Treatment," GAO Report GAO-04-721R
    (Washington, DC: April 2004), pp. 1-32.
    - , "Military Personnel: DOD Has Not Implemented the High Deployment
    Allowance that Could Compensate Servicemembers Deployed Frequently for
    Short Periods," GAO Report GAO-04-805 (Washington, DC: June 2004), pp.
    1-27.
    - , "Military Personnel: Bankruptcy Filings Among Active Duty
    Servicemembers," GAO Report GAO-04-465R (Washington, DC: February
    2004), pp. 1-8.
    U.S. General Accounting Office, "Military Compensation: Active Duty
    Compensation and Its Tax Treatment," GAO Report GAO-04-721R
    (Washington, DC: April 2004), pp. 1-32.

    National Defense

    EXCLUSION OF MILITARY DISABILITY BENEFITS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.1

     -

    0.1

    2007

    0.1

     -

    0.1

    2008

    0.1

     -

    0.1

    2009

    0.1

     -

    0.1

    2010

    0.1

     -

    0.1

    	Authorization

    Section 104(a)(4) or (5) and 104(b).

    	Description

    Members of the armed forces on or before September 24, 1975, are eligible
    for tax exclusion of disability pay.  The payment from the Department of
    Defense is based either on the percentage-of-disability or years-of-service
    methods.

    In the case of the percentage-of-disability method, the pension is the
    percentage of disability multiplied by the terminal monthly basic pay.  These
    disability pensions are excluded from gross income.

    In the years-of-service method, the terminal monthly basic pay is multiplied
    by the number of service years times 2.5.  Only that portion that would have
    been paid under the percentage-of-disability method is excluded from gross
    income.

    Members of the United States armed forces joining after September 24,
    1975, and who retire on disability, may exclude from gross income
    Department of Defense disability payments equivalent to disability payments
    they could have received from the Veterans Administration.  Otherwise,
    Department of Defense disability pensions may be excluded only if the
    disability is directly attributable to a combat-related injury.

    Under the Victims of Terrorism Tax Relief Act of 2001 an exclusion from
    gross income for disability income is extended to any individual (civilian or
    military) when attributable to a terrorist or military action regardless of where
    the activity occurs (inside or outside the United States).

    Impact

    Disability pension payments that are exempt from tax provide more net
    income than taxable pension benefits at the same level.  The tax benefit of
    this provision increases as the marginal tax rate increases, and is greater for
    higher-income individuals.

    	Rationale

    Typically, acts which provided for disability pensions for American
    veterans also provided that these payments would be excluded from
    individual income tax.  In 1942, the provision was broadened to include
    disability pensions furnished by other countries (many Americans had joined
    the Canadian armed forces).  It was argued that disability payments, whether
    provided by the United States or by Canadian governments, were made for
    essentially the same reasons and that the veteran's disability benefits were
    similar to compensation for injuries and sickness, which at that time was
    already excludable from income under Internal Revenue Code provisions.

    In 1976, the exclusion was repealed, except in certain instances.  Congress
    sought to eliminate abuses by armed forces personnel who were classified as
    disabled shortly before becoming eligible for retirement in order to obtain tax-
    exempt treatment for their pension benefits.  After retiring from military
    service, some individuals would earn income from other employment while
    receiving tax-free military disability benefits.  Since present armed forces
    personnel may have joined or continued their service because of the
    expectation of tax-exempt disability benefits, Congress deemed it equitable to
    limit changes in the tax treatment of disability payments to those joining after
    September 24, 1975.

    Assessment

    The exclusion of disability benefits paid by the federal government alters
    the distribution of net payments to favor higher income individuals.  If
    individuals had no other outside income, distribution could be altered either
    by changing the structure of disability benefits or by changing the tax
    treatment.

    The exclusion causes the true cost of providing for military personnel to be
    understated in the budget.

    	Selected Bibliography

    Bittker, Boris I. "Tax Reform and Disability Pensions-the Equal
    Treatment of Equals," Taxes, v. 55.  June 1977, pp. 363-367.
    Cullinane, Danielle.  Compensation for Work-Related Injury and Illness.
    Santa Monica, CA: RAND, 1992.  60pp.  (RAND Publication Series N-3343-
    FMP.)
    Ogloblin, Peter K.  Military Compensation Background Papers:
    Compensation Elements and Related Manpower Cost Items, Their Purposes
    and Legislative Backgrounds.  Washington, DC: U.S. Government Printing
    Office, September 1996, pp. 545-556.
    Poulson, Linda L. and Ananth Seetharaman.  "Taxes and the Armed
    Forces,"  The CPA Journal, April 1996, pp. 22-26.
    U.S. Congress, Joint Committee on Taxation.  General Explanation of the
    Tax Reform Act of 1976 (H.R. 10612, 94th Congress; Public Law 94-455).
    Washington, DC: U.S. Government Printing Office, 1976, pp. 129-131.
    U.S. Dept. of the Treasury, Office of the Secretary.  Tax Reform for
    Fairness, Simplicity, and Economic Growth; the Treasury Department
    Report to the President.  Washington, DC: November, 1984, pp. 51-57.
    U.S. General Accounting Office.  Disability Benefits: Selected Data on
    Military and VA Recipients; Report to the Committee on Veterans' Affairs,
    House of Representatives, GAO/HRD-92-106.  Washington, DC: August
    1992. 19pp.
    -.  Disability Compensation: Current Issues and Options for Change.
    Washington, DC: 1982.
    -.  VA Disability Compensation: Comparison of VA Benefits with those of
    Workers' Compensation Programs, Report to the Chairman, Subcommittee
    on Benefits, Committee on Veterans' Affairs, House of Representatives.
    Washington, DC: Government Accounting Office, February 14, 1997
    -.  VA Disability Compensation: Disability Ratings May Not Reflect
    Veterans' Economic Losses, Report to the Chairman, Insurance and Memorial
    Affairs, Committee on Veterans' Affairs, House of Representatives.
    Washington, DC: Government Accounting Office, January 7, 1997.

    -. Military and Veterans' Benefits: Observations on the Concurrent
    Receipt of Military Retirement and VA Disability Compensation, Testimony
    before the Subcommittee on Personnel, Committee on Armed Services, U.S.
    Senate, March 27, 2003.

    National Defense

    DEDUCTION FOR OVERNIGHT-TRAVEL EXPENSES OF
    NATIONAL GUARD AND RESERVE MEMBERS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.1

     -

    0.1

    2007

    0.1

     -

    0.1

    2008

    0.1

     -

    0.1

    2009

    0.1

     -

    0.1

    2010

    0.1

     -

    0.1

    	Authorization

    Section 162.

    	Description

    An above-the-line deduction is available for un-reimbursed overnight
    travel, meals, and lodging expenses of National Guard and Reserve members.
     In order to qualify for the provision, he or she must have  traveled more than
    100 miles away from home and stayed overnight as part of an activity while
    on official duty. The deduction applies to all amounts paid or incurred in tax
    years beginning after December 31, 2002.  No deduction is generally
    permitted for commuting expenses to and from drill meetings and the amount
    of  expenses that may be deducted may not exceed the general Federal
    Government per diem rate applicable to that locale.

    This deduction is available to taxpayers regardless of whether they claim
    the standard deduction or itemize deductions when filing their income tax
    return.  The deduction is not restricted by the overall limitation on itemized
    deductions.

    Impact

    The value of the benefit (or cash payment made in lieu of the benefit) is not
    included in gross income.  Since these deductions are not counted in income,
    the tax savings are a percentage of the amount excluded, dependent upon the
    marginal tax bracket of the recipient.

    An individual in the 10-percent tax bracket (Federal tax law's lowest tax
    bracket) would not pay taxes equal to $10 for each $100 excluded.  Likewise,
    an individual in the 35-percent tax bracket (Federal law's highest tax bracket)
    would not pay taxes of $35 for each $100 excluded.  Hence, the same
    exclusion can be worth different amounts to different military personnel,
    depending on their marginal tax bracket.  By providing military compensation
    in a form not subject to tax, the benefits have greater value for members of
    the armed services with high income than for those with low income.

    One of  the benefits of an "above-the-line" deduction is that it reduces the
    taxpayer's adjusted gross income (AGI). As AGI increases, it can cause other
    tax deductions and credits to be reduced or eliminated.  Therefore, deductions
    that reduce AGI will often provide a greater tax benefit than deductions
    "below-the-line" that do not reduce AGI.

    	Rationale

    The deduction was authorized by the  Military Family Tax Relief Act of
    2003 (P.L. 108-121) which expanded tax incentives for military personnel.
    Under previous law, the expenses could have been deducted as itemized
    deductions only to the extent that they and other miscellaneous deductions
    exceeded 2 percent of adjusted gross income.  So reservists who did not
    itemize were not able to deduct these expenses and reservists who did itemize
    could deduct the expenses only in reduced form.

    In enacting the new deduction, Congress identified the increasing role that
    Reserve and National Guard members fulfill in defending the nation and a
    heavy reliance on service personnel to participate in national defense.
    Congress noted that more than 157,000 reservists and National Guard were
    on active duty status- most assisting in Operation Iraqi Freedom at the time of
    enactment.

    Assessment

    Some military benefits are akin to the "for the convenience of the
    employer" benefits provided by private enterprise, such as the allowances for
    housing, subsistence, payment for moving and storage expenses, overseas
    cost-of-living allowances, and uniforms.  Other benefits are equivalent to
    employer-provided fringe benefits such as medical and dental benefits,
    education assistance, group term life insurance, and disability and retirement
    benefits.  The tax deduction can be justified both as a way of providing
    support to reservists and as a means of easing travel expense burdens.

    	Selected Bibliography

    Garrison, Larry R.  "Tax Planning for Armed Forces Personnel (Part I),"
    The Tax Advisor, v. 30, December 1999, pp. 838-843.
    -, "Tax Planning for Armed Forces Personnel (Part II)," The Tax Advisor,
    v. 31, January 2000, pp. 44-47.
    Kusiak, Patrick J.  "Income Tax Exclusion for Military Personnel During
    War: Examining the Historical Development, Discerning Underlying
    Principles, and Identifying Areas for Change," Federal Bar News and
    Journal, v. 39, February 1992, pp. 146-151.
    Ogloblin, Peter K.  Military Compensation Background Papers:
    Compensation Elements and Related Manpower Cost Items, Their Purposes
    and Legislative Backgrounds.  Washington, DC: Department of Defense,
    Office of the Secretary of Defense, September 1996, pp. 137-149.
    Poulson, Linda L. and Ananth Seetharaman.  "Taxes and the Armed
    Forces,"  The CPA Journal, April 1996, pp. 22-26.
    U.S. Congress, House Committee on Veterans' Affairs, Subcommittee on
    Education, Training and Employment.  Transition Assistance Program,
    Hearing, 102nd Congress, 2nd session, Serial no. 102-31.  Washington, DC:
    U.S. Government Printing Office, 1992.
    -, House Committee on Ways and Means.  Tax Benefits for Individuals
    Performing Services in Certain Hazardous Duty Areas; Report to Accompany
    H.R. 2778 including Cost Estimate of the Congressional Budget Office, 104th
    Congress, 2nd Session.  Washington, DC: U.S. Government Printing Office,
    1996.
    -, Joint Committee on Taxation.  General Explanation of the Tax Reform
    Act of 1986, H.R. 3838, 99th Congress, Public Law 99-514.  Washington,
    DC: U.S. Government Printing Office, 1987, pp. 828-830.
    -, Joint Committee on Taxation.  Technical Explanation of H.R. 3365, The
    "Military Family Tax Relief Act of 2003," as Passed by the House of
    Representatives and the Senate.  Washington, DC: U.S. Government Printing
    Office, 2003, pp. 1-19.
    U.S. Dept. of Defense.  Report and Staff Analysis of the Seventh
    Quadrennial Review of Military Compensation.  Washington, 7 volumes,
    August 21, 1992.
    U.S. Dept. of the Treasury, Internal Revenue Service.  Publication 3:
    Armed Forces' Tax Guide. Washington, DC: U.S. Government Printing
    Office, 2005.
    U.S. Dept. of the Treasury, Office of the Secretary.  Tax Reform for
    Fairness, Simplicity, and Economic Growth; the Treasury Department
    Report to the President.  Washington, DC: November 1984, pp. 47-48.

    U.S. General Accounting Office, Military Compensation: Active Duty
    Compensation and Its Tax Treatment, GAO Report GAO-04-721R
    (Washington: May 2004), pp. 1-32.

    International Affairs

    EXCLUSION OF INCOME EARNED ABROAD
    BY U.S. CITIZENS

    Estimated Revenue Loss*

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    3.8

    -

    3.8

    2007

    4.0

    -

    4.0

    2008

    4.2

    -

    4.2

    2009

    4.4

    -

    4.4

    2010

    4.6

    -

    4.6

    * Note: the estimates in the table do not reflect new restrictions on
    the earned income exclusion contained in the Taxpayer Increase
    Prevention and Reconciliation Act of 2006 (TIPRA; P.L. 109-222).
     According to estimates by the Joint Tax Committee, TIPRA's
    changes reduced the revenue loss from the exclusion by the
    following amounts: FY2006: $15 million; FY2007: $261 million;
    FY2008: $199 million; FY2009: $206 million; and FY2010: $222
    million.

    	Authorization

    Section 911.

    	Description

    U.S. citizens are generally subject to U.S. taxes on their foreign- as well as
    domestic-source income.  However, section 911 of the tax code permits U.S.
    citizens (other than Federal employees) who live and work abroad an
    exclusion of wage and salary income from taxable income.  (Foreign tax
    credits, however, cannot be claimed for foreign taxes paid on excluded
    income.)   The amount that can be excluded is indexed for U.S. inflation,
    beginning with tax year 2006; in 2006, the exclusion is $82,400.  The
    exclusion is scheduled to be indexed for U.S. inflation, beginning in 2008.
    Qualifying individuals can also exclude certain expenditures for overseas
    housing.  To qualify for either exclusion, a person must be a U.S. citizen,
    must have their tax home in a foreign country, and must either be a bona fide
    resident of a foreign country or have lived abroad for at least 330 days of any
    12 consecutive months.  Qualified income must be "earned" income rather
    than investment income.  If a person qualifies for the exclusion for only part
    of the tax year, only part of the exclusion can be claimed.  The housing
    exclusion is designed to approximate the extra housing costs of living abroad.
     It is equal to the excess of actual foreign housing costs over 16 percent of the
    applicable year's earned income exclusion amount, but is capped at 30
    percent of the taxpayer's maximum foreign earned income exclusion.  While
    a taxpayer can claim both the housing and the income exclusion, the
    combined exclusions cannot exceed total foreign earned income, including
    housing allowances.

    Impact

    The exclusion's impact depends partly on whether foreign taxes paid are
    higher or lower than U.S. taxes.  If an expatriate pays high foreign taxes, the
    exclusion has little importance; the U.S. person can use foreign tax credits to
    offset any U.S. taxes.  For expatriates who pay little or no foreign taxes,
    however, the exclusion reduces or eliminates U.S. taxes.  Available data
    suggest that U.S. citizens who work abroad have higher real incomes, on
    average, than persons working in the United States.  Thus, where it does
    reduce taxes the exclusion reduces tax progressivity.

    The exclusion's effect on horizontal equity is more complicated.  Because
    foreign countries have costs of living that differ from that of the United
    States, the tax liabilities of U.S. persons working abroad differ from the tax
    burdens of persons with identical real incomes living in the United States.  A
    person working in a high-cost country needs a higher nominal income to
    match the real income of a person in the United States; an expatriate in a low-
    cost country needs a lower nominal income.  Since tax brackets, exemptions,
    and the standard deduction are expressed in terms of nominal dollars, persons
    living in low-cost countries generally have lower tax burdens than persons
    with identical real incomes living in the United States.  Similarly, if not for
    the foreign earned income exclusion, U.S. citizens working in high-cost
    countries would pay higher taxes than their U.S. counterparts.

    Because the maximum income exclusion is not linked to the actual cost of
    living, the provision overcompensates for the cost of living abroad in some
    cases.  Indeed, some have argued that because the tax code does not take into
    account variations in living costs within the United States, the appropriate
    equity comparison is between expatriates and a person living in the highest
    cost area within the United States.  In this case, the likelihood that the
    exclusion reduces rather than improves horizontal equity is increased.

    Rationale

    The Revenue Act of 1926 provided an unlimited exclusion of earned
    income for persons residing abroad for an entire tax year.  Supporters of the
    exclusion argued that the provision would bolster U.S. trade performance,
    since it would provide tax relief to U.S. expatriates engaged in trade
    promotion.

    The subsequent history of the exclusion shows a continuing attempt by
    policymakers to find a balance between the provision's perceived beneficial
    effects on U.S. trade and economic performance and perceptions of tax
    equity.  In 1962, the Kennedy Administration recommended eliminating the
    exclusion in some cases and scaling it back in others in order to "support the
    general principles of equity and neutrality in the taxation of U.S. citizens at
    home and abroad."  The final version of the Revenue Act of 1962 simply
    capped the exclusion in all cases at $20,000.  The Tax Reform Act of 1976
    would have pared the exclusion further (to $15,000), again for reasons of tax
    equity.

    However, the Foreign Earned Income Act of 1978 completely revamped
    the exclusion so that the 1976 provisions never went into effect.  The 1978
    Act sought to provide tax relief more closely tied to the actual costs of living
    abroad.  It replaced the single exclusion with a set of separate deductions that
    were linked to various components of the cost of living abroad, such as the
    excess cost of living in general, excess housing expenses, schooling expenses,
    and home-leave expenses.

    In 1981, however, the emphasis again shifted to the perceived beneficial
    effects of encouraging U.S. employment abroad; the Economic Recovery Tax
    Act (ERTA) provided a large flat exclusion and a separate housing exclusion.
     ERTA's income exclusion was $75,000 for 1982, but was to increase to
    $95,000 by 1986.  However, concern about the revenue consequences of the
    increased exclusion led Congress to temporarily freeze the exclusion at
    $80,000 under the Deficit Reduction Act of 1984; annual $5,000 increases
    were to resume in 1988.  In 1986, as part of its general program of broadening
    the tax base, the Tax Reform Act fixed the exclusion at the $70,000 level.
    The Taxpayer Relief Act of 1997 provided the gradual increase of the
    exclusion to $80,000 by 2002, as well as indexing for U.S. inflation,
    beginning in 2008.

    The Taxpayer Increase Prevention and Reconciliation Act of 2006
    (TIPRA; P.L. 109-222) contained new restrictions on both the housing and
    earned income exclusions as a revenue-raising element designed to partly
    offset unrelated revenue-losing items in the act.  The act contained four
    principal changes.  First,  it moved up to 2006 the scheduled indexation of the
    exclusion.  (While the combined, net impact of TIPRA's changes is expected
    to reduce the benefit's revenue loss, the indexation provision, taken alone,
    will likely increase it.)  Second, TIPRA changed the way tax rates apply to a
    taxpayer's income that exceeds the exclusion.  Under prior law, if a person
    had income in excess of the maximum exclusion, tax rates applied to the
    addition income beginning with the lowest marginal rate.  Under TIPRA,
    marginal rates apply beginning with the rate that would apply if the taxpayer
    had not used the exclusion.  Third, TIPRA changed the "base amount" related
    to the housing exclusion.  Under prior law, the housing exclusion applied to
    housing exceeding 16 percent of the salary level applicable to the GS-14
    federal grade level; TIPRA set the base amount at 16 percent of the foreign
    earning income exclusion amount ($82,400 for 2006).  In addition,  TIPRA
    capped the housing exclusion at 30 percent of excluded income; no cap
    applied under prior law.

    Assessment

    The foreign earned income exclusion has the effect of increasing the
    number of Americans working overseas in countries where foreign taxes are
    low.  This effect differs across countries.  As noted above, without section
    911 or a similar provision, U.S. taxes would generally be high relative to
    domestic U.S. taxes and employment abroad would be discouraged in
    countries where living costs are high.  While the flat  exclusion eases this
    distortion in the case of some countries, it also overcompensates in others,
    thereby introducing new distortions.

    The foreign earned income exclusion has been defended on the grounds
    that it helps U.S. exports; it is argued that U.S. persons working abroad play
    an important role in promoting the sale of U.S. goods abroad.  The impact of
    the provision is uncertain.  If employment of U.S. labor abroad is a
    complement to investment by U.S. firms abroad--for example, if U.S.
    multinationals depend on expertise that can only be provided by U.S.
    managers or technicians--then it is possible that the exclusion has the indirect
    effect of increasing flows of U.S. capital abroad.

    The increased flow of investment abroad, in turn, could trigger exchange-
    rate adjustments that would increase U.S. net exports.  On the other hand, if
    the exclusion's increase in U.S. employment overseas is not accompanied by
    larger flows of investment, it is likely that exchange rate adjustments negate
    any possible effect section 911 has on net exports.  Moreover, there is no
    obvious economic rationale for promoting exports.

    	Selected Bibliography

    Association of the Bar of the City of New York, Committee on Taxation of
    International Transactions.  "The Effect of Changes in the Type of United
    States Tax Jurisdiction Over Individuals and Corporations: Residence, Source
    and Doing Business."  Record of the Association of the Bar of the City of New
    York  46 (December 1991):  914-925.
    Curry, Jeff, Maureen Keenan Kahr,  "Individual Foreign-Earned Income
    and Foreign Tax Credit, 2001." IRS Statistics of Income Bulletin (Spring
    2004): 98-120.
    Evans, Jeffrey.  "911: The Foreign Earned Income Exclusion-Policy and
    Enforcement." Virginia Journal of International Law 37 (Summer 1997):
    891-918.
    Gravelle, Jane G., and Donald W. Kiefer.  U.S. Taxation of Citizens
    Working in Other Countries: An Economic Analysis.  Library of Congress,
    Congressional Research Service Report 78-91 E.  Washington, DC: 1978.
    Hrechak, Andrew, and Richard J. Hunter, Jr.  "Several Tax Breaks
    Available for those Working Abroad."  Taxation for Accountants 52 (May
    1994):  282-286.
    Oliver, Joseph R.  "The Foreign Earned Income Exclusion: An Update"
    CPA Journal 69 (August 1999):  46-50.
    U.S. Congress, Conference Committees, 2006.  Tax Increase Prevention
    and Reconciliation Act of 2005.  Conference report to accompany H.R. 4297.
     H. Rpt. 109-455, 109th Cong., 2nd sess.  Washington, U.S. Government
    Printing Office, 2006.  pp.  307-310.
    U.S. Congress, Senate, Committee on Finance.  Background Fact Sheet on
    Section 911 Prepared by Chairman Grassley's Finance Committee Staff.
    Washington, May 25, 2006.  Posted on the committee's web site, at
    [http://finance.senate.gov/sitepages/grassley.htm].  (Visited Oct. 12, 2006.)
    U.S. Congress, Joint Committee on Taxation. Options to Improve Tax
    Compliance and Reform Tax Expenditures.  Prepared by the Staff of the Joint
    Committee on Taxation.  Publication JCS-02-05.  Washington, Jan. 27, 2005.
     pp. 174-177.
    U.S. Department of the Treasury.  Taxation of Americans Working
    Overseas: the Operation of the Foreign Earned Income Exclusion in 1987.
    Washington, DC: 1993.

    	International Affairs

    EXCLUSION OF CERTAIN ALLOWANCES
     FOR FEDERAL EMPLOYEES ABROAD

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.6

    -

    0.6

    2007

    0.6

    -

    0.6

    2008

    0.7

    -

    0.7

    2009

    0.7

    -

    0.7

    2010

    0.8

    -

    0.8

    	Authorization

    Section 912.

    	Description

    U.S. Federal civilian employees who work abroad are allowed to exclude
    from income certain special allowances that are generally linked to the cost of
    living.  They are not eligible for the foreign earned income or housing
    exclusion provided to private-sector individuals under section 911.  (Like
    other U.S. citizens, they are subject to U.S. taxes and can credit foreign taxes
    against their U.S. taxes.  Federal employees are, however, usually exempt
    from foreign taxes.)

    Specifically, section 912 excludes certain amounts received under the
    Foreign Service Act of 1980, the Central Intelligence Act of 1949, the
    Overseas Differentials and Allowances Act, and the Administrative Expenses
    Act of 1946.  The allowances are primarily for the general cost of living
    abroad, housing, education, and travel.  Special allowances for hardship posts
    are not eligible for exclusion.  Section 912 also excludes cost-of-living
    allowances received by Federal employees stationed in U.S. possessions,
    Hawaii, and Alaska.  In addition, travel, housing, food, clothing, and certain
    other allowances received by members of the Peace Corps are excluded.

    Impact

    Federal employees abroad may receive a significant portion of their
    compensation in the form of housing allowances, cost-of-living differentials,
    and other allowances.  Section 912 can thus reduce taxes significantly.  Since
    the available data suggest real incomes for Federal workers abroad are
    generally higher than real incomes in the United States, section 912 probably
    reduces the tax system's progressivity.

    Section 912's impact on horizontal equity (the equal treatment of equals) is
    more ambiguous.  Without it or a similar provision, Federal employees in
    high-cost countries would likely pay higher taxes than persons in the United
    States with identical real incomes, because the higher nominal incomes
    necessary to offset higher living costs would place these employee stationed
    abroad in a higher tax bracket and would reduce the value of personal
    exemptions and the standard deduction.

    The complete exemption of cost-of-living allowances, however, probably
    overcompensates for this effect.  It is thus uncertain whether the relative
    treatment of Federal workers abroad and their U.S. counterparts is more or
    less uneven with section 912.  U.S. citizens employed abroad in the private
    sector are permitted to exclude up to $80,000 per year, rather than an amount
    explicitly linked to cost-of-living allowances.  Given that flat amount,
    whether the tax treatment of federal workers is more or less favorable than
    that of private sector workers depends of the size of the federal workers' cost-
    of-living allowance.

    Some have argued that because no tax relief is provided for persons in high
    cost areas in the United States, horizontal equity requires only that persons
    abroad be taxed no more heavily than a person in the highest-cost U.S. area.
    It might also be argued that the cost of living exclusion for employees in
    Alaska and Hawaii violates horizontal equity, since private-sector persons in
    those areas do not receive a tax exclusion for cost-of-living allowances.

    Rationale

    Section 912's exclusions were first enacted with the Revenue Act of 1943.
     The costs of living abroad were apparently rising, and Congress determined
    that because the allowances merely offset the extra costs of working abroad
    and since overseas personnel were engaged in "highly important" duties, the
    Government should bear the full burden of the excess living costs, including
    any taxes that would otherwise be imposed on cost-of-living allowances.

    The Foreign Service Act of 1946 expanded the list of excluded allowances
    beyond cost-of-living allowances to include housing, travel, and certain other
    allowances.  In 1960, exemptions were further expanded to include
    allowances received under the Central Intelligence Agency Act and, in 1961,
    certain allowances received by Peace Corps members were added.

    Assessment

    The benefit is largest for employees who receive a large part of their
    incomes as cost-of-living, housing, education, or other allowances.  Beyond
    this, the effects of the exclusions are uncertain.  For example, it might be
    argued that because the Federal Government bears the cost of the exclusion in
    terms of forgone tax revenues, the measure does not change the Government's
    demand for personnel abroad and has little impact on the Government's work
    force overseas.

    On the other hand, it could be argued that an agency that employs a person
    who claims the exclusion does not bear the exclusion's full cost.  While the
    provision's revenue cost may reduce Government outlays in general, an
    agency that employs a citizen abroad probably does not register a cut in its
    budget equal to the full amount of tax revenue loss that the employee
    generates.  If this is true, section 912 may enable agencies to employ
    additional U.S. citizens abroad.

    	Selected Bibliography

    Field, Marcia, and Brian Gregg.  U.S. Taxation of Allowances Paid to U.S.
    Government Employees.  In Essays in International Taxation: 1976 (U.S.
    Department of the Treasury).  Washington, DC: Government Printing Office,
    1976, pp. 128-150.
    U.S. Internal Revenue Service.  U.S. Government Civilian Employees
    Stationed Abroad.  Publication 516.  Washington, DC: Government Printing
    Office, 2005.

    International Affairs

    EXCLUSION OF EXTRATERRITORIAL INCOME

    Estimated Revenue Loss*

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.1

    3.9

    4.0

    2007

    (1)

    1.9

    1.9

    2008

    (1)

    0.1

    0.1

    2009

    (1)

    0.1

    0.1

    2010

    (1)

    0.1

    0.1

    (1) Less than $50 million

    *The estimates in the table do not reflect the impact of the Tax Increase
    Prevention and Reconciliation Act of 2006 (TIPRA; P.L. 109-222), which
    rescinded transition rules related to the exclusion's repeal.  According to
    estimates by the Joint Committee on Taxation, TIPRA's changes will reduce
    the provision's revenue loss by the following amounts: $6 million in FY2006;
    $209 million in FY2007; $144 million in FY2008; $72 million in FY2009;
    and $36 million in FY2010.

    Authorization

    Sections 114 and 941-2.

    Description

    Prior to enactment of the American Jobs Creation Act of 2004 (AJCA), the
    tax code's extraterritorial income (ETI) provisions permitted U.S. exporters to
    exclude between 15% and 30% of their export income from U.S. tax.  The
    provisions also effectively permitted exporters to exclude a certain amount of
    income from foreign operations from tax - generally, an amount equal to the
    amount of export income that is excluded.  The AJCA, however, provided for
    the phase-out of the benefit beginning in 2005, with exporters permitted to
    use 80% of the benefit they could otherwise claim in 2005, and 60% in 2006.
     The ETI benefit is generally not available in 2007 and thereafter.

    Repeal of the ETI provisions was intended to resolve a long-running
    controversy between the United States and the European Union (EU).  The
    ETI provisions were enacted as a replacement for the Foreign Sales
    Corporation (FSC) tax benefit for exporting, which (in response to a
    complaint by the EU) was found by a World Trade Organization (WTO)
    panel to be in violation of the WTO agreements' strictures against export
    subsidies.  However, WTO panels also found the ETI provisions to be non-
    compliant and the WTO authorized the countries of the EU to apply
    retaliatory tariffs to items imported from the United States.  The EU began to
    phase in its tariffs in March, 2004, but suspended their application upon
    enactment of the AJCA.

    The statutory mechanics of the ETI benefit worked by defining
    "extraterritorial income" and excluding that income from tax.  Extraterritorial
    income, in turn, was generally defined as a specified portion of income from
    the sale of property produced either within the United States or abroad, with
    the added proviso that no more than 50% of the value of the property can be
    attributable to foreign products or to labor performed outside the United
    States.  The part of extraterritorial income that was exempt varied, depending
    on which of several alternative calculation rules a taxpayer used; the
    exemption could be as small as 15% of qualified income or as large as 30%.

    For exports, the size of the ETI tax benefit was the same as the FSC
    benefit it replaced.  Again, however, the ETI exclusion could apply to a
    certain amount of income from foreign operations where the FSC benefit did
    not, so the total tax benefit a particular firm could obtain was potentially
    larger under the ETI exclusion than it was under FSC.  Also, to use the FSC
    benefit exporters were required to sell their goods through specially-defined
    subsidiary sales corporations (FSCs).  A firm could use the ETI benefit by
    selling its exports directly.

    Impact

    The ETI exclusion increased the after-tax return on investment in export-
    producing property, and to the extent it applied to foreign operations, the
    exclusion increased the after-tax return to investment abroad.  The tax benefit
    therefore accrued, in part, to owners of firms that export and firms that both
    export and conduct foreign operations.  However, in the long run, the burden
    of the corporate income tax - and the benefit of corporate tax exclusions -
    probably spreads beyond corporate stockholders to owners of capital in
    general, including, for example, unincorporated businesses and owner-
    occupied housing.

    The ETI benefit is therefore probably shared by U.S. capital in general.
    And because capital tends to be owned by upper-income individuals, the
    distributional effect of the provision probably reduced the progressivity of the
    tax system.  Also, because part of the export benefit was passed on to foreign
    consumers in the form of lower prices, a part of the ETI benefit probably
    accrues to foreign consumers of U.S. exports.

    Rationale

    While the ETI benefit was intended as a WTO-compliant replacement for
    FSC, FSC itself was enacted as a replacement for another tax benefit that
    encountered difficulties with U.S. trading partners: the Domestic International
    Sales Corporation (DISC) provisions.  DISC was enacted with the Revenue
    Act of 1971, and was intended to increase U.S. exports and to pose a tax
    incentive for firms to locate their operations in the United States rather than
    abroad.  DISC thus was thought to provide a counterweight to the tax code's
    deferral incentive for overseas investment.

    Soon after DISC was enacted, a number of U.S. trading partners -
    including what was then the European Economic Community, or EEC -
    charged that the provision was an export subsidy and so violated the General
    Agreement on Tariffs and Trade (GATT), a multilateral trade agreement to
    which the United States was signatory.  In response to the complaints, the
    Deficit Reduction Act of 1984 largely replaced DISC with FSC, which
    contained a number of features designed to ensure GATT-legality.  An
    understanding adopted by the GATT Council had held that a country need not
    tax economic processes occurring beyond its own borders.  With this in mind,
    the FSC provisions included requirements that the FSC sales subsidiaries be
    incorporated abroad or in a U.S. possession and likewise conduct certain
    minimal economic processes overseas.

    The countries of the EEC were still not fully satisfied of FSC's GATT-
    legality.  Still, the controversy was generally below the surface until 1998,
    when what had become the European Union (EU) lodged a complaint with
    the World Trade Organization (WTO, GATT's successor) arguing that FSC
    violated the agreements on which the WTO is based.  A WTO panel
    subsequently upheld the EC's position, and under WTO procedures, the
    United States was required to make its laws WTO-compliant or face either
    retaliatory tariffs or compensatory payments.  As 2000 drew to a close, the
    United States enacted the FSC Repeal and Extraterritorial Income Exclusion
    Act containing the ETI exclusion.  The European countries, however,
    maintained that the ETI provisions are themselves not WTO compliant and
    asked the WTO to rule on the WTO-legality of ET provisions.  The EU also
    asked the WTO to approve retaliatory tariffs, should the ETI regime prove to
    be non-compliant.  In August, 2001, a WTO panel ruled against the ETI
    provisions, and in January, 2002, the WTO Appellate Body rejected a U.S.
    appeal.  In August 2002 the WTO set the amount of sanctions that can be
    applied by the EU at $4 billion.  The EU delayed in implementing its tariffs
    while legislation addressing the controversy was considered by the U.S.
    Congress.  In March, 2004, however, the EU began to phase in its tariffs.

    While AJCA provided for ETI's ultimate repeal, the act also contained
    transition rules to which the EU also objected.  In part, the transition rules
    provided that exporters could still claim part of the benefit for two years:
    80% of the exclusion in 2005 and 60% in 2006, before the provision's
    ultimate phase out in 2007 and after.  In addition, the rules provided that the
    full exclusion was to remain in effect for binding contracts existing on
    September 17, 2003.  The EU filed a new WTO complaint, arguing that
    because of the transition rules, the United States continued to maintain a
    prohibited export subsidy.  A WTO panel supported the EU, and in May 2006
    TIPRA repealed the transition rule for binding contracts.  The 60% phase-out
    percentage, however, remains in effect for 2006.

    Assessment

    Because the ETI exclusion increased the after-tax return from investment
    in exporting, it posed a tax incentive to export.  Its supporters argued that the
    provision did indeed boost U.S. exports and thus had a beneficial effect on
    U.S. employment.  Economic analysis, however, suggests that the provision's
    effects were not what might be expected from an export incentive. The ETI
    exclusion probably triggered exchange-rate adjustments that ensured that U.S.
    imports expanded along with any increase the exclusion might have caused in
    exports; it probably produced little direct improvement in the U.S. balance of
    trade.  Instead, as the provision probably increased both imports and exports,
    it likely increased the overall level of U.S. trade.

    Economic theory suggests that another effect of the ETI exclusion was
    probably to shift economic welfare from the United States to foreign
    consumers.  This occurred when part of the tax benefit was passed on to
    foreign consumers in the form of reduced prices for U.S. goods.  The
    provision also likely reduced economic efficiency by inducing the United
    States to trade more than it otherwise would.

    Selected Bibliography

    Ahearn, Raymond J.  European Trade Retaliation: The FSC-ETI Case.
    Library of Congress, Congressional Research Service Report RS21742.
    Baldwin, Robert E.  "Are Economist's Traditional Trade Policy Views
    Still Valid?"  Journal of Economic  Literature 30 (June 1992), pp. 804-829.

    Brumbaugh, David.  The Foreign Sales Corporation (FSC) Tax Benefit for
    Exporting and the WTO.  Library of Congress, Congressional Research
    Service Report RS20571.
    - .  The Foreign Sales Corporation (FSC) Tax Benefit for Exporting: WTO
    Issues and an Economic Analysis.  Library of Congress, Congressional
    Research Service Report RL30684.
    Byrd, Kristin.  "Can We Provide a Level Playing Field for U.S.
    Corporations and Increase U.S. Jobs While Repealing the Extraterritorial
    Income Act?"  Houston Business and Tax Law Journal 5 (2005), p. 338.
    Desai, Mihir A. and James R. Hines.  The Uneasy Marriage of Export
    Subsidies and the Income Tax.  NBER Working Paper No. 8009. Cambridge,
    MA: National Bureau of Economic Research, 2000.
    Funk, William M.  "The Thirty-Years Tax War."  Tax Notes 93 (Oct. 8,
    2001), pp. 271-281.
    Krugman, Paul R. and Maurice Obstfeld.  "Export Subsidies: Theory," In
    International Economics: Theory and Policy, 3rd ed.  New York: Harper
    Collins, 1994.
    Rousslang, Donald J. and Stephen P. Tokarick.  "The Trade and Welfare
    Consequences of U.S. Export-Enhancing Tax Provisions." IMF Staff Papers
    41 (December 1994), pp. 675-686.
    U.S. Congress, Joint Committee on Taxation.  "Foreign Sales
    Corporations."  In General Explanation of the Revenue Provisions of the
    Deficit Reduction Act of 1984.  Committee Print, 98th Congress, 2nd Session.
    Washington, DC: Government Printing Office (1984), pp. 1037-1070.
    -.  "FSC Repeal and Extraterritorial Income Exclusion Act of 2000 (Public
    Law 106-519)."  In General Explanation of Tax Legislation Enacted in the
    106th Congress.  Joint Committee Print, 107th Congress, 1st Session.
    Washington, DC: Government Printing Office, April 19, 2001,  pp. 84-113.
     	U.S. Department of the Treasury.  The Operation and Effect of the Foreign
    Sales Corporation Legislation: January 1, 1985 to June 30, 1988.
    Washington, DC: 1993.

    International Affairs

    DEFERRAL OF ACTIVE INCOME OF CONTROLLED
    FOREIGN CORPORATIONS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    -

    3.4

    3.4

    2007

    -

    5.8

    5.8

    2008

    -

    6.4

    6.4

    2009

    -

    7.0

    7.0

    2010

    -

    7.5

    7.5

    	Authorization

    Sections 11(d), 882, and 951-964.

    	Description

    The United States taxes firms incorporated in the United States on their
    worldwide income but taxes foreign-chartered corporations only on their
    U.S.-source income.  Thus, when a U.S. firm earns foreign-source income
    through a foreign subsidiary, U.S. taxes apply to the income only when it is
    repatriated to the U.S. parent firm as dividends or other income; the income is
    exempt from U.S. taxes as long as it remains in the hands of the foreign
    subsidiary.  At the time the foreign income is repatriated, the U.S. parent
    corporation can credit foreign taxes the subsidiary has paid on the remitted
    income against U.S. taxes, subject to certain limitations.  Because the deferral
    principle permits U.S. firms to delay any residual U.S. taxes that may be due
    after foreign tax credits, it provides a tax benefit for firms that invest in
    countries with low tax rates.

    Subpart F of the Internal Revenue Code (sections 951-964) provides an
    exception to the general deferral principle.  Under its provisions, certain
    income earned by foreign corporations controlled by U.S. shareholders is
    deemed to be distributed whether or not it actually is, and U.S. taxes are
    assessed on a current basis rather than deferred.  Income subject to Subpart F
    is generally income related to passive investment rather than income from
    active business operations.  Also, certain types of sales, services, and other
    income whose geographic source is relatively easily shifted is included in
    Subpart F.

    While U.S. tax (less foreign tax credits) generally applies when tax-
    deferred income is ultimately repatriated to the United States, a provision of
    the American Jobs Creation Act of 2004 (P.L. 108-357) provided a temporary
    (one-year) 85% deduction for repatriated dividends.  For a corporation subject
    to the top corporate tax rate of 35%, the deduction had an effect similar to a
    reduction in the tax rate on repatriations to 5.25%.  The deduction applied to
    a one-year period consisting (at the taxpayer's election) of either the first tax
    year beginning on or after P.L. 108-357's date of enactment (October 22,
    2004) or the taxpayer's last tax year beginning before the date of enactment.

    Impact

    Deferral provides an incentive for U.S. firms to invest in active business
    operations in low-tax foreign countries rather than the United States, and thus
    probably reduces the stock of capital located in the United States.  Because
    the U.S. capital-labor ratio is therefore probably lower than it otherwise
    would be and U.S. labor has less capital with which to work, deferral likely
    reduces the general U.S. wage level.  At the same time, U.S. capital and
    foreign labor probably gain from deferral.  Deferral also probably reduces
    world economic efficiency by distorting the allocation of capital in favor of
    investment abroad.

    The one-year deduction for repatriations enacted in 2004 is likely to have
    increased the repatriation of funds from foreign subsidiaries.  However, at
    least part of the increase has likely consisted of a shift in the timing of
    repatriations from future periods towards the present, as firms take advantage
    of the one-year window.  While the provision was intended, in part, to
    increase domestic investment - its supporters argued that repatriated funds
    would be invested in the United States - firms disposition of the
    repatriations is not certain.

    	Rationale

    Deferral has been part of the U.S. tax system since the origin of the
    corporate income tax in 1909.  While deferral was subject to little debate in
    its early years, it later became controversial.  In 1962, the Kennedy
    Administration proposed a substantial scaling-back of deferral in order to
    reduce outflows of U.S. capital.  Congress, however, was concerned about the
    potential effect of such a step on the position of U.S. multinationals vis- a-vis
    firms from other countries and on U.S exports.  Instead of repealing deferral,
    the Subpart F provisions were adopted in 1962, and were aimed at taxpayers
    who used deferral to accumulate funds in so-called "tax haven" countries.
    (Hence, Subpart F's concern with income whose source can be easily
    manipulated.)

    In 1975, Congress again considered eliminating deferral, and in 1978
    President Carter proposed its repeal, but on both occasions the provision was
    left essentially intact.  Subpart F, however, was broadened by the Tax
    Reduction Act of 1975, the Tax Reform Act of 1976, the Tax Equity and
    Fiscal Responsibility Act of 1982, the Deficit Reduction Act of 1984, the Tax
    Reform Act of 1986, and the Omnibus Reconciliation Act of 1993
    (OBRA93).  OBRA93 added section 956A to the tax code, which expanded
    Subpart F to include foreign earnings that firms retain abroad and invest in
    passive assets beyond a certain threshold.

    In recent years, however, the trend has been incremental restrictions of
    Subpart F and expansions of deferral.  For example, the Small Business Job
    Protection Act of 1996 repealed section 956A.  And the Tax Relief Extension
    Act of 1999 (P.L. 106-170) extended a temporary exemption from Subpart F
    for financial services income.  In 2004, the American Jobs Creation Act
    relaxed Subpart F in the area of shipping income and provided a one-year
    temporary tax reduction for income repatriated to U.S. parents from overseas
    subsidiaries.

    Assessment

    The U.S. method of taxing overseas investment, with its worldwide
    taxation of branch income, limited foreign tax credit, and the deferral
    principle, can either pose a disincentive, present an incentive, or be neutral
    towards investment abroad, depending on the form and location of the
    investment.  For its part, deferral provides an incentive to invest in countries
    with tax rates that are lower than those of the United States.

    Defenders of deferral argue that the provision is necessary to allow U.S.
    multinationals to compete with firms from foreign countries; they also
    maintain that the provision boosts U.S. exports.  However, economic theory
    suggests that a tax incentive such as deferral does not promote the efficient
    allocation of investment.  Rather, capital is allocated most efficiently--and
    world economic welfare is maximized--when taxes are neutral and do not
    distort the distribution of investment between the United States and abroad.
    Economic theory also holds that while world welfare may be maximized by
    neutral taxes, the economic welfare of the United States would be maximized
    by a policy that goes beyond neutrality and poses a disincentive for U.S.
    investment abroad.

    Supporters of a "territorial" tax system would permanently exempt U.S.
    tax on repatriated dividends, thus eliminating U.S. tax even on a postponed
    basis.  Several arguments have been made in support of territorial taxation.
    One is based on the notion that changes in the international economy have
    made economic theory's traditional notions of efficiency and neutrality
    obsolete.  (This analysis, however, is not the consensus views of economists
    expert in the area.)  This argument maintains that efficiency is promoted if
    taxes do not inhibit U.S. multinationals' ability to compete for foreign
    production opportunities or interfere with their ability to exploit the returns to
    research and development.  Another argument holds that the current tax
    system produces so many distortions in multinationals' behavior that simply
    exempting foreign-source business income from tax would improve economic
    efficiency.

    	Selected Bibliography

    Altshuler, Rosanne.  "Recent Developments in the Debate on Deferral."
    Tax Notes 20 (April 3, 2000):  p. 1579.
    Ault, Hugh J., and David F. Bradford.  "Taxing International Income: An
    Analysis of the U.S. System and Its Economic Premises."  In Taxation in the
    Global Economy, ed. Assaf Razin and Joel Slemrod, 11-52.  Chicago:
    University of Chicago Press, 1990.
    Bergsten, C. Fred, Thomas Horst, and Theodore H. Moran.  "Tax Issues."
    In  American Multinationals and American Interests.  Washington, DC:  The
    Brookings Institution, 1977.
    Brumbaugh, David L.  U.S. Taxation of Overseas Investment and Income:
    Background and Issues in 2005.  Library of Congress, Congressional
    Research Service Report RL32749.
    -.  Tax Exemption for Repatriated Earnings: Proposals and Analysis.
    Library of Congress, Congressional Research Service Report RL32125.
    Desai, Mihir, and James Hines, "Old Rules and New Realities: Corporate
    Tax Policy in a Global Setting," National Tax Journal 57 (December 2004),
    pp. 937-960.
    Engel, Keith.  "Tax Neutrality to the Left, International Competitiveness to
    the Right, Stuck in the Middle with Subpart F."  Texas Law Review 79 (May
    2001), pp. 1525-1606.
    Frisch, Daniel J.  "The Economics of International Tax Policy: Some Old
    and New Approaches."  Tax Notes 47 (April 30, 1990) , pp. 581-591.
    Gourevitch, Harry G.   Anti-Tax Deferral Measures in the United States
    and Other Countries.  Library of Congress, Congressional Research Service
    Report 95-1143 A.
    Graetz, Michael J., and Paul W. Oosterhuis, "Structuring an Exemption
    System for Foreign Income of U.S. Corporations," National Tax Journal
    54(December 2001), pp. 771-786.
    Gravelle, Jane G.  "Issues in International Tax Policy."  National Tax
    Journal 57 (September 2004), pp. 773-778.

    Grubert, Harry,  "Comment on Desai and Hines, 'Old Rules and New
    Realities: Corporate Tax Policy in a Global Setting," National Tax Journal,
    vol. 58, Jun. 2005, pp. 263-278.
    _. and John Mutti, Taxing International Business Income: Dividend
    Exemption versus the Current System (Washington: American Enterprise
    Inst., 2001), 67 pp.
    Hartman, David G.  "Deferral of Taxes on Foreign Source Income,"
    National Tax Journal 30 (December 1977), pp. 457-462.
    -.  "Tax Policy and Foreign Direct Investment." Journal of Public
    Economics  26  (February 1985), pp. 107-121.
    Rousslang, Donald.  "Deferral and the Optimal Taxation of International
    Investment Income."  National Tax Journal 53 (September 2000), pp. 589-
    601.
    Slemrod, Joel.  "Effect of Taxation with International Capital Mobility."
    In Uneasy Compromise: Problems   of a Hybrid Income-Consumption Tax,
    ed. Henry J. Aaron, et al., 115-147.  Washington, DC: The Brookings
    Institution, 1988.
    U.S. Congress.  Joint Committee on Taxation.  Factors Affecting the
    International Competitiveness of the United States.  Joint Committee Print.
    102nd Congress, 1st session.  Washington, DC: Government Printing Office,
    May 30, 1991.
    U.S. Department of the Treasury, Office of Tax Policy.  The Deferral of
    Income Earned Through U.S. Controlled Foreign Corporations.
    Washington, DC: December, 2002.
    Yoder, Llowell D.  "Subpart F in Turmoil: Low Taxed Active Income
    Under Siege." Taxes 77 (March 1999), pp. 142-166.

    International Affairs

    INVENTORY PROPERTY SALES SOURCE RULE EXCEPTION

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    -

    6.2

    6.2

    2007

    -

    6.4

    6.4

    2008

    -

    6.6

    6.6

    2009

    -

    6.8

    6.8

    2010

    -

    7.0

    7.0

    Authorization

    Sections 861, 862, 863, and 865.

    Description

    The tax code's rules governing the source of inventory sales interact with
    its foreign tax credit provisions in a way that can effectively exempt a portion
    of a firm's export income from U.S. taxation.

    In general, the United States taxes U.S. corporations on their worldwide
    income.  The United States also permits firms to credit foreign taxes they pay
    against U.S. taxes they would otherwise owe.

    Foreign taxes, however, are only permitted to offset the portion of U.S.
    taxes due on foreign-source income.  Foreign taxes that exceed this limitation
    are not creditable and become so-called "excess credits."  It is here that the
    source of income becomes important: firms that have excess foreign tax
    credits can use these credits to reduce U.S. taxes if they can shift income from
    the U.S. to the foreign operation.  This treatment effectively exempts such
    income from U.S. taxes.

    The tax code contains a set of rules for determining the source ("sourcing")
    of various items of income and deduction.  In the case of sales of personal
    property, gross income is generally sourced on the basis of the residence of
    the seller.  U.S. exports covered by this general rule thus generate U.S.-rather
    than foreign-source income.

    The tax code provides an important exception, however, in the case of
    sales of inventory property.  Inventory that is purchased and then resold is
    governed by the so-called "title passage" rule: the income is sourced in the
    country where the sale occurs.  Since the country of title passage is generally
    quite flexible, sales governed by the title passage rules can easily be arranged
    so that the income they produce is sourced abroad.

    Inventory that is both manufactured and sold by the taxpayer is treated as
    having a divided source.  Unless an independent factory price can be
    established for such property, half of the income it produces is assigned a
    U.S. source and half is governed by the title passage rule.  As a result of the
    special rules for inventory, up to 50 percent of the combined income from
    export manufacture and sale can be effectively exempted from U.S. taxes.  A
    complete tax exemption can apply to export income that is solely from sales
    activity.

    Impact

    When a taxpayer with excess foreign credits is able to allocate an item of
    income to foreign rather than domestic sources, the amount of foreign taxes
    that can be credited is increased and the effect is identical to a tax exemption
    for a like amount of income.  The effective exemption that the source rule
    provides for inventory property thus increases the after-tax return on
    investment in exporting.  In the long run, however, the burden of the
    corporate income tax (and the benefit of corporate tax exemptions) probably
    spreads beyond corporate stockholders to owners of capital in general.

    Thus, the source-rule benefit is probably shared by U.S. capital in general,
    and therefore probably disproportionately benefits upper-income individuals.
    To the extent that the rule results in lower prices for U.S. exports, a part of the
    benefit probably accrues to foreign consumers of U.S. products.

    Rationale

    The tax code has contained rules governing the source of income since the
    foreign tax credit limitation was first enacted as part of the Revenue Act of
    1921.  Under the 1921 provisions, the title passage rule applied to sales of
    personal property in general; income from exports was thus generally
    assigned a foreign source if title passage occurred abroad.  In the particular
    case of property both manufactured and sold by the taxpayer, income was
    treated then, as now, as having a divided source.

    The source rules remained essentially unchanged until the advent of tax
    reform in the 1980s.  In 1986, the Tax Reform Act's statutory tax rate
    reduction was expected to increase the number of firms with excess foreign
    tax credit positions and thus increase the incentive to use the title passage rule
    to source income abroad.

    Congress was also concerned that the source of income be the location
    where the underlying economic activity occurs.  The Tax Reform Act of 1986
    thus provided that income from the sale of personal property was generally to
    be sourced according to the residence of the seller.  Sales of property by U.S.
    persons or firms were to have a U.S. source.

    Congress was also concerned, however, that the new residence rule would
    create difficulties for U.S. businesses engaged in international trade.  The Act
    thus made an exception for inventory property, and retained the title passage
    rule for purchased-and-resold items and the divided-source rule for goods
    manufactured and sold by the taxpayer.

    More recently, the Omnibus Budget Reconciliation Act of 1993 repealed
    the source rule exception for exports of raw timber.

    Assessment

    Like other tax benefits for exporting, the inventory source-rule exception
    probably increases exports.  At the same time, however, exchange rate
    adjustments probably ensure that imports increase also.  Thus, while the
    source rule probably increases the volume of U.S. trade, it probably does not
    improve the U.S. trade balance.  Indeed, to the extent that the source rule
    increases the Federal budget deficit, the provision may actually expand the
    U.S. trade deficit by generating inflows of foreign capital and their
    accompanying exchange rate effects.  In addition, the source-rule exception
    probably reduces U.S. economic welfare by transferring part of its tax benefit
    to foreign consumers.

    Selected Bibliography

    Brumbaugh, David L.  "Export Tax Subsidies," in Cordes, et al, eds., The
    Encyclopedia of Taxation and Tax Policy, 2nd edition.  Washington: Urban
    Institute, 2005.  pp. 130-133.
    -.  Tax Benefit for Exports: The Inventory Source Rules.  Library of
    Congress, Congressional Research Service Report 97-414 E.  April 2, 1997.
    -.  Taxes and International Competitiveness. Library of Congress,
    Congressional Research Service Report RS22445.

    Hammer, Richard M., and James D. Tapper.  The Foreign Tax Credit
    Provisions of the Tax  Reform Act of 1986.  Tax Adviser 18 (February 1987),
    pp. 76-80, 82-89.
    Krugman, Paul R. and Maurice Obstfeld.  "Export Subsidies: Theory," In
    International Economics: Theory and Policy, 3rd ed.  New York: Harper
    Collins, 1994.
    Maloney, David M., and Terry C. Inscoe.  A Post-Reformation Analysis of
    the Foreign Tax Credit Limitations.  International Tax Journal 13 (Spring
    1987), pp.  111-127.
    Rousslang, Donald J. "The Sales Source Rules for U.S. Exports: How
    Much Do They Cost?  Tax Notes International  8 (February 21, 1994), pp.
    527-535.
    - , and Stephen P. Tokarick.  The Trade and Welfare Consequences of
    U.S. Export-Enhancing   Tax Provisions.   IMF Staff Papers  41 (December
    1994), pp. 675-686.
    U.S. Congress, Joint Committee on Taxation.  Factors Affecting the
    International Competitiveness of the United States.  Joint Committee Print.
    98th Congress, 2nd  session.  Washington, DC:  May 30, 1991.
    -.  "Determination of Source in Case of Sales of Personal Property."  In
    General Explanation of the Tax Reform Act of 1986.  Joint Committee Print,
    100th Congress, 1st session.  May 4, 1987.
    U.S. Congressional Budget Office.  "Options to Increase Revenues:
    Eliminate the Source Rules Exception for Inventory Sales."  In Budget
    Options.  Washington, DC:  2003.
    U.S. Department of the Treasury.  Report to the Congress on the Sales
    Source Rules.  Washington, DC: 1993.

    International Affairs

    DEFERRAL OF CERTAIN FINANCING INCOME

    Estimated Revenue Loss*

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    -

    1.1

    1.1

    2007

    -

    1.7

    1.7

    2008

    -

    -

    -

    2009

    -

    -

    -

    2010

    -

    -

    -

    *The estimates do not include the impact of the Tax Increase Prevention
    and Reconciliation Act of 2006 (TIPRA; P.L. 109-222), which extended this
    provision beyond its previously scheduled expiration date.  According to
    estimates by the Joint Tax Committee, TIPRA's extension will increase the
    provision's revenue loss by $775 million in FY2007, $2,339 million in
    FY2008, and $1,682 million in FY2009.

    Authorization

    Sections 953 and 954.

    Description

    Under the U.S. method of taxing overseas investment, income earned
    abroad by foreign-chartered subsidiary corporations that are owned and
    controlled by U.S. investors or firms is generally not taxed if it is reinvested
    abroad.  Instead, a tax benefit known as "deferral" applies:  U.S. taxes on the
    income are postponed until the income is repatriated to the U.S. parent as
    dividends or other income.

    The deferral benefit is circumscribed by several tax code provisions; the
    broadest in scope is provided by the tax code's Subpart F.  Under Subpart F,
    certain types of income earned by certain types of foreign subsidiaries are
    taxed by the United States on a current basis, even if the income is not
    actually remitted to the firm's U.S. owners.  Foreign corporations potentially
    subject to Subpart F are termed Controlled Foreign Corporations (CFCs); they
    are firms that are more than 50% owned by U.S. stockholders, each of whom
    own at least 10% of the CFC's stock.  Subpart F subjects each 10%
    shareholder to U.S. tax on some (but not all) types of income earned by the
    CFC.  In general, the types of income subject to Subpart F are income from a
    CFC's passive investment - for example, interest, dividends, and gains from
    the sale of stock and securities -  and a variety of types of income whose
    geographic source is thought to be easily manipulated.

    Ordinarily, income from banking and insurance could in some cases be
    included in Subpart F.  Much of banking income, for example, consists of
    interest; investment income of insurance companies could also ordinarily be
    taxed as passive income under Subpart F.  Certain insurance income is also
    explicitly included in Subpart F, including income from the insurance of risks
    located outside a CFC's country of incorporation.  However, Congress
    enacted a temporary exception from Subpart F for income derived in the
    active conduct of a banking, financing, or similar business by a CFC
    predominantly engaged in such a business.  Congress also enacted a
    temporary exception for investment income of an insurance company earned
    on risks located within its country of incorporation.

    In short, Subpart F is an exception to the deferral tax benefit, and the tax
    expenditure at hand is an exception to Subpart F itself for a range of certain
    financial services income.  Prior to enactment of the Tax Increase Prevention
    and Reconciliation Act of 2006 (TIPRA; P.L. 109-222), the exception was
    scheduled to expire at the end of 2006.  TIPRA extended the provision for
    two years, through 2008.

    Impact

    The temporary exceptions pose an incentive in certain cases for firms to
    invest abroad; in this regard its effect is parallel to that of the more general
    deferral principle, which the exception restores in the case of certain banking
    and insurance income.

    The provision only poses an incentive to invest in countries with tax rates
    lower than those of the United States; in other countries, the high foreign tax
    rates generally negate the U.S. tax benefit provided by deferral.  In addition,
    the provision is moot (and provides no incentive) even in low-tax countries
    for U.S. firms that pay foreign taxes at high rates on other banking and
    insurance income.  In such cases, the firms have sufficient foreign tax credits
    to offset U.S. taxes that would be due in the absence of deferral.  (In the case
    of banking and insurance income, creditable foreign taxes must have been
    paid with respect to other banking and insurance income.  This may
    accentuate the importance of the exception to Subpart F.)

    Rationale

    Subpart F itself was enacted in 1962 as an effort to curtail the use of tax
    havens by U.S. investors who sought to accumulate funds in countries with
    low tax rates - hence Subpart F's emphasis on passive income and income
    whose source can be manipulated.  The exception for banking and insurance
    was likewise in the original 1962 legislation (though not in precisely the same
    form as the current version).  The stated rationale for the exception was that
    interest, dividends, and like income were not thought to be "passive" income
    in the hands of banking and insurance firms.

    The exceptions for banking and insurance were removed as part of the
    broad Tax Reform Act of 1986 (Public Law 99-514).  In removing the
    exception (along with several others), Congress believed they enabled firms
    to locate income in tax haven countries that have little "substantive economic
    relation" to the income.  As passed by Congress, the Taxpayer Relief Act of
    1997 (Public Law 105-34) generally restored the exceptions with minor
    modifications.  In making the restoration, Congress expressed concern that
    without them, Subpart F extended to income that was neither passive nor
    easily movable.  However, the Act provided for only a temporary restoration,
    applicable to 1998.  Additionally, the Joint Committee on Taxation identified
    the exceptions' restoration as a provision susceptible to line-item veto under
    the provisions of the 1996 Line-Item Veto Act because of its applicability to
    only a few taxpaying entities, and President Clinton subsequently vetoed the
    exceptions' restoration.  The Supreme Court, however, ruled the line-item
    veto to be unconstitutional, thus making the temporary restoration effective
    for 1998, as enacted.

    The banking and insurance exceptions to Subpart F were extended with a
    few modifications for one year by the Tax and Trade Relief Extension Act of
    1998.  (The Act was part of Public Law 105-277, the omnibus budget bill
    passed in October, 1998.)  The modifications include one generally designed
    to require that firms using the exceptions conduct "substantial activity" with
    respect to the financial service business in question and added a "nexus"
    requirement under which activities generating eligible income must take place
    within the CFC's home country.  In 1999, Public Law 106-170 extended the
    provision through 2001.  In 2002, Public Law 107-147 extended the
    provision for five additional years, through 2006.  The American Jobs
    Creation Act of 2004 (P.L. 108-357) added rules permitting, in some
    circumstances, certain qualifying activities to be undertaken by related
    entities.   In 2006, TIPRA (P.L. 109-222) extended the provision for two
    years, through 2008.

    Assessment

    Subpart F attempts to deny the benefits of tax deferral to income that is
    passive in nature or that is easily movable.  It has been argued that the
    competitive concerns of  U.S. firms are not as much an issue in such cases as
    they are with direct overseas investment.  Such income is also thought to be
    easy to locate artificially in tax haven countries with low tax rates.  But banks
    and insurance firms present an almost insoluble technical problem; the types
    of income generated by passive investment and income whose source is easily
    manipulated are also the types of income financial firms earn in the course of
    their active business.  The choice confronting policymakers, then, is whether
    to establish an  approximation that is fiscally conservative or one that places
    most emphasis on protecting active business income from Subpart F.  The
    exceptions' repeal by the Tax Reform Act of 1986 appeared to do the former,
    while the recent restoration of the exceptions appears to do the latter.

    It should be noted that traditional economic theory questions the merits of
    the deferral tax benefit itself.  Its tax incentive for investment abroad
    generally results in an allocation of investment capital that is inefficient from
    the point of view of both the capital exporting country (in this case the United
    States) and the world economy in general.  Economic theory instead
    recommends a policy known as "capital export neutrality" under which
    marginal investments face the same tax burden at home and abroad.  From
    that vantage, then, the exceptions to Subpart F likewise impair efficiency.

    Selected Bibliography

    McLaughlin, Megan.  "Truly a Wolf, Or Just a Sheep in Wolf's Clothing?
     The Active Finance Exception to Subpart F."  Virginia Tax Review 21
    (Spring 2002) : 649
    Sullivan, Martin A.  "Economic Analysis: Large U.S. Banks Keeping
    More Profits in Tax Havens."  Tax Notes, 14 June, 2004, 1340.
    U.S. Congress, Joint Committee on Taxation.  "Extension and
    Modification of Exceptions under Subpart F for Active Financing Income." In
    General Explanation of Tax Legislation Enacted in the 107th Congress.  Joint
    Committee Print.  107th  Congress, 2nd session.  Washington, DC: U.S.
    Government Printing Office, 2003.  Pp. 279-283.
    U.S. Department of the Treasury, Office of Tax Policy.  The Deferral of
    Income Earned Through U.S. Controlled Foreign Corporations.
    Washington, DC: December, 2002.
    Yoder, Lowell D.  "The Subpart F Exception for Active Financing
    Income."  Tax Management International Journal 31 (June 14, 2002) : 283-
    303.

    General Science, Space, and Technology

    TAX CREDIT FOR
    INCREASING RESEARCH EXPENDITURES

    Estimated Revenue Loss*

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    2007

    2008

    2009

    2010

    *This provision expired on December 31, 2005 and was modified
    and extended through 2007 by H.R. 6111 in December 2006.  If
    permanently reinstated in its 2005 form, the annual cost would be about
    $8.6 billion, according to the Treasury Department.  The December
    2006 revisions resulted a a projected  cost for fiscal years 2007-2010 of
    $7.5, $4,2, $2.2, and $1.6 billion; FY2006 would presumably be about
    the same magnitude as FY2007.

    	Authorization

    Section 41.

    	Description

    A non-refundable, 20-percent tax credit is allowed for certain research
    expenditures paid or incurred in carrying on the trade or business of a
    taxpayer.  In reality, this credit is the sum of three separate and distinct
    credits: a regular or alternative incremental credit, a basic research credit, and
    a credit for energy research.

    The regular credit applies only to the taxpayer's qualified research
    expenditures for a tax year in excess of a base amount.  This amount is
    computed by multiplying a fixed ratio-which for so-called established
    corporations is total research expenditures divided by total gross receipts in
    1984-1988-by average gross receipts for the past four years.  The base
    amount cannot be less than 50 percent of current-year qualified research
    expenditures, and the fixed ratio may not exceed 0.16.  Firms not considered
    established are assigned an initial fixed ratio of 0.03 during the first five tax
    years in which they have both gross receipts and qualified research expenses.

    Firms also have the option of claiming an alternative incremental research
    tax credit.  It is equal to the sum of 2.65 percent of a firm's qualified research
    expenditures above 1 percent but not greater than 1.5 percent of its average
    gross receipts in the four previous years, 3.2 percent of its qualified research
    expenditures above 1.5 percent but not greater than 2.0 percent of the same
    receipts, and 3.75 percent of its qualified research expenditures that exceed
    2.0 percent of the same receipts. (These credit  rates are increased to  3, 4, and
    5 percent respectively for 2007).  In general, firms are likely to benefit more
    from the alternative credit than the regular credit if their qualified research
    expenditures in the current tax year are somewhat greater than their base
    amounts for the regular credit.  Firms can also elect an alternative simplified
    credit of 12% of expenses that exceed 50% of spending in the last three years
    (6% if there are no expenditures in any one of those years).

    The definition of research that qualifies for the credit has been a
    contentious and unresolved issue since the credit first entered the tax code in
    July 1981.  As it now stands, research must satisfy three criteria in order to
    qualify for the credit.  First, the research must relate to activities that can be
    expensed under section 174, which is to say that the research must be
    "experimental" in the laboratory sense.  Second, the research must be
    undertaken to discover information that is "technological in nature" and
    useful in the development of a new or improved product, process, computer
    software technique, formula, or invention that is to be sold, leased, licensed,
    or used by the firm performing the research.  Finally, the research must relate
    to activities that constitute a process of experimentation whose goal is the
    development of a product or process with a "new or improved function,
    performance, or reliability or quality."

    Not all spending on qualified research is eligible for the incremental or
    alternative credits.  Only outlays for the following purposes can be used to
    compute the credit:

    (1) wages, salaries, and supplies used in research conducted in house;

    (2) certain time-sharing costs for computers used in research, and

    (3)  65 percent of amounts paid by the taxpayer for contract research; the
    share rises to 75 percent if non-profit scientific research consortia perform
    the research, and to 100 percent if the research is performed by qualified
    small firms, certain universities, or federal laboratories.

    The credit does not apply to expenditures for equipment and structures
    used in qualified research, the fringe benefits of employees involved in this
    research, and overhead costs related to research activities (e.g., rent, utility
    costs, leasing fees, administrative and insurance costs, and property taxes).
    Nor can it be claimed for research done after the start of commercial
    production, research aimed at adapting existing products for a specific
    customer's needs, research that duplicates existing products, surveys, routine
    testing, research to modify computer software for internal use, foreign
    research, research funded by others, and research in the social sciences, arts,
    or humanities.

    If a taxpayer claims a research tax credit and a deduction for research
    expenditures under section 174, then the deduction must be reduced by the
    amount of the credit.  This reduction, which is sometimes referred to as a
    basis adjustment, has the effect of including the credit in a firm's taxable
    income, thereby lowering the marginal effective rate of the credit.

    In addition, payments made by most firms for basic research conducted by
    universities and non-profit scientific research organizations are eligible for a
    basic research tax credit.  The credit is equal to 20 percent of these payments
    above a base amount, which is defined as the sum of 1 percent of a taxpayer's
    in-house and contract research spending in the base period and any excess of
    its average non-basic research contributions to qualified organizations in the
    base period, adjusted for increases in the cost of living, over its contributions
    in the current tax year.  Research expenditures used to compute the basic
    research credit may not also be used to compute the regular or alternative
    research credits.

    Firms may also claim a 20 percent credit for any payments they make to an
    energy research consortium.

    The credit may not be claimed for eligible expenses paid or incurred after
    June 30, 1995 and before July 1, 1996, for the reason that the credit was not
    in effect during that period and has not been renewed retroactively to cover it.

    	Impact

    The credit reduces the after-tax or net cost to a business of performing
    qualified research.  Though the statutory rate of the credit is 20 percent for
    qualified research expenses above the base amount, the marginal effective
    rate is much less in many cases.  The reason lies in some of the rules
    governing the computation of the credit.  One such rule requires that any
    deduction claimed for research expenditures under section 174 be reduced by
    the amount of any research credit claimed.  Doing so lowers the credit's
    marginal effective rate to 13 percent:  [0.20 x (1-0.35)].  Another rule
    stipulates that a firm's base amount for the credit must be equal to 50 percent
    or more of qualified research expenses in the current tax year.  As a result of
    this rule, the marginal effective rate of the credit can fall to 6.5 percent for
    research expenditures in excess of double the base amount.  This rate can be
    even lower when outlays for structures and equipment, which are not eligible
    for the credit, account for a large share of the total cost of an R&D
    investment.

    Because of its design, the credit does not provide benefits to all firms
    undertaking qualified research.  For instance, it is of no benefit to firms
    whose research intensity (i.e., research expenditures as a share of gross
    receipts in a certain period) is declining.  If the reason for the decline in
    research intensity is faster growth in sales than research expenditures, then it
    is conceivable that the credit could function as an implicit and slight tax on
    sales growth.

    At the same time, the credit provides the largest benefits to firms whose
    investment in research and development (R&D) is rising faster than their sales
    revenue.

    Individuals to whom the credit is properly allocated from a partnership or
    subchapter S corporation may use the credit in a particular year to offset only
    the tax on their taxable income derived from that business.  This means that -
    owners of partnerships or S corporations cannot use research tax credits
    earned by these entities to offset the tax on income from the other sources.

    The credit is claimed mostly by C corporations, while its direct tax benefits
    accrue largely to higher-income individuals (see discussion in the
    Introduction).

    	Rationale

    Section 41 first entered the federal tax code through the Economic
    Recovery Tax Act of 1981.  Under the act, the credit rate was fixed at 25
    percent, there was no basis adjustment, and the base amount was equal to the
    average of the past three years of research expenditures.  Such a design served
    two purposes:  (1) to give U.S.-based firms an incentive to invest more in
    R&D than they otherwise would, and (2) to offset some of the significant
    costs associated with initiating or expanding business R&D programs.

    The original credit was supposed to expire at the end of 1985, to give
    Congress an opportunity to evaluate its effects before deciding whether or not
    to extend it.  It was extended retroactively through 1988, at a reduced rate of
    20 percent, by the Tax Reform Act of 1986.  The Technical and
    Miscellaneous Revenue Act of 1988 extended the credit for another year and
    a half and added a basis adjustment equal to 50 percent of the credit.

    Additional changes were made in the credit through the Omnibus
    Reconciliation Act of 1989. Specifically, the act extended the credit through
    1990, allowed the base amount to increase in pace with gross receipts rather
    than research expenditures, allowed the credit to apply to research intended to
    explore future lines of business as well as to develop current ones, and
    provided for the full basis adjustment.  The Omnibus Reconciliation Act of
    1990 extended the credit through the end of 1991, and the Tax Extension Act
    of 1991 further extended it through June 1992.  After the credit expired and
    remained in abeyance for about one year, the Omnibus Budget Reconciliation
    Act of 1993 retroactively extended it through June 1995.  After the credit
    again expired and lapsed for about one year, the Small Business Job
    Production Act of 1996 reinstated it retroactively to July 1, 1996 and
    extended it through May 31, 1997, leaving a one-year gap in coverage that
    still exists.  That act also introduced the three-tiered alternative credit and
    allowed 75 percent of payments to  non-profit research consortia to be eligible
    for the credit.  The Taxpayer Relief Act of 1997 further extended the credit
    through June 1998, and the omnibus budget bill passed in 1998 (P.L. 105-
    277) extended the credit through June 1999.  After expiring yet again, the
    credit was extended to June 30, 2004 by the Ticket to Work and Work
    Incentives Improvement Act of 1999 (P.L. 106-170).  In October 2004,
    President Bush signed into law a tax bill (the Working Families Tax Relief
    Act of 2004, P.L. 108-311) that included a provision extending the credit
    through December 31, 2005.  H.R. 6111, adopted in December 2006,
    extended the credit through 2007, increased the alternative rates for 2007, and
    added the alternative simplified credit.

    Assessment

    Among economists and policymakers, there is widespread agreement that
    investment in research and development (R&D) exerts a profound influence
    on long-term economic growth through the innovations it spawns.  At the
    same time, it is thought that private R&D investment is bound to be less than
    optimal in an economy dominated by competitive markets, mainly because
    firms other than the ones financing the R&D may capture some of the
    economic benefits from research.  This leakage can occur in spite of the
    presence of patents and other forms of intellectual property protection.  For
    example, when a group of research scientists and engineers decides to break
    away from a company and start a new company for the purpose of developing
    a technology related to technologies owned and sold by their former
    employer, some (or even all) of any returns they eventually earn on their
    investment could be attributed to the R&D investments made by their former
    employer.  There is some evidence that the social returns to R&D are much
    larger than the private returns.  In the absence of government intervention in
    the market for R&D, the private sector is likely to invest less in R&D than its
    potential social returns would warrant.  Public subsidies for R&D (e.g.,
    research tax credits) can remedy this market failure, making everyone better
    off.

    Since its enactment in 1981, the research tax credit has provided over $1
    billion a year in tax subsidies for business R&D investment.  The credit's
    effectiveness hinges on the sensitivity of this investment to declines in its real
    after-tax cost.  Available evidence suggests that in the 1980s, a decline in this
    cost of one dollar was associated with an increase in business R&D
    investment of one to two dollars.  Because this sensitivity may shift over long
    periods, it is not known whether R&D investment remains as responsive
    today.

    Even though the existing credit can be justified on economic grounds and
    is thought to be cost-effective, it is open to several criticisms.  First, a tax
    subsidy may not be the most efficient way to encourage increased investment
    in basic research, since an open-ended subsidy like the credit does not
    necessarily target R&D with the greatest social returns.  Second, the lack of a
    clear and comprehensive definition of the research that qualifies for the credit
    makes it easier for firms to claim the credit for expenses that may have little
    or nothing to do with R&D.  Third, the credit's incentive effect may be too
    weak to boost business R&D to levels commensurate with its social benefits.
    Fourth, some critics of the credit contend that it mostly subsidizes R&D that
    would be done even if the credit did not exist.  Finally, the credit's lack of
    permanence is thought to deter some R&D investment by heightening the
    uncertainty surrounding the expected after-tax returns on prospective R&D
    investments.

    	Selected Bibliography

    Altschuler, Rosanne.  "A Dynamic Analysis of the Research and
    Experimentation Credit," National Tax Journal, v. 41.  December 1988, pp.
    453-466.
    Atkinson, Robert D.  The Research and Experimentation Tax Credit: A
    Critical Policy Tool for Boosting Research and Enhancing U.S. Economic
    Competitiveness.  Information Technology and Innovation Foundation.
    Washington, D.C.: September 4, 2006.
    Baily, Martin Neil, and Robert Z. Lawrence. "Tax Policies for Innovation
    and Competitiveness," Paper Commissioned by the Council on Research and
    Technology.  Washington, DC, April 1987.
      -.  "Tax Incentives for R&D:  What do the Data Tell Use?"  Study
    Commissioned by the Council on Research and Technology. Washington,
    DC, 1992.
    Berger, Philip G.  "Explicit and Implicit Tax Effects of the R&D Tax
    Credit."  Journal of Accounting Research, v. 3, August 1993, pp. 131-71.

    Bernstein, Jeffry I. and M. Ishaq Nadiri. "Interindustry R&D Spillovers,
    Rates of Return, and Production in High Tech Industries,"  American
    Economic Review, v. 76.  June 1988, pp. 429-434.
    Billings, B. Anthony and Randolph Paschke, "Would H.R. 463 Improve
    the Competitiveness of U.S. R&D Tax Incentives?," Tax Notes, June 9, 2003,
    pp. 1509-1524.
    -.  "Permanent Research Tax Credit Could Reverse Offshoring of Jobs,"
    Tax Notes, March 29, 2004, pp. 1655-1666.
    Brown, Kenneth M., ed.  The R&D Tax Credit.  Issues in Tax Policy and
    Industrial Innovation.  Washington, DC: American Enterprise Institute for
    Public Policy, 1984.
    Busom, Isabel.  An Empirical Evaluation of the Effects of R&D Subsidies.
     Burch Working Paper No. B99-05.  Berkeley, CA, University of California,
    Berkeley, May 1999.
    Cordes, Joseph J.  "Tax Incentives for R&D Spending: A Review of the
    Evidence," Research Policy, v. 18.  1989,  pp. 119-133.
    -.  "Research and Experimentation Tax Credit."  The Encyclopedia of
    Taxation and Tax Policy, edited by Joseph J. Cordes, Robert O. Ebel, and
    Jane G. Gravelle.  Washington, DC: Urban Institute Press, 2005. pp. 330-332.
    Cox, William A.  Research and Experimentation Credits:  Who Got How
    Much?  Library of Congress, Congressional Research Service Report 96-505,
    June 4, 1996.
    Gravelle, Jane G.  The Tax Credit for Research and Development: An
    Analysis.  Library of Congress, Congressional Research Service Report 85-6.
     Washington, DC, January 25, 1985.
    Grigsby, McGee and John Westmoreland, "The Research Tax Credit: A
    Temporary and Incremental Dinosaur."  Tax Notes, December 17, 2001, pp.
    1627-1640.
    Guenther, Gary.  Research and Experimentation Tax Credit: Current
    Status and Policy Issues for the 108th Congress.  Library of Congress,
    Congressional Research Service Report No. RL31181.  Washington, D.C.,
    September 22, 2006.
    Guinet, Jean, and Hroko Kamata.  "Do Tax Incentives Promote
    Innovation?"  OECD Observer, no. 202, October-November, 1996, pp. 22-
    25.
    Hall, Bronwyn H. "R & D Tax Policy During the 1980s," in Tax Policy
    and the Economy 7, ed. James M. Poterba.  Cambridge, MA: MIT Press,
    1993.
    -, and John van Reenen.  How Effective Are Fiscal Incentives for R&D?  A
    Review of the Evidence.  Working Paper 7098.  Cambridge, MA, National
    Bureau of Economic Research, April 1999.
    Hines, James R.  "On the Sensitivity of R&D to Delicate Tax Changes:
    The Behavior of U.S. Multinationals in the 1980s."  In Studies in
    International Taxation in the 1980s," Ed. Alberto Giovanni, R. Glenn
    Hubbard, and Joel Slemrod. Chicago:  The University of Chicago Press,
    1993.

    Kiley, Michael T. Social and Private Rates of Return to Research and
    Development in Industry.  Library of Congress, Congressional Research
    Service Report 93-770.  Washington, DC: August 27, 1993.
    KPGM Peat Marwick, LLP, Policy Economics Group, Extending the R&E
    Credit: The Importance of Permanence. Prepared for the Working Group on
    Research and Development.  Washington, DC: November 1994.
    Landau, Ralph, and Bruce Hannay, eds.  Taxation, Technology and the
    US. Economy.  NY: Pergamon Press, 1981.  See particularly George Carlson,
    "Tax Policy and the U.S. Economy," (a version of which was published as
    Office of Tax Analysis Paper 45, U.S. Treasury Department, January 1981),
    pp. 63-86, and Joseph Cordes, "Tax Policies for Encouraging Innovation: A
    Survey," pp. 87-99.
    Mamureas, Theofaris P. and M. Ishaq Nadiri.  "Public R&D Policies and
    Cost Behavior of the U.S. Manufacturing Industries."  National Bureau of
    Economic Research Working Paper 5059, Cambridge, MA, March 1995.
    Mansfield, Edwin, et al.  "Social and Private Rates of Return from
    Industrial Innovations,"  Quarterly Journal of Economics, v. 41.  March
    1977, pp. 221-240.
    McIntyre, Bob.  Proposed Extension of Corporate Tax Credit: Throwing
    Good Money After Bad, Citizens for Tax Justice.  Washington, D.C.: May 12,
    2006.
    Office of Technology Assessment, The Effectiveness of Research and
    Experimental Tax Credits, OTA-BRITC-174, September 1995.
    Ohmes, Christopher J., David S. Hudson, and Monique J. Migneault,
    "Final Research Credit Regulations Expected to Immediately Affect IRS
    Examinations," Tax Notes, February 23, 2004, pp. 1015-1024.
    Rashkin, Michael D.  Research and Development Tax Incentives: Federal,
    State, and Foreign.  Chicago:  CCH Inc., 2003.
    Tillinger, Janet W. "An Analysis of the Effectiveness of the Research and
    Experimentation Tax Credit in a Q Model of Valuation."  The Journal of the
    American Taxation Association, Fall 1991, pp. 1-29.
    U.S. Congress, House Committee on Ways and Means.  Research and Ex-
    perimentation Tax Credit Hearing, 98th Congress, 2nd session. August 2,
    1984.
    -, Joint Committee on Taxation.  Description and Analysis of Tax
    Provisions Expiring in 1992.   January 27, 1992: pp. 59-68.
    -, Joint Economic Committee.  The R&D Tax Credit: An Evaluation of
    Evidence on Its Effectiveness, 99th Congress, 1st Session.  Senate Report 99-
    73, August 23, 1985.
    U.S. General Accounting Office.  Additional Information on the Research
    Tax Credit.  Testimony of Natwar Gandhi Before the House Ways and Means
    Subcommittee on Oversight.  Publication GGD-95-162, Washington, 1995.
    -.  Studies of the Effectiveness of the Research Tax Credit.  Publication
    GGD-96-43.  May 1996.
      Watson, Harry.  "The 1990 R&D Tax Credit:  A Uniform Tax on Inputs and
    a Subsidy for R&D."  National Tax Journal, v. 49, March 1996, pp. 93-103.

    General Science, Space, and Technology

    EXPENSING  OF
    RESEARCH AND EXPERIMENTAL EXPENDITURES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    (1)

    2.0

    2.0

    2007

    0.1

    3.7

    3.8

    2008

    0.1

    5.5

    5.6

    2009

    0.1

    6.0

    6.1

    2010

    0.1

    5.8

    5.9

    (1)Less than $50 million.

    Authorization

    Section 174.

    Description

    As a general rule, business expenditures to acquire an asset with a useful
    life extending beyond a single tax year, such as a machine tool or computer
    system, must be capitalized and cannot be deducted in the year when the
    expenditures are made or incurred.  These costs usually are recovered through
    depreciation deductions taken over the useful life of the asset, or through the
    sale or abandonment of the asset.

    Under section 174, however, a business taxpayer may deduct, as a current
    expense, certain research expenditures that are paid or incurred in connection
    with the taxpayer's trade or business.  This treatment is available even though
    the research expenditures are likely to generate intangible assets (e.g., patents)
    with a useful life extending far beyond a single tax year.  Alternatively, a
    taxpayer may treat these expenditures as deferred expenses and deduct them
    on a straight-line basis over a period of 60 months or more; this treatment is
    know as amortization.  Treasury regulations define the expenditures eligible
    for the section 174 deduction as "research and development costs in the
    experimental or laboratory sense."  The regulations also specify that eligible
    research expenditures include all costs related to "the development of an
    experimental or pilot model, a plant process, a product, a formula, an
    invention, or similar property, and the improvement of already existing
    property."

    Expenditures for the acquisition or improvement of land, or for the
    acquisition or improvement of depreciable or depletable property to be used
    in connection with research, cannot be deducted under section 174.  In
    practice, this means that outlays for structures and equipment used in research
    and development (R&D) must be recovered over 15 years and 3 years,
    respectively, using the depreciation schedules allowed under section 167.  In
    addition, expenditures to determine the existence, location, extent, or quality
    of mineral deposits, including oil and gas, may not be deducted under section
    174.

    To prevent business taxpayers from benefitting twice from the same
    research expenditures, the deduction allowed under section 174 must be re-
    duced by the amount (if any) of any credit claimed under section 41 for
    certain increases in research expenditures.

    Impact

    The expensing of research spending under section 174 has the effect of
    deferring taxes on the return to investment in the assets generated by this
    spending.  Such a deferral can yield a significant tax savings, after adjustment
    for inflation, for a firm over the life of a depreciable asset.  For example, if a
    profitable corporation were to spend $1 million on wages and supplies related
    to R&D in a tax year, it would be able to deduct that amount from its taxable
    income, producing an addition to cash flow (at a 35-percent marginal tax rate)
    of $350,000.  The value to the corporation of such treatment is the amount by
    which the present value of the immediate deduction exceeds the present value
    of the periodic deductions that otherwise would be taken over the useful life
    of any asset (such as a patent) generated by the research expenditures.  Under
    certain circumstances, expensing is equivalent to taxing the returns to an asset
    at a marginal effective rate of zero.  In other words, expensing has the
    potential to equalize the after-tax and pre-tax returns on an investment.

    The direct beneficiaries of the section 174 deduction obviously are firms
    that undertake research.  For the most part, these tend to be larger
    manufacturing corporations engaged in developing, producing, and selling
    technologically advanced products.  As a corporate tax deduction, the benefits
    of expensing any capital cost accrue mainly to upper-income individuals (see
    discussion in the Introduction).

    	Rationale

    Section 174 was enacted as part of the Internal Revenue Code of 1954.
    The legislative history of the act indicates that Congress was pursuing two
    overriding aims in enacting section 174.  One was to encourage firms
    (especially smaller ones) to invest in R&D.  The second aim was to eliminate
    the difficulties and uncertainties facing business taxpayers as a result of the
    depreciation of research expenditures under previous tax law.

    Assessment

    There appears to be no controversy over the desirability of the provision,
    reflecting a widely held view that its benefits outweigh its costs.  Section 174
    simplifies tax compliance and accounting for business taxpayers by
    eliminating the problems associated with identifying qualified R&D
    expenditures and assigning useful lives to any assets created through these
    expenditures.  It can also be argued that the provision stimulates business
    R&D investment by boosting real after-tax returns to such investment and
    increasing the cash flow of firms engaged in R&D.  This benefit addresses the
    perennial concern that firms are inclined to invest too little in R&D in the
    absence of government support, mainly because of the spillover effects of
    R&D.  There is some empirical evidence that the social returns to R&D
    exceed the private returns.

    While these considerations may constitute a strong economic case for
    subsidizing R&D investments, they do not necessarily support the use of a tax
    preference like section 174.  A principal shortcoming with tax subsidies like
    section 174 is that they do not target R&D investments with the largest social
    benefits.

    Selected Bibliography

    Baily, Martin Neil, and Robert Z. Lawrence.  "Tax Policies for Innovation
    and Competitiveness," Paper Commissioned by the Council on Research and
    Technology.   April 1987.
    Bernstein, Jeffry I., and M. Ishaq Nadiri.  "Interindustry R&D Spillovers,
    Rates of Return, and Production in High Tech Industries,"  American
    Economic Review, v. 76.  June 1988, pp. 429-434.
    Cordes, Joseph J.  "Tax Incentives for R&D Spending: A Review of the
    Evidence," Research Policy, v. 18.  1989, pp. 119-133.

    -.  "Expensing."  The Encyclopedia of Taxation and Tax Policy, edited by
    Joseph J. Cordes, Robert O. Ebel, and Jane G. Gravelle.  Washington, D.C.:
    Urban Institute Press, 2005.  pp. 128-130.
    Goldbas, Michael and Greg Alan Fairbanks.  "The Final Step in
    Computing the R&E Credit."  Tax Adviser, vol. 36, no. 3, March 1, 2005.  p.
    136.
    Guenther, Gary.  Research and Experimentation Tax Credit: Current
    Status and Policy Issues for the 108th Congress.  Library of Congress,
    Congressional Research Service Report RL31181.  Washington, updated
    September 22, 2006.
    Hall, Bronwyn H. and John van Reenen, "How Effective are Fiscal
    Incentives for R&D?  A Review of the Evidence.  Working Paper 7098.
    National Bureau of Economic Research, Cambridge, MA, April 1999.
    Hudson, David S.  "The Tax Concept of Research or Experimentation."
    Tax Lawyer, v. 45, Fall 1991, pp. 85-121.
    Kiley, Michael T. Social and Private Rates of Return to Research and
    Development in Industry.  Library of Congress, Congressional Research
    Service Report 93-770.  Washington, DC: August 27, 1993.
    Landau, Ralph, and Bruce Hannay, eds.  Taxation, Technology and the
    U.S. Economy.  New York: Pergamon Press, 1981.  See particularly George
    Carlson, "Tax Policy and the U.S. Economy" (a version of which was
    published as Office of Tax Analysis Paper 45, U.S. Treasury Department,
    January 1981), pp. 63-86, and Joseph J. Cordes, "Tax Policies for
    Encouraging Innovation: A Survey," pp. 87-99.
    Lee, Andrew B., "Section 174: "Just in Time" for Deducting Costs of
    Developing New or Improved Manufacturing Processes," The Tax Adviser,
    July 1996, p. 401.
    Mansfield, Edwin, et al.  "Social and Private Rates of Return from
    Industrial Innovations,"  Quarterly Journal of Economics, v. 41.   March
    1977,  pp. 221-240.
    McClelland, David Huston, "Deductibility of Contract Development Costs
    Under Section 174," The Tax Adviser, January 2000, p. 19.
    McConaghy, Mark L. and Richard B. Raye.  "Congressional Intent, Long-
    Standing Authorities Support Broad Reading of Section 174," Tax Notes,
    Feb. 1, 1993, pp. 639-653.
    Mamureas, T., and M.J. Nadiri.  "Public R&D Policies and Cost Behavior
    of the U.S. Manufacturing Industries," Journal of Public Economics, v. 63,
    no. 1, pp. 57-83.
    Rashin, Michael. D.  Research and Development Tax Incentives: Federal,
    State, and Foreign.  CCH, Inc.  Chicago: 2003, pp. 23-44.
    Tobin, Brian F., "New Regulations Clarify R&E Definition," The Tax
    Adviser, May 1995, p. 287.
    U.S. Congress, Congressional Budget Office.  Federal Support for R&D
    and Innovation, April 1984.

    	Energy

    EXPENSING OF EXPLORATION AND DEVELOPMENT COSTS;
    AMORTIZATION OF GEOLOGICAL AND GEOPHYSICAL
    COSTS:  OIL, GAS, AND OTHER FUELS

    Estimated Revenue Loss*

    [In billions of dollars]

    Individuals

    Corporations

    Total

    Fiscal year

    Oil and
    Gas

    Other
    Fuels

    Oil and
    Gas

    Other
    Fuels

    Oil and
    Gas

    Other
    Fuels

    2006

    (1)

    (1)

    1.1

    (1)

    1.1

    (1)

    2007

    (1)

    (1)

    1.7

    (1)

    1.7

    (1)

    2008

    0.1

    (1)

    1.9

    (1)

    2.0

    (1)

    2009

    0.1

    (1)

    1.0

    (1)

    1.1

    (1)

    2010

    (1)

    (1)

    0.7

    (1)

    0.7

    (1)

    (1)Less than $50 million.
    *The Tax Increase Prevention and Reconciliation Act (P.L. 109-222)
    increased the recovery period for the amortization of geological and
    geophysical costs for major integrated oil companies from 2 to 5 years, which
    increased revenues by the following amounts: $5 million in FY2006, $28
    million in FY2007, $49 million in FY2008, $48 million in FY2009, and  $30
    million in FY 2010.

    	Authorization

    Section 263(c), 291, 616-617, 57(a)(2), 59(e) and 1254.

    	Description

    Firms engaged in the exploration and development of oil, gas, or
    geothermal properties have the option of expensing  (deducting in the year
    paid or incurred) rather than capitalizing (i.e., recovering  such costs through
    depletion or depreciation) certain intangible drilling and development costs
    (IDCs). Expensing is an exception to general tax rules that provide for the
    capitalization of costs related to generating income from capital assets.  In lieu
    of expensing, firms have the option of amortizing IDCs in equal amounts over
    a five-year period. This option may reduce or eliminate the alternative
    minimum tax on the IDCs, which, as discussed below, is a tax preference
    item.

    IDCs are amounts paid by the operator for fuel, labor, repairs to drilling
    equipment, materials, hauling, and supplies.  They are expenditures incident
    to and necessary for the drilling of wells and preparing a site for the
    production of oil, gas, or geothermal energy. IDCs include the cost to
    operators of any drilling or development work done by contractors under any
    form of contract, including a turnkey contract. Amounts paid for casings,
    valves, pipelines, and other tangible equipment that have a salvage value are
    capital expenditures and they cannot be expensed; they are recovered through
    depreciation. (And as discussed in the subsequent entry on percentage
    depletion, amounts expended to purchase a property are depleted using either
    percentage or cost depletion.)  Geological and geophysical (G&G) costs  -
    exploratory costs associated with determining the precise location and
    potential size of a mineral deposit - are amortized by independents over two
    years and by major integrated oil companies over five years.

    The option to expense IDCs applies to domestic properties, which include
    certain off-shore wells (essentially those within the exclusive economic zone
    of the United States), including generally offshore platforms subject to certain
    restrictions. Except for IDCs incurred in the North Sea, IDCs on foreign
    properties must be either amortized (deducted in equal amounts) over 10
    years or added to the adjusted cost basis and recovered through cost
    depletion. An integrated oil company, generally a large producer that also has
    refining and marketing operations, can expense only 70% of the IDCs - the
    remaining 30% must be amortized over a five-year period. Dry hole costs for
    either domestic or foreign properties may be expensed or capitalized at the
    discretion of the taxpayer.

    For integrated producers, the excess of expensed IDCs over the
    amortizable value (over a 10-year period) is a tax preference item that is
    subject to the alternative minimum tax to the extent that it exceeds 65% of the
    net income from the property.  Independent (non-integrated) producers
    include only 60% of their IDCs as a tax preference item.  As noted above,
    instead of expensing, a taxpayer may choose to amortize IDCs over a five-
    year period and avoid the alternative minimum tax. The amortization claimed
    under IRC section 59(e) is not considered a tax preference item for alternative
    minimum tax purposes.  Prior to 1993, an independent producer's intangible
    drilling costs were subject to the alternative minimum tax, and they were
    allowed a special "energy deduction" for 100% of certain IDCs, subject to
    some limitations. If an operator has elected to amortize IDCs on a well that
    proves later to be a dry hole, the operator may deduct such costs as an
    ordinary loss. The taxpayer is not required to include these costs as an IDC
    tax preference item in computing alternative minimum tax. If a property is
    disposed of prior to its exhaustion, any expensed IDCs are recaptured as
    ordinary income.

    	Impact

    IDCs and other intangible exploration and development costs represent a
    major portion of the costs of finding and developing a mineral reserve.  In the
    case of oil and gas, which historically accounted for 99% of the revenue loss
    from this provision, IDCs typically account for about 66% of the total
    exploration and development costs - the cost of creating a mineral asset.

    Historically, expensing of IDCs was a major tax subsidy for the oil and gas
    industry, and, combined with other tax subsidies such as the depletion
    allowance, reduced effective tax rates significantly below tax rates on other
    industries. These subsidies provided incentives to increase investment,
    exploration, and output, especially of oil and gas.  Oil and gas output, for
    example, rose from 16% of total U.S. energy production in 1920 to 71.1% in
    1970 (the peak year). Coupled with reductions in corporate income tax rates,
    increased limits on expensing, and the alternative minimum tax, the value of
    this subsidy has declined over time.  And, since the early 1970s, domestic
    crude oil production has fallen substantially. However, the subsidy still keeps
    effective marginal tax rates on oil and gas (especially for independent
    producers) somewhat below the marginal effective tax rates on other
    industries in most cases.

    Unlike percentage depletion, which may only be claimed by independent
    producers, this tax expenditure is shared by both independents and by the
    integrated oil and gas producers. However, independent oil producers, many
    of which are large, drill 80-90% of the wells and undertake the bulk of the
    expenditures for exploration and development, thus receiving the bulk of the
    benefits from this tax expenditure.  The at-risk, recapture, and minimum tax
    restrictions that have since been placed on the use of the provision have
    primarily limited the ability of high-income taxpayers to shelter their income
    from taxation through investment in mineral exploration. However, the
    exemption for working interests in oil and gas from the passive loss limitation
    rules still creates opportunities for tax shelters in oil and gas investments.

    	Rationale

         Expensing of IDCs was originally established in a 1916 Treasury
    regulation (T.D. 45, article 223), with the rationale that such costs were
    ordinary operating expenses.

    In 1931, a court ruled that IDCs were capital costs, but permitted
    expensing, arguing that the 15-year precedent gave the regulation the force of
    a statute.  In 1942, Treasury recommended that expensing be repealed, but the
    Congress did not take action. A 1945 court decision invalidated expensing,
    but the Congress endorsed it (on the basis that it reduced uncertainty and
    stimulated exploration of a strategic mineral) and codified it as section 263(c)
    in 1954.  Continuation of expensing has been based on the perceived need to
    stimulate exploratory drilling, which can increase domestic oil and gas
    reserves, and (eventually) production, reduce imported petroleum, and
    enhance energy security.  However, none of the four economic rationales for
    intervention in the energy markets (the market failures rationales) justify
    expensing treatment of IDCs.

    The Tax Reform Act of 1976 added expensing of IDCs as a tax preference
    item subject to the minimum tax.  Expensing of IDCs for geothermal wells
    was added by the Energy Tax Act of 1978.  The Tax Equity and Fiscal
    Responsibility Act of 1982 limited expensing for integrated oil companies to
    85%; the remaining 15% of IDCs had to be amortized over 3 years.

    The Deficit Reduction Act of 1984 limited expensing for integrated
    producers to 80% of IDCs. The Tax Reform Act of 1986 established uniform
    capitalization rules for the depreciation of property, but IDCs (as well as mine
    development and other exploration costs) are exempt from those rules.  The
    Tax Reform Act further limited expensing for integrated producers to 70% of
    costs, and also repealed expensing of foreign properties.

    In 1990, a special energy deduction was introduced, against the alternative
    minimum tax, for a portion of the IDCs and other oil and gas industry tax
    preference items. For independent producers, the Energy Policy Act of 1992
    limited the amount of IDCs subject to the alternative minimum tax to 60%
    (70% after 1993) and suspended the special energy deduction through 1998.
    The Energy Policy Act of 2005 (P.L. 109-58) included a provision to
    amortize geological and geophysical (G&G) costs over two years.  The Tax
    Increase Prevention and Reconciliation Act (P.L. 109-222) raised the
    amortization period to 5 years for major integrated oil companies.

    	Assessment

    IDCs are generally recognized to be capital costs, which, according to
    standard economic principles, should be recovered using depletion (cost
    depletion adjusted for inflation). Lease bonuses and other exploratory costs
    (survey costs, geological and geophysical costs) are properly treated as capital
    costs, although they may be recovered through percentage rather than cost
    depletion. From an economic perspective, dry hole costs should also be
    depleted, rather than expensed, as part of the costs of drilling a successful
    well.

    Immediate expensing of IDCs provides a tax subsidy for capital invested in
    the mineral industry, especially for oil and gas producers, with a relatively
    larger subsidy for independent producers. Technological innovation has
    reduced the percentage of dry holes in both exploratory and development
    drilling, thus reducing the tax benefits from immediate expensing of dry hole
    costs.

    Expensing rather than capitalizing IDCs allows taxes on income to be
    effectively eliminated. As a capital subsidy, however, expensing is
    economically inefficient because it promotes investment decisions that are
    based on tax considerations rather than inherent economic considerations.

    To the extent that IDCs stimulate drilling of successful wells, they reduce
    dependence on imported oil in the short run, but contribute to a faster
    depletion of the nation's resources in the long run.  Arguments have been
    made over the years to justify expensing on grounds of unusual risks, national
    security, uniqueness of oil as a commodity, the industry's lack of access to
    capital, and protection of small producers.

    Volatile oil prices make oil and gas investments very risky, but this would
    not necessarily justify expensing. The corporate income tax does have
    efficiency distortions, but economists argue that income tax integration may
    be a more appropriate policy to address this issue; sustained high oil and gas
    prices increase profits and provide sufficient financial incentives for
    exploration and drilling, making expensing unnecessary. For the goal of
    enhancing energy security, one alternative approach is through an oil
    stockpile program such as the Strategic Petroleum Reserve.

    	Selected Bibliography

    Congressional Budget Office. Budget Options. Section 28: Repeal the
    Expensing of Exploration and Development Costs for Extractive Industries
    February 2005.
    Eicher, Jeffrey D. And Leo N. Hitt.  "The Alternative Minimum Tax
    System: A Stealth Tax,"  Taxes, v. 84 July 2006, pp. 37-45.
    Friske, Karyn Bybee. "Alternative Minimum Tax Credit and the
    Consolidated Regulations: Is Simplification Possible?" The Oil and Gas and
    Energy Quarterly, September 2001, pp.139-145.
    Ghiselin, Dick.  "Drilling Economics" Oil and Gas Investor, December
    2005, pp.13-22.
    Gravelle, Jane G.  "Effective Federal Tax Rates on Income from New
    Investments in Oil and Gas Extraction," The Energy Journal, v. 6 (1985), pp.
    145-153.
    Lazzari, Salvatore. Energy Tax Policy: History and Current Issues. Library
    of Congress, Congressional Research Service, Report RL33578. Washington,
    DC: Updated September 23, 2004.

    - . Energy Tax Policy: An Economic Analysis.  Library of Congress,
    Congressional Research Service Report RL30406. Washington, DC: June 28,
    2005.
    - . Energy Tax Provisions in the Energy Policy Act of 1992.  Library of
    Congress, Congressional Research Service, Report 94-525 E.  Washington,
    DC: June 22, 1994. (Archived: Available upon request from the author.)
    Lucke, Robert, and Eric Toder.  "Assessing the U.S. Federal Tax Burden
    on Oil and Gas Extraction," The Energy Journal, v. 8.  October 1987, pp. 51-
    64.
    Rook, Lance W.  "The Energy Policy Act of 1992 Changes the Effect of
    the AMT on Most Oil and Gas Producers," Tax Adviser, v. 24 (August 1993),
    pp. 479-484.
    U.S Congress, Senate Committee on Finance.  JCT Description of Federal
    Energy Tax Provisions, Hearings, 107th Congress, 1st session.  Washington,
    DC: U.S. Government Printing Office, July 10th and 11, 2001.
    U.S. General Accounting Office.  Additional Petroleum Production Tax
    Incentives Are of Questionable Merit, GAO/GGD-90-75.  July 1990.
    Washington, DC: U.S. Government Printing Office, July 1990.
    U.S. Treasury Department. Tax Reform for Fairness, Simplicity, and
    Economic Growth, v. 2.  November 1984, Washington, DC: 1984, pp. 229-
    231.
    U.S. Treasury Department.  Internal Revenue Service.  Publication 535:
    Business Expenses. 2005.
    Zlatkovich, Charles P., and Karl B. Putnam.  "Economic Trends in the Oil
    and Gas Industry and Oil and Gas Taxation," Oil and Gas Quarterly, v. 41.
    March, 1993, pp. 347-365.

    	Energy

    EXCESS OF PERCENTAGE OVER COST DEPLETION:
    OIL, GAS, AND OTHER FUELS

    Estimated Revenue Loss

    [In billions of dollars]

    Individuals

    Corporations

    Total

    Fiscal year

    Oil and
    Gas

    Other
    Fuels

    Oil and
    Gas

    Other
    Fuels

    Oil and
    Gas

    Other
    Fuels

    2006

    (1)

    (1)

    1.0

    0.1

    1.0

    0.1

    2007

    (1)

    (1)

    1.0

    0.1

    1.0

    0.1

    2008

    (1)

    (1)

    0.9

    0.1

    0.9

    0.1

    2009

    (1)

    (1)

    0.9

    0.1

    0.9

    0.1

    2010

     (1)

    (1)

    0.9

    0.1

    0.9

    0.1

    (1)Less than $50 million.  H.R. 6111, which extended a portion of this
    tax benefit cost an additional $0.1 billion in FY2007.

    	Authorization

    Sections 611, 612, 613, 613A, and 291.

    	Description

    Firms that extract oil, gas, or other minerals are permitted a deduction to
    recover their capital investment in a mineral reserve, which depreciates due to
    the physical and economic depletion or exhaustion  as the mineral is
    recovered (section 611). Depletion, like depreciation, is a form of capital
    recovery: An asset, the mineral reserve itself, is being expended in order to
    produce income.  Under an income tax, such costs are deductible.

    There are two methods of calculating this deduction: cost depletion and
    percentage depletion. Cost depletion allows for the recovery of the actual
    capital investment - the costs of discovering, purchasing, and developing a
    mineral reserve - over the period during which the reserve produces income.
     Each year, the taxpayer deducts a portion of the adjusted basis (original
    capital investment less previous deductions) equal to the fraction of the
    estimated remaining recoverable reserves that have been extracted and sold.
    Under this method, the total deductions cannot exceed the original capital
    investment.

    Under percentage depletion, the deduction for recovery of capital
    investment is a fixed percentage of the "gross income"-  i.e., revenue -
    from the sale of the mineral. Under this method, total deductions typically
    exceed, despite the limitations, the capital invested to acquire and develop the
    reserve.

    Section 613 states that mineral producers must claim the higher of cost or
    percentage depletion. The percentage depletion rate for oil and gas is 15%
    and is limited to average daily production of 1,000 barrels of oil, or its
    equivalent in gas. For producers of both oil and gas, the limit applies on a
    combined basis. For example, an oil producing company with 2006 oil
    production of 100,000 barrels, and natural gas production of 1.2 billion cubic
    feet (the equivalent of 200,000 barrels of oil) has average daily production of
    821.92 barrels (300,000 ? 365 days). Percentage depletion is not available to
    integrated major oil companies - it is available only for independent
    producers and royalty owners. An independent producer is one that does not
    have refinery operations that refine more than 75,000 barrels of oil per day,
    and does not have retail oil and gas operations grossing more than $5 million
    per year. Beginning in 1990, the percentage depletion rate on production from
    marginal wells - oil from stripper wells (those producing no more than 15
    barrels per day, on average), and heavy oil -  was raised. This rate starts at
    15% and increases by one percentage point for each whole $1 that the
    reference price of oil for the previous calendar years is less than $20 per
    barrel (subject to a maximum rate of 25%). This higher rate is also limited to
    independent producers and royalty owners, and for up to 1,000 barrels,
    determined as before on a combined basis (including non-marginal
    production).  Small independents operate about 400,000 small stripper wells
    in about 28 states, which  produce about 1 million barrels of marginal oil/day,
    about 20% of domestic production.

    Percentage depletion is limited to 65% of the taxable income from all
    properties for each producer.  A second limitation, the 100% net-income
    limitation, which applied to each individual property rather than to all the
    properties, was retroactively suspended for oil and gas production from
    marginal wells by the  Working Families Tax Relief Act of 2004 (P.L. 108-
    311) through December 31, 2005. From 1998-2007, the 100% net-income
    limitation has also been suspended.  Since 1990, transferred properties have
    been eligible for percentage depletion. The difference between percentage
    depletion and cost depletion is considered a subsidy.  It was once a tax
    preference item for purposes of the alternative minimum tax, but this was
    repealed by the Energy Policy Act of 1992 (P.L. 102-486).

    The percentage depletion allowance is available for many other types of
    fuel minerals, at rates ranging from 10% (coal, lignite) to 22% (uranium). The
    rate for regulated natural gas and gas sold under a fixed contract is 22%; the
    rate for geo-pressurized methane gas is 10%.  Oil shale and geothermal
    deposits qualify for a 15% allowance.  The net-income limitation to
    percentage depletion for coal and other fuels is 50%, as compared to 100%
    for oil and gas. Under code section 291, percentage depletion on coal mined
    by corporations is reduced by 20% of the excess of percentage over cost
    depletion.

    	Impact

    Historically, generous depletion allowances and other tax benefits reduced
    effective tax rates in the fuel minerals industry significantly below tax rates
    on other industries, which provided additional incentives to increase
    investment, exploration, and output, especially of oil and gas.  Oil and gas
    output, for example, rose from 16% of total U.S. energy production in 1920 to
    71.1% of 1970 (the peak year).

    The combination of this subsidy and the deduction of intangible drilling
    and other costs (see previous entry) represented a significant boon to mineral
    producers who were eligible for both. The deduction of intangible drilling
    costs allows up to three-quarters of the original investment to be "written off"
    immediately, and under the percentage depletion allowance a portion of gross
    revenues can be written off for the life of the investment. It was possible for
    cumulative depletion allowances to total many times the amount of the
    original investment.

    The 1975 repeal of percentage depletion for the major integrated oil
    companies, and declining oil production, means that the value of this tax
    subsidy has been greatly reduced in the last 30 years. The reduction in the
    depletion allowance to 15% in 1984 means that independent producers
    benefit from it much less than they used to, although independents have
    increased their share of total output, and they qualify for the higher depletion
    rate on marginal production. Most recently, high oil and gas prices may have
    raised somewhat the subsidy value of percentage depletion to the
    independents. In addition, cutbacks in other tax benefits and additional excise
    taxes have raised effective tax rates in the mineral industries, although
    independent oil and gas producers continue to be favored.  However, the
    exemption for working interests in oil and gas from the passive loss limitation
    rules still creates opportunities for tax shelters in oil and gas investments.
    This rule allows losses incurred from exploring for and producing oil and gas
    to offset ordinary non oil and gas income.

    Undoubtedly, these cutbacks in percentage depletion contributed to the
    decline in domestic oil production, which peaked in 1970 and recently
    dropped to a 30-year low.  Percentage depletion for other mineral deposits
    was unaffected by the 1975 legislation.  Nevertheless, in an average year
    more than half the percent revenue loss is a result of oil and gas depletion.
    The value of this expenditure to the taxpayer is the amount of tax savings that
    results from using the percentage depletion method instead of the cost
    depletion method.

    Percentage depletion has little, if any, effect on oil prices, which are
    determined by supply and demand in the world oil market.  However, it may
    encourage higher prices for drilling and mining rights.

    	Rationale

    Provisions for a mineral depletion allowance based on the value of a mine
    were made under a 1912 Treasury Department regulation (T.D. 1742) but
    were never implemented.  A court case resulted in the enactment, as part of
    the Tariff Act of 1913, of a "reasonable allowance for depletion" not to
    exceed 5% of the value of mineral output. Treasury regulation No. 33 limited
    total deductions to the original capital investment.

    This system was in effect from 1913 to 1918, although in the Revenue Act
    of 1916, depletion was restricted to no more than the total value of output,
    and in the aggregate no more than capital originally invested or fair market
    value on March 1, 1913 (the latter so that appreciation occurring before
    enactment of income taxes would not be taxed).

    The 1916 depletion law marked the first time that the tax laws mentioned
    oil and gas specifically.  On the grounds that the newer discoveries that
    contributed to the war effort were treated less favorably, discovery value
    depletion was enacted in 1918. Discovery depletion, which was in effect
    through 1926, allowed deductions in excess of capital investment because it
    was based on the market value of the deposit after discovery.  Congress
    viewed oil and gas as a strategic mineral, essential to national security, and
    wanted to stimulate the wartime supply of oil and gas, compensate producers
    for the high risks of prospecting, and relieve the tax burdens of small-scale
    producers.

    In 1921, because of concern with the size of the allowances, discovery
    depletion was limited to net income; it was further limited to 50% of net
    income in 1924. Due to the administrative complexity and arbitrariness of the
    method, and due to its tendency to establish high discovery values, which
    tended to overstate depletion deductions, discovery value depletion was
    replaced in 1926 by the percentage depletion allowance, at the rate of 27.5%.

    In 1932, percentage depletion was extended to coal and most other
    minerals.  In 1950, President Truman recommended that the depletion rate be
    reduced to 15%, but Congress disagreed.  In 1969, the top depletion rates
    were reduced from 27.5% to 22%, and in 1970 the allowance was made
    subject to the minimum tax.

    The Tax Reduction Act of 1975 eliminated the percentage depletion
    allowance for major oil and gas companies and reduced the rate for
    independents to 15% for 1984 and beyond.  This was in response to the Arab
    oil embargo of 1973-74, which caused oil prices to rise sharply.  The
    continuation of percentage depletion for independents was justified by
    Congress on the grounds that independents had more difficulty in raising
    capital than the major integrated oil companies, that their profits were smaller,
    and that they could not compete with the majors.

    The Tax Equity and Fiscal Responsibility Act of 1982 limited the
    allowance for coal and iron ore.  The Tax Reform Act of 1986 denied
    percentage depletion for lease bonuses, advance royalties, or other payments
    unrelated to actual oil and gas production.

    The Omnibus Budget and Reconciliation Act of 1990 introduced the
    higher depletion rates on marginal production, raised the net income
    limitation from 50% to 100%, and made the allowance available to
    transferred properties.  These liberalizations were based on energy security
    arguments.  The Energy Policy Act of 1992 repealed the minimum tax on
    percentage depletion.  The Taxpayer Relief Act of 1997 suspended the 100%
    taxable income limitation for marginal wells for two years, and further
    extensions were made by the Ticket to Work and Work Incentives
    Improvement Act of 1999 and the Job Creation and Worker Assistance Act of
    2002. The Working Families Tax Relief Act of 2004 retroactively suspended
    the 100% net-income limitation through December 31, 2005.  H.R.
    6111extended the suspension of this limitation through 2007.

    	Assessment

    Standard accounting and economic principles state that the appropriate
    method of capital recovery in the mineral industry is cost depletion adjusted
    for inflation. The percentage depletion allowance permits independent oil and
    gas producers, and other mineral producers, to continue to claim a deduction
    even after all the investment costs of acquiring and developing the property
    have been recovered.  Thus it is a mineral production subsidy rather than an
    investment subsidy.

    As a production subsidy, however, percentage depletion is economically
    inefficient. It incorrectly  measures the income of qualifying independent oil
    and gas producers, and it encourages excessive development of existing
    properties - the source of the depletion benefit - over exploration for new
    ones, which will not produce a flow of depletion benefits until actual output
    results. This tax treatment contrasts with capital subsidies, such as accelerated
    depreciation for non-mineral assets. Although accelerated depreciation may
    lower effective tax rates by speeding up tax benefits, these assets cannot be
    used for depreciation deductions in excess of investment.

    Percentage depletion for oil and gas subsidizes independent producers that
    are primarily engaged in exploration and production. To the extent that it
    stimulates oil production, it reduces dependence on imported oil in the short
    run, but it contributes to a faster depletion of the Nation's resources in the
    long run, which may increase long-term oil import dependence. Arguments
    have been made over the years to justify percentage depletion on grounds of
    unusual risks, the distortions in the corporate income tax, national security,
    uniqueness of oil as a commodity, the industry's lack of access to capital, and
    protection of small producers.

    Volatile oil prices make oil and gas investments more risky, but this would
    not necessarily justify percentage depletion or other tax subsidies.  The
    corporate income tax does have efficiency distortions, but from an economic
    perspective income tax integration may be a more appropriate policy to
    address this problem.

    To address national security concerns, one alternative is an oil stockpile
    program such as the Strategic Petroleum Reserve.

    	Selected Bibliography

    Congressional Budget Office. Budget Options. Section 31: Curtail Income
    Tax Preferences for Businesses and Other Entities. February 2001.
    Edmunds, Mark A.  "Economic Justification for Expensing IDC and
    Percentage Depletion Allowance," Oil & Gas Tax Quarterly, v. 36.
    September 1987, pp. 1-11.
    Energy Information Administration.  Accelerated Depletion: Assessing the
    Impact on Domestic Oil and  Natural Gas Prices and Production.
    SR/OIAF/2000-04.  July 2000.
    Fenton, Edmund D.  "Percentage Depletion, RMFP, and the Exxon
    Cases," Oil and Gas Tax Quarterly, v.52.  September 2003, pp. 1-17.
    Frazier, Jessica, and Edmund D. Fenton. "The Interesting Beginnings of
    the Percentage Depletion Allowance," Oil and Gas Tax Quarterly, v. 38.
    June 1990, pp. 697-712.
    Ghiselin, Dick.  "Drilling Economics" Oil and Gas Investor, December
    2005, pp.13-22.
    Gravelle, Jane G. "Effective Federal Tax Rates on Income from New
    Investments in Oil and Gas Extraction," The Energy Journal, v.6.  1985, pp.
    145-153.
    Harberger, Arnold G. Taxation and Welfare. Chicago: Univ. of Chicago
    Press, 1974, pp. 218-226.

    Hennessee, Patrick A. Percentage Depletion - How Natural Gas
    Producers Can Avoid the Retailer Exclusion of 613A.  The Journal of
    Taxation.  July 2005, pp. 39-46.
    Lazzari, Salvatore. Energy Tax Policy: History and Current Issues.
    Library of Congress, Congressional Research Service, CRS Report RL33578.
    Washington, DC: Updated July 28, 2006.
    - .  Energy Tax Policy: An Economic Analysis.  Library of Congress,
    Congressional Research Service, Report RL 30406.  Washington, DC: June
    28, 2005.
    Lucke, Robert, and Eric Toder.  "Assessing the U.S. Federal Tax Burden
    on Oil and Gas Extraction," The Energy Journal, v. 8.  October 1987, pp. 51-
    64.
    Lyon, Andrew B. "The Effect of Changes in the Percentage Depletion
    Allowance on Oil Firm Stock Prices,"  The Energy Journal, v.10. October
    1989, pp.101-116.
    McDonald, Stephen L. Federal Tax Treatment of Income from Oil and
    Gas.   The Brookings Institution, 1963.
    Rook, Lance W. "The Energy Policy Act of 1992 Changes the Effect of
    the AMT on Most Oil Producers," Tax Advisor, v. 24.  August 1993, pp. 479-
    484.
    Thomas, Christopher, Maurice, S. Charles, Crumbley, D. Larry.  Vertical
    Integration, Price Squeezing, and Percentage Depletion Allowance.  The
    Quarterly Review of Economics and Business, v. 29. Winter 1989, pp26-37.
    U.S. General Accounting Office.  Additional Petroleum Production Tax
    Incentives Are of Questionable Merit, GAO/GGD-90-75.  Washington, DC:
    July 1990.
    U.S. Treasury Department. Tax Reform for Fairness, Simplicity, and
    Economic Growth, v. 2.  Washington, DC: November 1984, pp. 229-231.
    U.S. Treasury Department.  Internal Revenue Service.  IRS Audit Guide:
    Oil and Gas Industry, Market Segmentation Specialization Program.  2006.

    	Energy

    	TAX CREDIT FOR
    	PRODUCTION OF NON-CONVENTIONAL FUELS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    1.0

    2.7

    3.7

    2007

    1.0

    3.2

    4.2

    2008

    0.2

    1.2

    1.4

    2009

    (1)

    (1)

    (1)

    2010

    (1)

    (1)

    (1)

    (1) Less than $50 million

    	Authorization

    Section 45K.

    	Description

    Section 45K provides for a production tax credit of $3 per barrel of
    oil-equivalent (in 1979 dollars) for certain types of liquid, gaseous, and solid
    fuels produced from selected types of alternative energy sources (so called
    "non-conventional fuels"), and sold to unrelated parties. The full credit is
    available if oil prices fall below $23.50 per barrel (in 1979 dollars); the credit
    is phased out as oil prices rise above $23.50 (in 1979 dollars) over a $6 range
    (i.e., the inflation-adjusted $23.50 plus $6).  The phase out limit does not
    apply to coke or coke gas.

    Both the credit and the phase-out range are adjusted for inflation
    (multiplied by an inflation adjustment factor) since 1979. With an inflation
    adjustment factor of 2.264  (meaning that inflation, as measured by the Gross
    National Product deflator, has more than doubled since 1979), the credit for
    2005 production was $6.79 per barrel of oil equivalent, which is the amount
    of the qualifying fuel that has a British thermal unit content of 5.8 million.
    The credit for gaseous fuels was $1.23 per thousand cubic feet (mcf).  The
    credit for tight sands gas is not indexed to inflation; it is fixed at the 1979
    level of $3 per barrel of oil equivalent (about $0.50 per mcf). With the
    reference price of oil, which was $50.76/barrel for 2005, still below the
    inflation adjustment phase-out threshold oil price of $53.20 for 2005 ($23.50
    multiplied by 2.264), the full credit of $6.56 per barrel of equivalent was
    available for qualifying fuels.

    Qualifying fuels include synthetic fuels (either liquid, gaseous, or solid)
    produced from coal, and gas produced from either geopressurized brine,
    Devonian shale, tight formations, or biomass. Synthetic fuels from coal, either
    liquid, gaseous, or solid, are also qualifying fuels provided that they meet the
    statutory and regulatory requirement that they undergo a significant chemical
    transformation, defined as a measurable and reproducible change in the
    chemical bonding of the initial components. In most cases, producers apply a
    liquid bonding agent to the coal or coal waste (coal fines), such as diesel fuel
    emulsions, pine tar, or latex, to produce the solid synthetic fuel. The coke
    made from coal and used as a feedstock, or raw material, in steel-making
    operations also qualifies as a synthetic fuel as does the breeze (which are
    small pieces of coke) and the coke gas (which is produced during the coking
    process). Depending on the precise Btu content of these synfuels, the section
    29 tax credit could be as high as $26/ton or more, which is a significant
    fraction of the market price of coal. Qualifying fuels must be produced within
    the United States. The credit for coke and coke gas is also $3/barrel of oil
    equivalent and is also adjusted for inflation, but the credit is set to a base year
    of 2004, making the nominal unadjusted tax credit less than for other fuels.

    The section 45K credit for gas produced from biomass, and synthetic fuels
    produced from coal or lignite,  is available through December 31, 2007,
    provided that the production facility was placed in service before July 1,
    1998, pursuant to a binding contract entered into before January 1, 1997. The
    credit for coke and coke gas is available through December 31, 2009, for
    plants placed in service before January 1, 1992, and after June 30, 1998.  The
    section 45K credit used to apply to oil produced from shale or tar sands, and
    coalbed methane (a colorless and odorless natural gas that permeates coal
    seams and that is virtually identical to conventional natural gas). But for these
    fuels the credit terminated on December 31, 2002 (and the facilities had to
    have been placed in service (or wells drilled) by December 31, 1992).

    The section 45K credit is part of the general business credit. It is not
    claimed separately; it is added together with several other business credits,
    and is also subject to the limitations of that credit. The section 45K credit is
    also offset (or reduced) by other types of government subsidies that a taxpayer
    may benefit from: government grants, subsidized or tax-exempt financing,
    energy investment credits, and the enhanced oil recovery tax credit that may
    be claimed with respect to such project. Finally, the credit is nonrefundable
    and cannot be used to offset a taxpayer's alternative minimum tax liability.
    Any unused section 45K credits generally may not be carried forward or back
    to another taxable year. (However, under the minimum tax section 53, a
    taxpayer receives a credit for prior-year minimum tax liability to the extent
    that a section 45K credit is disallowed as a result of the operation of the
    alternative minimum tax.)

    	Impact

    The production tax credit is intended to reduce the marginal (and average)
    costs of producing the qualifying non-conventional fuels so as to be profitable
    enough to compete with conventional fuels. For those fuels whose cost
    reductions (and increased rates of return) are sufficiently large, the resulting
    price effects could encourage increased production of the subsidized non-
    conventional fuels for the more conventional fuels. To the extent that these
    effects stimulate the supply of fuels such as shale oil or heavy oil, the
    resulting substitution effects lead to a reduction in the demand for petroleum,
    and a reduction in imported petroleum (the marginal source of oil), which
    would work toward the credit's original purpose:  enhancing energy security.

    However, to date, the credits have not stimulated production of fuels, such
    as shale oil or heavy oil, that would substitute for petroleum. These and other
    non-conventional fuels are still generally too costly to be profitably produced.
     With the exception of coalbed methane, tight sands gas, and "synfuels" from
    coal, the credit's effects have, generally, not been sufficient to offset the
    disincentive effects of previously low and unstable oil prices, and the high
    cost of non-conventional fuels mining and production. Recently high crude
    oil prices (over $70/barrel in 2006) might, if they remain high and stable,
    render some of the non-conventional petroleum fuels (such as oil shale and tar
    sands) competitive, which might stimulate production even without a tax
    credit.  However, variable oil prices add to the risk of these and other types of
    energy ventures and investments, and undermine profitability and investments
    in these areas.

    The primary supply effects of the section 45K tax credit have been on non-
    conventional gases, particularly of coalbed methane, tight sands gas, and
    shale gas. The credit has increased drilling for these gases, and added to total
    natural gas reserves.  In the case of coalbed methane, the combined effect of
    the large tax credit (the credit of $1.00 per mcf was, at times, 100% of natural
    gas prices) and declining production costs (due to technological advances in
    drilling and production techniques) has helped boost production from 0.1
    billion cubic feet in 1980 to 1.6 trillion cubic feet in 2003. More recently,
    favorable rulings by the Internal Revenue Service have increased the
    production of solid "synthetic" fuels from coal,  increasing the supply of these
    fuels for use as a feedstock in steel-making operations and in electricity
    generation. The credit for coalbed methane benefits largely oil and gas
    producers, both independent producers and major integrated oil companies,
    and coal companies. Many oil and gas companies, such as DTE Energy,
    Phillips Petroleum, and the Enron Corporation, used section 45K tax credits
    to help reduce their effective tax rates.

    	Rationale

    The original concept for the alternative fuels production tax credit goes
    back to an amendment by Senator Talmadge to H.R. 5263 (95th Congress),
    the Senate's version of the Energy Tax Act of 1978 (P.L. 95-618), one of five
    public laws in President Carter's National Energy Plan.  H.R. 5263 provided
    for a $3.00 per barrel tax credit or equivalent, but only for production of shale
    oil, gas from geopressurized brine, and gas from tight rock formations.

    The final version of the Energy Tax Act did not include the production tax
    credit.  The original concept was resuscitated in 1979 by Senator Talmadge as
    S. 847 and S. 848, which became part of the Crude Oil Windfall Profit Tax
    Act of 1980 (P.L. 96-223).

    The purpose of the credits was to provide incentives for the private sector
    to increase the development of alternative domestic energy resources because
    of concern over oil import dependence and national security.  The United
    States has a large resource base of unconventional energy resources, including
    shale oil and unconventional gases such as tight sands gas and coalbed
    methane. According to the U.S. Geological Survey and the Minerals
    Management Service, estimated U.S. recoverable reserves of unconventional
    gases exceed those of any other category of gas, including estimates of
    conventional reserves, comprising 35% of the total.

    The section 45K credit's "placed-in-service" rule has been amended
    several times in recent years. The original 1980 windfall profit tax law
    established a placed-in-service deadline of December 31, 1989.  This was
    extended by one year to December 31, 1990, by the Technical and
    Miscellaneous Revenue Act of 1988 (P.L. 100-647). That deadline was
    extended to December 31, 1991, as part of OBRA, the Omnibus Budget
    Reconciliation Act of 1990 (P.L.101-508).  The Energy Policy Act of 1992
    (P.L.102-486) extended coverage for facilities for biomass and fuels produced
    from coal  through 1997 and extended the credit on production from these
    facilities through 2007.  The Small Business Jobs Protection Act of 1996
    (P.L. 104-188) further extended the placed-in-service rule by an additional
    eighteen months.  In Rev. Proc. 2001-30 and 2001-34, the Internal Revenue
    Service implemented regulations that permitted greater production of solid
    synthetic fuels from coal to qualify for the section 45K credit. Some have
    questioned the scientific validity of these rules and have christened the
    process "spray and pray."

    The American Jobs Creation Act of 2004 (P.L. 108-357) provided a
    production tax credit for refined coal.  The production tax credit's provisions
    were inserted in section 45 of the tax code, the section that provides a tax
    credit for electricity produced from renewable energy resources.  (A
    discussion of the section 45 tax credit appears elsewhere in the Energy section
    of this compendium.)

    The Energy Policy Act of 2005 (P.L. 109-58) made several amendments to
    the section 45K tax credit. First, the credit's provisions were moved from
    section 29 of the tax code to new 45K. Before this, this credit was
    commonly known as the "section 29 credit." Second, the credit was made
    available for qualified facilities that produce coke or coke gas that were
    placed in service before January 1, 1993, or after June 30, 1998, and before
    January 1, 2010. Coke and coke gas produced and sold during the period
    beginning on the later of January 1, 2006, or the date the facility is placed in
    service, and ending on the date which is four years after such period begins,
    would be eligible for the production credit, but at a reduced rate and only for
    a limited quantity of fuel. The tax credit for coke and coke gas would be
    $3.00/barrel of oil equivalent, but the credit would be indexed for inflation
    starting with a 2004 base year as compared with a 1979 base year for other
    fuels. A facility producing coke or coke gas and receiving a tax credit under
    the previous section 29 rules would not be eligible to claim the credit under
    the new section 45K. The new provision also requires that the amount of
    credit-eligible coke produced not exceed an average barrel-of-oil equivalent
    of 4,000 barrels per day. Third, the 2005 Act provided that, with respect to
    the IRS moratorium on taxpayer-specific guidance concerning the credit, the
    IRS should consider issuing rulings and guidance on an expedited basis to
    those taxpayers who had pending ruling requests at the time that the IRS
    implemented the moratorium. Finally, the 2005 legislation made the general
    business limitations applicable to the tax credit. Any unused credits could be
    carried back one year and forward 20 years, except that the credit could not be
    carried back to a taxable year ending before January 1, 2006.  These new
    rules were made effective for fuel produced and sold after December 31,
    2005, in taxable years ending after such date.

    H.R. 6111 (December 2006) eliminated the phase out limit for coke and
    coke gas, and clarified that petroleum based coke or coke gas does not
    qualify.

    	Assessment

    The section 45K credit has significantly reduced the cost and stimulated
    the supply of unconventional gases - particularly of coalbed methane from
    coal seams not likely to be mined for coal in the foreseeable future, and of
    tight sands gas and shale gas. Due to recently tight natural gas markets and
    relatively high prices, these additional supplies might have kept natural gas
    prices from rising even more.  In general, much of the added gas output has
    substituted for domestic and imported (i.e., Canadian) conventional natural
    gas rather than for imported petroleum, meaning that the credit has basically
    not achieved its underlying energy policy objective of enhancing energy
    security by reducing imported petroleum. More recently, additional supplies
    of domestic unconventional gases may be substituting for imported LNG
    (liquefied natural gas). Declining conventional natural gas production in
    Texas, New Mexico, Oklahoma, Louisiana, and the Gulf of Mexico has been
    partially offset by increases in Colorado and Wyoming, reflecting the growing
    prominence of unconventional sources such as tight sands, shales, and
    coalbeds. Unconventional gas production, currently at nearly 5 trillion cubic
    feet (1/4 of total domestic production), is projected to increase at the fastest
    rate of any other type of natural gas, largely because of expansion of
    unconventional gases from the Rocky Mountain region.

    Economists see little justification for such a credit on grounds of allocative
    efficiency, distributional equity, or macroeconomic stability.  From an
    economic perspective, although tax incentives are generally less distortionary
    than mandates and standards, critics maintain that the section 45K tax credit
    compounds distortions in the energy markets, rather than correcting for
    preexisting distortions due to pollution, oil import dependence, "excessive"
    market risk, and other factors.  Such distortions may be addressed by other
    policies: Pollution and other environmental externalities may be dealt with by
    differential taxes positively related to the external cost; excessive dependence
    on imported petroleum and vulnerability to embargoes and price shocks have
    led to calls for either an oil import tax or a petroleum stockpile such as the
    Strategic Petroleum Reserve.

     The credit has not encouraged the collection of coalbed methane from
    active coal mines, which continues to be vented and which contributes a
    potent greenhouse gas linked to possible global warming.  Hydraulic
    fracturing of coal beds, and other environmental effects from the production
    of coalbed methane and other unconventional gases, is coming under greater
    scrutiny.

    In recent years, much of the benefits of the tax credits has accrued to coal
    producers and users, who spray the coal with a fuel and sell it as a solid
    "synthetic fuel." The coal industry has also benefitted from the expansion of
    the credit to coke and coke gas. Under the original statute and regulations,
    such conversion of coal into a synthetic fuel was premised on a significant
    chemical transformation that would increase the energy content of the
    resulting fuel.

    	Selected Bibliography

    Andrews, Anthony. Oil Shale: History, Incentives, and Policy.  Library of
    Congress. Congressional Research Service Report RL33359, Washington,
    D.C. April 13, 2006.
    Bryner, Gary C. "Coalbed Methane Development: The Costs and Benefits
    of an Emerging Energy Resource."  Natural Resource Journal, v. 43, Spring
    2003. pp. 519-560.
    Clark, Judy. "Geopolitics, Unconventional Fuels to Reshape Industry," Oil
    and Gas Journal, April 25, 2005, pp 44-44
    Crow, Patrick, and A.D. Koen. "Tight Gas Sands Drilling Buoying U.S. E
    & D Activity." Oil and Gas Journal, v. 90.  November 2, 1992, pp. 21-27.
    Fletcher, Sam. "Major U.S. Supply Role Seen for Unconventional Gas,"
    Oil and Gas Journal, December 20, 2004, pp. 32-34.
    Kuuskraa, Vello A., and Charles F. Brandenburg.  "Coalbed Methane
    Sparks New Energy Industry," Oil and Gas Journal, v. 87.  October 9, 1989,
    pp. 49-56.
    Lazzari, Salvatore.   Economic Analysis of the Section 29 Tax Credit for
    Unconventional Fuels, Library of Congress, Congressional Research Service
    Report 97-679 E.  Washington, DC: July 7, 1997.
    -. "Energy Taxation: Subsidies for Biomass," Encyclopedia of Energy
    Technology and the Environment, John Wiley & Sons, 1995, pp. 1238-1245.
    -. Energy Tax Policy: History and Current Issues. Library of Congress,
    Congressional Research Service Report RL33578, Washington, D.C. July 28,
    2006.
    _.  Energy Tax Policy: An Economic Analysis.  Library of Congress,
    Congressional Research Service Report RL 30406.  Washington, DC: June
    28, 2005.
    Lemons, Bruce N. and Larry Nemirow. "Maximizing the Section 29 Credit
    in Coal Seam Methane Transactions," The Journal of Taxation.  April 1989,
    pp. 238-245.
    Matlock, Judith M. and Laurence E. Nemirow.  "Section 29 Credits: The
    Case Against Requiring an NGPA Well-Category Determination," Journal of
    Taxation, v. 85.  August 1996, pp. 102-107.
    McIntire Robert, and T.D. Coo Nguyen. Corporate Income Taxes in the
    1990s. Citizens for Tax Justice. October 2000.
    McKinnon, John D. "Washington Alchemy Turns Coal Products Into Big
    Tax Credits."  The Wall Street Journal, v. 238, July 12, 2001.
    Morgan, Dan. "Coal State Senators Question Tax Audits: IRS Reviews
    Use of Synthetic Fuel Credits." The Washington Post, September 13, 2003. p.
    A-3.
    Schraufnagel, D. G. Hill and R. A. McBane.  Coalbed Methane: A Decade
    of Success.  Paper Presented at the Conference of the Society of Petroleum
    Engineers. 1994.
    Wills, Irene Y, and Norman A. Sunderman. "Section 29 Tax Credit Still
    Available," Oil and Gas Tax Quarterly, v. 40. December 1991.

    	Energy

    	TAX CREDITS FOR ALCOHOL AND BIODIESEL FUELS

    Estimated Revenue Loss*

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

     -

    (1)

    (1)

    2007

     -

    0.1

    0.1

    2008

     -

    0.1

    0.1

    2009

     -

    (1)

    (1)

    2010

     -

    (1)

    (1)

    * The figures exclude the revenue loss from the equivalent excise tax
    credit.  The JCT estimates that the credits result in a reduction in excise tax
    receipts, net of income tax effect, of $11.15 billion over the FY2006-2010
    period.
    (1)Less than $50 million.

    	Authorization

    Section 38, 40, 40A, 87, 196, 6426.

    	Description

    There are three income tax credits for alcohol-based motor fuels: the
    alcohol mixtures credit, the pure alcohol fuel credit, and the small ethanol
    producer credit.  The existing alcohol mixture (or blender's) credit and the
    pure alcohol fuel credit is 51� per gallon of ethanol (60� for methanol) of at
    least 190 proof, and 37.78� for each gallon of alcohol between 150 and 190
    proof (45�  for methanol).  No credit is available for alcohol that is less than
    150 proof. The 51� credit was reduced from 52� on January 1, 2005. The
    alcohol mixtures credit is available to the blender (who typically is either the
    refiner, wholesale distributor or marketer); the pure (or "neat") alcohol credit
    may only be claimed by the consumer or retail seller.

    The alcohol fuels mixtures tax credit is typically claimed as an instant
    excise tax credit that is equivalent to the excise tax exemption, and which
    may be claimed in lieu of the income tax credits. For 90/10 mixtures (90%
    gasoline, 10% ethanol) the excise tax credit is 5.1� per gallon of the blend -
    the blend is taxed at 13.3� per gallon, 5.1� less than the full rate of 18.4� per
    gallon on gasoline blends. The current 5.1� credit, which is equivalent to 51�
    per gallon of ethanol, is generally claimed up front on sales of gasoline loaded
    onto tanker trucks. Blenders prefer to claim the excise tax credit, rather than
    the income tax credit, because its benefits accrue immediately upon the
    purchase of the fuels for blending rather than when the tax return is filed.
    Also, the excise tax credit is not treated as taxable income, whereas the
    income tax credits have to be reported as taxable  income, and are thus taxed.
     Before January 1, 2005, the primary tax subsidy for alcohol fuel
    blends was an excise tax exemption (at the rate of 5.2�/gallon of
    blended fuels (mixtures of 10% ethanol, and 90% gasoline). This
    exemption was taken against the excise taxes otherwise due on each
    gallon of blended mixtures. This exemption, which was scheduled to
    decline to 5.1� on January 1, 2005, reduced the gasoline excise tax
    for "gasohol," from 18.4� to 13.2�/gallon. Because the primary benefits
    from alcohol fuels were realized through an exemption rather than a tax
    credit, revenue losses (or reduced excise taxes) accrued to the Highway Trust
    Fund (HTF) rather than the general fund.

    For fuel ethanol, current law also provides for a production tax credit in
    the amount of 10� per gallon of ethanol produced and sold for use as a
    transportation fuel. This credit, called the "small ethanol producer credit," is
    limited to the first 15 million gallons of annual alcohol production for each
    small producer, defined as one with an annual production capacity of under
    60 million gallons.  This is in addition to any blender's tax credit claimed on
    the same fuel.  The small ethanol producer's tax credit currently flows
    through to the members of a farmers' cooperative, which means that the
    current system of ethanol incentives effectively is of no benefit to such
    cooperatives.

    A 1990 IRS ruling allowed mixtures of gasoline and ETBE (Ethyl Tertiary
    Butyl Ether) to qualify for the 52� blender's credit. ETBE is a compound that
    results from a chemical reaction between ethanol (which must be produced
    from renewables under this ruling) and isobutylene.  ETBE is technically
    feasible as a substitute for ethanol or MTBE (Methyl Tertiary Butyl Ether) as
    a source of oxygen in gasoline regulated under the Clean Air Act (CAA).  Up
    until recently, MTBE was the preferred oxygenate, although ethanol was also
    used in some regions of the United States, particularly in the Midwest. MTBE
    has, however, been linked to groundwater contamination and has been banned
    in many states.  The Energy Policy Act of 2005  (P.L. 109-58) repealed the
    oxygenate requirement for reformulated gasoline and imposed a renewable
    fuel standard, which effectively stimulates the use of ethanol in place of
    MTBE as a fuel additive.

    The alcohol fuels income tax credits must be included as income, and are
    taxable, under IRC 87.  Also, the alcohol credits are components of the
    general business credit and are subject to the limitations and the carry-back
    and carry-forward rules of that credit. Under tax code section 196, any credit
    amount that is unused because of these limitations may be claimed as a
    deduction in the subsequent tax year.

    For biodiesel fuel, the structure of the tax subsidies is similar to those for
    fuel ethanol, although very little of these blends is actually produced.  There
    are essentially three  new tax credits: a credit for biodiesel fuel mixtures
    (blends of biodiesel and petroleum diesel), a credit for unblended (pure)
    biodiesel either used or sold at retail by the taxpayer, and a small biodiesel
    producer credit. The biodiesel mixtures credit and pure biodiesel credit is 50�
    per gallon of biodiesel made from recycled oils and $1.00 per gallon of
    biodiesel made from virgin oils - so called "agri"-biodiesel. The mixtures
    tax credit may also be claimed as an instant excise tax credit against the 24.4�
    per gallon tax on diesel blends. The mixtures credit is proportionate to the
    fraction of biodiesel in the mixture- a blend of 80% diesel with 20% virgin
    biodiesel would qualify for a 20�/gallon tax credit against the 24.4� tax.

    Also, effective on August 9, 2005, an "eligible small agri-biodiesel
    producer credit" of  10� is available for each gallon of "qualified
    agri-biodiesel production." An eligible "small agri-biodiesel producer" is
    defined as any person who, at all times during the taxable year, has annual
    productive capacity for agri-biodiesel not in excess of 60,000,000 gallons.
    The term "qualified agri-biodiesel production" would be defined as any
    agri-biodiesel, not to exceed 15,000,000 gallons, that: (1) the producer sells
    during the taxable year for use by the purchaser (a) in the production of a
    qualified biodiesel mixture in the purchaser's trade or business, (b) as a fuel in
    a trade or business, or (c) for sale at retail to another person who places the
    agri-biodiesel in that person's fuel tank; or (2) the producer uses or sells for
    any of such purposes. Aggregation rules are provided for determining the
    15,000,000 and 60,000,000 gallon limits, for applying the limits to
    passthrough entities, and for allocating productive capacity among multiple
    persons with interests in one facility, and authorize anti-abuse regulations.
    The section also permits IRC 1381(a) cooperative organizations to elect to
    apportion the eligible small agri-biodiesel producer credit among their
    patrons, and would set forth the election procedure. The eligible small
    agri-biodiesel producer credit is effective for taxable years ending after
    August 8, 2005 and sunsets after December 31, 2008.

    Thus, as of January 1, 2005, the reduced rates of excise taxes (i.e., the
    exemptions) for alcohol-blended fuels that were the principal tax incentives
    are repealed. Blenders instead will pay the full rate of tax on gasoline and
    diesel purchases (18.4� and 24.4�, respectively) - and claim the respective
    tax credits on each gallon of ethanol and biodiesel intended to be blended
    with gasoline and petroleum diesel, respectively.  Taxpayers are to file a claim
    for a refund of these tax credits, which must be paid by the IRS within 45
    days, after which interest begins to accrue. Both the restructured fuel ethanol
    tax credits and the new biodiesel tax credits are part of the general business
    credit and subject to its limits. The provisions restructuring the tax incentives
    for fuel ethanol and introducing the biodiesel tax credits are effective for fuel
    produced, sold, or used after December 31, 2004, and before January 1, 2011,
    for both biodiesel and fuel ethanol. This means that the biodiesel tax credits
    and the fuel ethanol blender's tax credits expire on these dates, respectively.

    In all cases, the alcohol fuels tax credits apply to biomass ethanol (alcohol
    from renewable resources such as vegetative matter), and to methanol derived
    from biomass, including wood.  Alcohol derived from petroleum, natural gas,
    or coal (including peat) does not qualify for either the current (or the
    restructured) tax credits or the current exemption. Most economically feasible
    methanol is derived primarily from natural gas; methanol from renewable
    resources is generally too costly to produce economically.  The effect of this
    is to exclude most of actual methanol production from the tax incentives.
    However, methanol derived from methane gas produced from landfills is not
    alcohol produced from natural gas, and is included for credit purposes.  About
    90% of current biomass ethanol production is derived from corn.   Most
    biodiesel is made from either recycled or virgin vegetable oil, but biodiesel
    made from animal fats also qualifies for the biodiesel tax credits.  Agri-
    biodiesel is derived from virgin oils including esters derived from corn,
    soybeans, sunflower seeds, and other agricultural products.

    	Impact

    The fuel ethanol tax subsidies increase the demand for ethanol, which
    further raises its price (on a before-tax basis) and increases the output of
    ethanol. After taxes, however, the net price of ethanol to the blender is
    comparable to the wholesale price of gasoline and to other blending
    components. Thus, the effect of the subsidies is to create a market for ethanol
    producers, such as Archer Daniels Midland, who supply the ethanol to the
    blenders. It should be noted that although ethanol producers do not claim the
    tax credits, the economic benefit of the subsidies accrues primarily to them.
    Most of the alcohol fuel produced in the United States is ethanol; about 90%
    of it is produced from corn, which is the cheapest feedstock..

    Production of ethanol as a motor fuel, most of which is a gasoline blend,
    has increased from about 40 million gallons in 1979 to 1.7 billion gallons in
    2001, 2.8 billion gallons in 2003, and 3.9 billion gallons in 2005. Ethanol
    production for 2006 is estimated to reach 5 billion gallons. This represents
    about 3.0% of the gasoline consumption of about 140 billion gallons, but at
    10% blends, ethanol is now used in a significant fraction of the total gasoline
    market (currently about 30% of the gasoline sold in the United States contains
    10% ethanol). The initial growth in ethanol production was mostly due to the
    federal excise tax exemption, the excise tax exemptions at the state and local
    level, tariffs on imported ethanol, and the high oil prices in the late 1970s and
    early 1980s, rather than to the alcohol fuels tax credits, which have been little
    used. More recently environmental policy - Clean Air Act requirements for
    reformulated and oxygenated fuels, the widespread banning of MTBE, and
    the establishment of a renewable fuels standard - have also increased
    demand for fuel ethanol.  In addition to the various tax and regulatory
    subsidies for fuel ethanol, the Energy Policy Act of 2005 also established a
    mandate (the "renewable fuels standard") for refiners to use ethanol in certain
    proportions in place of other oxygenates such as MTBE. The standard for
    2006 is 4.0 billion gallons of ethanol, increasing to 7.5 billion gallons in
    2012.

    The banning of MTBE by many states and the repeal of the Clean Air
    Act's oxygenate requirement, and the renewable fuels standard are projected
    to further stimulate the production of ethanol for use as an oxygen source for
    reformulated gasoline, and thus to reduce the production and importation of
    alternate oxygen sources. As this occurs, it will increase the share of the U.S.
    corn crop allocated to ethanol production  (13% in 2004). It is expected also
    to increase federal revenue losses from the alcohol fuels credits, which
    heretofore have been negligible due to blenders' use of the exemption over
    the credit.

    Under the modified tax incentives, the ethanol blender's tax credits against
    the excise tax are roughly equivalent to the value of the excise tax exemption
    on each gallon of ethanol, but the tax restrictions under the general business
    credit, and the inclusion of the credit itself in income, will reduce the
    economic value of the tax credits. For biodiesel, however, which had no tax
    subsidies prior to the restructuring, the new tax credits are potentially of
    significant economic benefit, even with the requirement that they be taxable
    income.

    	Rationale

    The alcohol fuels tax credits enacted in 1980 were intended to complement
    the excise-tax exemptions for alcohol fuels enacted in 1978. These
    exemptions provided the maximum tax benefit when the gasohol mixture was
    90% gasoline and 10% alcohol. Subsequent tax law changes provided a
    prorated exemption to blends of 7.7% and 5.7% alcohol, so that ethanol used
    to meet the former CAA requirement for reformulated and the continuing
    requirement for oxygenated gasoline receives the maximum tax benefit.
    Under the restructured incentives and the mandate, these prorated exemptions
    will no longer be used.

    The Congress wanted the credits to provide incentives for the production
    and use of alcohol fuels in mixtures that contained less than 10% alcohol. The
    Congress also wanted to give tax-exempt users (such as farmers) an incentive
    to use alcohol fuel mixtures instead of tax-exempt gasoline and diesel.
    Ethanol-blended gasoline leads to greater reductions in carbon monoxide than
    does MTBE-blended gasoline.  Ethanol-blended gasoline, however, has
    relatively higher evaporative emissions, as compared with reformulated
    gasoline with MTBE, which cause increases in the ozone-forming potential of
    volatile organic compounds, which leads to increased ozone (smog)
    formation.

    Both the credits and excise-tax exemptions were enacted to encourage the
    substitution of alcohol fuels produced from renewables for petroleum-based
    gasoline and diesel. The underlying policy objective is, as with many other
    energy tax incentives, to reduce reliance on imported petroleum. In addition,
    the Congress wanted to help support farm incomes by finding another market
    for corn, sugar, and other agricultural products that are the basic raw materials
    for alcohol production. About 1.6 billion bushels of corn were used in 2005 to
    produce fuel ethanol, over 15% of the total corn crop. The increased demand
    for corn will raise the price of all corn and may increase annual income from
    corn farming by $5 billion or more. The rationale for the biodiesel tax credits
    is to provide tax incentives to create an environmentally friendly substitute for
    conventional diesel fuel, while also creating additional markets for farm
    products.

    The alcohol fuels mixture credit and the pure alcohol fuels credit were
    enacted as part of the Crude Oil Windfall Profit Tax Act of 1980 (P.L. 96-
    223), at the rate of 40� per gallon for alcohol that was 190 proof or more, and
    30� per gallon for alcohol between 150 and 190 proof. The credits were
    increased in 1982 and 1984. The Omnibus Reconciliation Act of 1990 (P.L.
    101-508) reduced the credits to 54� and 40� and introduced the 10� per-
    gallon small ethanol producer credit. The Transportation Equity Act for the
    21st Century (P.L. 105-178) reduced the blender's tax credit from 54� to its
    current rate of 52�, and to 51� beginning in 2005.

    The American Jobs Creation Act of 2004 (P.L. 108-357) reformed the tax
    incentives for fuel ethanol, by, in effect, treating the tax credits as if they were
    payments of excise tax liability. The rationale for the restructuring was to
    increase revenues for the Highway Trust Fund (HTF). Consumption of fuel
    ethanol blends results in revenue losses to the HTF in the amount of the 5.2�
    exemption times the quantity of fuel ethanol blends used. In addition, under
    tax code sections enacted in 1990, 2.5� of the taxable portion of the tax (the
    13.2� for 90/10 fuel ethanol blends) was retained in the general fund.  Thus,
    in total, the HTF lost, under previous law, 7.7�/gallon of fuel ethanol blends
    (5.2� plus 2.5�).  Under the restructured incentives, tax revenue losses accrue
    to the general fund, rather than the HTF. The American Jobs Creation Act of
    2004 also introduced the biodiesel fuel tax credits, and allowed, for the first
    time, the small ethanol producer's tax credit to flow through to members of a
    farmers' cooperative.

    The Energy Policy Act of 2005 made several amendments to the tax
    subsidies for ethanol and biodiesel fuels. First, it raised the maximum annual
    alcohol production capacity for an eligible small ethanol producer from 30
    million gallons to 60 million gallons. The provision also modified the election
    by a cooperative to allocate the credit to its patrons by conditioning the
    validity of the election on the cooperative's mailing a written notice of the
    allocation to its patrons during the period beginning on the first day of the
    taxable year covered by the election and ending with the fifteenth day of the
    ninth month following the close of that taxable year. Second, the Energy
    Policy Act of 2005 added the 10�/gallon "eligible small agri-biodiesel
    producer credit" to the list of credits that comprise the biodiesel fuels credit.
    The Energy Policy Act also permitted cooperative organizations to elect to
    apportion the eligible small agri-biodiesel producer credit among their
    patrons, and set forth the election procedure.  Another provision extended the
    existing income tax credit, excise tax credit, and payment incentives for
    biodiesel (which were enacted in 2004 under the "Jobs Bill") through
    December 31, 2010.

    	Assessment

    The alcohol fuels tax credits were enacted as part of President Carter's
    National Energy Program to increase the development and use of a domestic
    renewable fuel as a substitute for imported petroleum motor fuels, which
    account for the bulk of petroleum consumption and imports.  The subsidies
    lower the cost of producing and marketing ethanol fuels that would otherwise
    not be competitive. They target one specific alternative fuel over many others
    - such as methanol, liquefied petroleum gas, compressed natural gas, or
    electricity - that could theoretically substitute for gasoline and diesel.
    Alcohol fuel is a more costly fuel or fuel additive, as compared with
    alternatives such as MTBE, especially when total resource costs, including
    revenue losses, are factored in.  Alcohol fuels also require substantial energy
    to produce, thereby diminishing the net overall conservation effect.

    These incentives originated as energy security measures - reducing
    dependence on petroleum imports - but their effect in expanding farm
    incomes (due to the increase in corn demand, and a higher corn price for all
    corn output) has not been overlooked by policymakers. To the extent that the
    credits induce a substitution of domestically produced ethanol for petroleum-
    based motor fuels, they reduce petroleum imports and provide some
    environmental gains, although not necessarily more than other alternative
    fuels. So far, it is the excise tax exemptions, rather than the blender's credits,
    that have provided these stimulative effects.

    At 51� per gallon of alcohol, the ethanol subsidy is approximately $22 per
    barrel of oil displaced (43% of the average domestic oil price of $51 in 2005);
    at $1.00/gallon of virgin biodiesel, the biodiesel subsidy is $42/barrel of
    displaced oil (82% of the 2005 crude price).  Tax subsidies are generally an
    inefficient way of dealing with energy security or environmental concerns,
    and this is also the case with the alcohol and biodiesel fuels tax subsidies,
    which do not directly address the external costs of petroleum motor fuels
    production, use, and importation. Providing tax subsidies for one type of fuel
    over others could further distort market decisions and engender an inefficient
    allocation of resources, even if doing so produces some energy security and
    environmental benefits.

    With a renewable fuels standard the tax credits no longer become
    incentives for demand and production, but increase profits for ethanol
    producers and farmers, raise costs for refiners (as ethanol prices increase), and
    increase fuel prices for consumers.  This leads to not just substantial losses in
    federal tax revenue, but additional economic distortions in fuels and
    agricultural markets.

    	Selected Bibliography

    Congressional Budget Office. Budget Options. Section 31: Curtail Income
    Tax Preferences for Businesses and Other Entities. February 2001.
    Consumer Reports.  The Ethanol Myth. Consumers Union of U.S., Inc.
    October 2006.
    Downstream Alternatives, Inc. Infrastructure Requirements for an
    Expanded Fuel Ethanol Industry.  January 15, 2002.
    Evans, Michael K.  Economic Impact of the Demand for Ethanol.
    Midwestern Governors' Conference.  February 1997.
    Fischer, Carolyn and Michael Toman. Environmentally and Economically
    Damaging Subsidies: Concepts and Illustrations  (Climate Issue Brief #14).
    Resources for the Future, 2000.
    Kane, Sally, John Reilly, Michael LeBlanc, and James Hrubovcak.
    "Ethanol's Role: An Economic Assessment," Agribusiness, v. 5. September
    1989, pp. 505-522.
    Lareau, Thomas J. "The Economics of Alternative Fuel Use: Substituting
    Methanol for Gasoline."  Contemporary Policy Issues, v. 8. October 1990,
    pp. 138-155.
    Lazzari, Salvatore. Alcohol Fuels Tax Incentives. Library of Congress,
    Congressional Research Service Report RL 32979.  Washington, DC: July 6,
    2005.
    Lazzari, Salvatore. Energy Tax Policy: An Economic Analysis. Library of
    Congress, Congressional Research Service Report RL 30406.  Washington,
    DC: June 28, 2005.
    The Renewable Fuels Association.  Industry Outlook: 2006. February
    2006.
    U.S. Congress. House. Committee on Ways and Means. Certain Tax and
    Trade Alcohol Fuel Initiatives, Hearing, 101st Congress, 2nd session.
    Washington, DC: U.S. Government Printing Office, February 1, 1990.

    -. Joint Committee on Taxation.  General Explanation of the Crude Oil
    Windfall Profit Tax Act of 1980 (H.R. 3919, P.L. 96-233), 96th Congress,
    2nd session.  Washington, DC: U.S. Government Printing Office.
    U.S. Department of Energy. Breaking the Biological Barriers to Cellulosic
    Ethanol: A Joint Research Agenda.  DOE/SC-0095. June 2006.
    U.S. General Accounting Office. Effects of the Alcohol Fuels Tax
    Incentives, GAO/GGD-97-41.  March 6, 1997.
    Womach, Jasper, and Brent Yacobucci.  Fuel Ethanol: Background and
    Public Policy Issues.  Library of Congress, Congressional Research Service
    Report RL30369, Washington, DC: October 19, 2006.
    Yacobucci, Brent. Biofuels Incentives: A Summary of Federal Programs.
    Library of Congress, Congressional Research Service Report RL33572,
    Washington, DC: July 25, 2006.
    Yacobucci, Brent. "Boutique Fuels" and Reformulated Gasolines:
    Harmonization of Fuel Standards. Library of Congress, Congressional
    Research Service Report RL31361, Washington, DC: May 10, 2006.

    Energy

    EXCLUSION OF INTEREST ON STATE AND LOCAL
    GOVERNMENT QUALIFIED PRIVATE ACTIVITY BONDS
    FOR ENERGY PRODUCTION FACILITIES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.1

    (1)

    0.1

    2007

    0.1

    (1)

    0.1

     2008

    0.1

    (1)

    0.1

    2009

    0.1

    (1)

    0.1

    2010

    0.1

    (1)

    0.1

    (1) Less than $50 million.

    	Authorization

    Sections 103, 141, 142, and 146.

    	Description

    Interest income on State and local bonds used to finance the construction
    of certain energy facilities for a city and one contiguous county or two
    contiguous counties, is tax exempt.  These energy facility bonds are classified
    as private-activity bonds, rather than as governmental bonds, because a
    substantial portion of their benefits accrues to individuals or business rather
    than to the general public.  For more discussion of the distinction between
    governmental bonds and private-activity bonds, see the entry under General
    Purpose Public Assistance: Exclusion of Interest on Public Purpose State
    and Local Debt.

    These bonds may be issued to finance the construction of hydroelectric
    generating facilities at dam sites constructed before March 18, 1979, or at
    sites without dams that require no impoundment of water.  Bonds may also be
    issued to finance solid waste disposal facilities that produce electric energy.
    These exempt facility bonds generally are subject to the State private-activity
    bond annual volume cap.  Bonds issued for government-owned solid waste
    disposal facilities, a different category of private activity bond, are not,
    however, subject to the volume cap.

    	Impact

    Since interest on the bonds is tax exempt, purchasers are willing to accept
    lower before-tax rates of interest than on taxable securities.  These low
    interest rates enable issuers to provide the services of local energy facilities at
    lower cost.

    Some of the benefits of the tax exemption also flow to bondholders.  For a
    discussion of the factors that determine the shares of benefits going to
    bondholders and users of the energy facilities, and estimates of the
    distribution of tax-exempt interest income by income class, see the "Impact"
    discussion under General Purpose Public Assistance: Exclusion of Interest on
    Public Purpose State and Local Debt.

    	Rationale

    The Crude Oil Windfall Profits Tax Act of 1980 used tax credits to
    encourage the private sector to invest in renewable energy sources.  Because
    State and local governments pay no Federal income tax, Congress in this Act
    authorized governmental entities to use tax-exempt bonds to reduce the cost
    of investing in hydroelectric generating facilities.  The portion of the facility
    eligible for tax-exempt financing ranged from 100 percent for 25-megawatt
    facilities to zero percent for 125-megawatt facilities.

    The definition of solid waste plants eligible for tax-exempt financing was
    expanded by the 1980 Act because the Treasury regulations then existing
    denied such financing to many of the most technologically efficient methods
    of converting waste to energy.  This expansion of eligibility included plants
    that generated steam or produced alcohol.  Tax exemption for steam
    generation and alcohol production facilities bonds were eliminated by the
    1986 Tax Act.

    	Assessment

    Any decision about changing the status of these two eligible private
    activities would likely consider the Nation's need for renewable energy
    sources to replace fossil fuels, and the importance of solid waste disposal in
    contributing to environmental goals.

    Even if a case can be made for a Federal subsidy of energy production
    facilities based on  underinvestment at the State and local level, it is important
    to recognize the potential costs.  As one of many categories of tax-exempt
    private-activity bonds, those issued for energy production facilities increase
    the financing cost of bonds issued for other public capital.  With a greater
    supply of public bonds, the interest rate on the bonds necessarily increases to
    lure investors.  In addition, expanding the availability of tax-exempt bonds
    increases the range of assets available to individuals and corporations to
    shelter their income from taxation.

    	Selected Bibliography

    Maguire, Steven.  Private Activity Bonds: An Introduction.  Library of
    Congress, Congressional Research Service Report RL31457.  June 9, 2006.
    -.  Tax-Exempt Bonds: A Description of State and Local Government
    Debt.  Library of Congress, Congressional Research Service Report
    RL30638.  March 10, 2006.
    U.S. Congress,  Joint Committee on Taxation, Present Law and
    Background Related to State and Local Government Bonds, Joint Committee
    Print JCX-14-06, March 16, 2006.
    U.S. Congress, Joint Committee on Internal Revenue Taxation.  General
    Explanation of the Crude Oil Windfall Profits Tax Act of 1980.  96th
    Congress, 2nd session, 1980.
    U.S. Department of Treasury,  Internal Revenue Service.  Tax-Exempt
    Private Activity Bonds, Publication 4078, June 2004.
    Zimmerman, Dennis.  Electricity Restructuring and Tax-Exempt Bonds:
    Economic Analysis of Legislative Proposals, Library of Congress,
    Congressional Research Service Report RL30411.
    -.  The Private Use of Tax-Exempt Bonds: Controlling Public Subsidy of
    Private Activity.  Washington, DC: The Urban Institute Press, 1991.

    Energy

    EXCLUSION OF ENERGY CONSERVATION SUBSIDIES
    PROVIDED BY PUBLIC UTILITIES

    Estimated Revenue Loss

     [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    (1)

    -

    (1)

    2007

    (1)

    -

    (1)

     2008

    (1)

    -

    (1)

    2009

    (1)

    -

    (1)

    2010

    (1)

    -

    (1)

    (1)Less than $50 million.

    	Authorization

    Section 136.

    	Description

    Gross income does not include the value of any subsidy provided (directly
    or indirectly) by a public utility to a customer for the purchase or installation
    of any energy conservation measure. An energy conservation measure is any
    installation or modification primarily designed to reduce consumption of
    electricity or natural gas or to improve the management of energy demand
    with respect to a dwelling unit.  To the extent that an energy conservation
    expenditure by a taxpayer qualifies for this exclusion, tax law denies any
    other tax benefits on the same expenditure, and requires a reduction in the
    adjusted basis of the property to which the energy conservation devices were
    added.

    Impact

    The exclusion reduces the total cost of energy-efficiency devices provided
    under programs by utilities to conserve energy, since, absent such provisions,
    the value of the rebates or other incentives provided by the utility would be
    included in the customer's gross income and subject to tax.  Depending on the
    marginal tax rate of the customer, the tax saving could be as much as one-
    third the value of the subsidy. While beneficiaries will be primarily residential
    customers, the exclusion applies to dwelling units and so could also be
    claimed by businesses that own condominiums or apartments, for example.

    	Rationale

    An exclusion for residential customers had originally been enacted as part
    of the National Energy Conservation Policy Act of 1978 (P.L. 95-619). This
    exclusion was amended by Title V of the Energy Security Act of 1980 (P.L.
    96-294), but had expired in mid-1989. The current provision was adopted as
    part of the Energy Policy Act of 1992 (P.L. 102-486), to encourage residential
    and business customers of public utilities to participate in energy conservation
    programs sponsored by the utility. The goal was to enhance the energy
    efficiency of dwelling units and encourage energy conservation in residential
    and commercial buildings. The Small Business Job Protection Act of 1996
    (P.L. 104-188) repealed the partial exclusion with respect to business
    property, effective on January 1, 1997, unless pursuant to a binding contract
    in effect on September 13, 1995. In addition, the 1996 amendments dropped a
    part of section 136 that allowed the exclusion to apply to industrial energy
    conservation devices and technologies.

    Assessment

    Utilities sometimes use rebates and other incentives to induce their
    customers to invest in more energy efficient heating and cooling equipment,
    and other energy-saving devices. Such a program might be justified on the
    grounds of conservation, if consumption of energy resulted in negative effects
    on society, such as pollution. In general, however, it would be more efficient
    to directly tax energy fuels than to subsidize a particular method of achieving
    conservation.  From an economic perspective, allowing special tax benefits
    for certain types of investment or consumption results in a misallocation of
    resources.

    There may be a market failure in tenant-occupied homes, if the tenant pays
    for electricity separately.  In rental housing, the tenant and the landlord lack
    strong financial incentives to invest in energy conservation equipment and
    materials, even when the benefits clearly outweigh the costs, because the
    benefits from such conservation may not entirely accrue to the party
    undertaking the energy-saving expenditure and effort.  Builders and buyers
    may also lack sufficient information, a problem which is discussed below.

    As a general rule, tenants are not going to improve the energy efficiency of
    a residence that does not belong to them, even if the unit is metered.  They
    might if the rate of return (or payback) is sufficiently large, but most tenants
    do not occupy rental housing long enough to reap the full benefits of the
    energy conservation investments. Part of the problem is also that it is not
    always easy to calculate the energy savings potential (hence rates of return)
    from the various retrofitting investments. Landlords may not be able to
    control the energy consumption habits of renters to sufficiently recover the
    full cost of the energy conservation expenditures, regardless of whether the
    units are individually metered. If the units are individually metered, then the
    landlord would not undertake such investments since all the benefits
    therefrom would accrue to the renters, unless a landlord could charge higher
    rents on apartments with lower utility costs.  If the units are not individually
    metered, but under centralized control, the benefits of conservation measures
    may accrue largely to the landlord, but even here the tenants may have
    sufficient control over energy use to subvert the accrual of any gains to the
    landlord.  In such cases, from the landlord's perspective, it may be easier and
    cheaper to forgo the conservation investments and simply pass on energy
    costs as part of the rents.  Individual metering can be quite costly,  and while
    it may reduce some of the distortions, it is not likely to completely eliminate
    them, because even if the landlord can charge higher rents, he may not be able
    to recover the costs of energy conservation efforts or investments.

    These market failures may lead to underinvestment in conservation
    measures in rental housing and provide the economic rationale for Internal
    Revenue Code (IRC) 136.  Without such explicit exclusion, such subsidies
    would be treated as gross income and subject to tax.  This exclusion,
    however, applies both to owner-occupied and to rental housing.

    	Selected Bibliography

    Bird, Bruce, Steven M. Platau, and Warren A. Beatty.  "Excluding Utility
    Rebates from Gross Income." The CPA Journal, v. 63, March 1993.
    Brown, Marilyn  "Market Failures and Barriers as a Basis for Clean
    Energy Policies," Energy Policy, v. 29.  November 2001, pp. 1197-1207.
    Fisher, Anthony C., and Michael H. Rothkopf.  "Market Failure and
    Energy Policy: A Rationale for Selective Conservation," Energy Policy, v. 17.
     August 1989, pp. 397-406.
    Hahn, Robert W. "Energy Conservation: An Economic Perspective."
    American Enterprise Institute, October 2005.
    Hassett, Kevin A., and Gilbert E. Metcalf.  "Energy Conservation
    Investment: Do Consumers Discount the Future Correctly?"  Energy Policy,
    v. 21.  June 1993, pp. 710-716.

    Howarth, Richard B. and Bo Anderson.  "Market Barriers to Energy
    Efficiency." Energy Economics, October, 1993. pp. 262-292.
    Lazzari, Salvatore.  Energy Tax Policy: History and Current Issues.
    Library of Congress, Congressional Research Service Report RL33578.
    Washington, DC: July 28, 2006.
    _. Energy Tax Policy: An Economic Analysis.  Library of Congress,
    Congressional Research Service Report RL 30406.  Washington, DC: June
    28, 2005.
    _. Energy Tax Provisions in the Energy Policy Act of 1992. Library of
    Congress, Congressional Research Service Report 94-525. Washington, DC:
    June 22, 1994.
    Loskamp, Wendy. Energy, Water Efficiencies and Savings Come From
    Meter Data Management.  Energy Pulse.  Insight Analysis and Commentary
    on the Global Power Industry.  http\www.energypulse.net.
    Pauley, Patricia, et al. "The Energy Policy Act of 1992: Provisions
    Affecting Individuals." Taxes, February, 1993, pp. 91-96.
    Metcalf, Gilbert E.  "Economics and Rational Conservation Policy."
    Energy Policy, v. 22.  October 1994, pp. 819-825.
    Sutherland, Ronald J.  "Energy Efficiency or the Efficient Use of Energy
    Resources."  Energy Sources, v. 16, pp. 257-268.
    Sutherland, Ronald J.  "The Economics of Energy Conservation Policy."
    Energy Policy, v. 24.  April 1996, pp. 361-370.
    U.S. Congress, House. Report to Accompany H.R. 776, the Comprehensive
    Energy Policy Act.  Washington, DC: U.S. Government Printing Office,
    Report 102-474, Part 6,  pp. 35-37.
    -. House. Committee on Energy and Commerce.  National Energy Policy:
    Conservation and Energy Efficiency. Hearings Before the Subcommittee on
    Energy and Air Quality. Washington, DC: U.S. Government Printing Office,
    June 22, 2001.
    U.S. Department of Energy. Lawrence Berkeley National Laboratory.
    "Energy Efficiency, Market Failures, and Government Policy."  Levine, Mark
    D. et al.  March 1994.

    Energy

    TAX CREDIT FOR INVESTMENTS
    IN SOLAR, GEOTHERMAL, FUEL CELLS, AND
    MICROTURBINES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    (1)

    (1)

    (1)

    2007

    (1)

    0.1

    0.1

    2008

    (1)

     (1)

    (1)

    2009

    (1)

    (1)

    (1)

    2010

    (1)

    (1)

    (1)

    (1) Less than $50 million.

    	Authorization

    Sections 46 and 48.

    	Description

    Sections 46 and 48 provide a  non-refundable income-tax credit for
    business investment in solar and geothermal energy equipment, fuel cells, and
    microturbines. The energy credit percentage is 30% for solar and fuel cell
    equipment, and 10% for geothermal and microturbine energy equipment. The
    30% business energy credit for the purchase of qualified fuel cells applies to
    the costs of the power plants subject to a limit of  $1,000 for each kilowatt of
    capacity. The power plant must have an electricity-only generation efficiency
    of greater than 30% and generation capacity of at least 0.5 kilowatt of
    electricity. For microturbines, the system must have an electricity-only
    generation efficiency of not less that 26% at International Standard
    Organization conditions and a capacity of less than 2,000 kilowatts. The
    microturbine credit is 10% of the equipment costs (or basis) subject to a limit
    of $200 for each kilowatt of capacity.

    Solar equipment is defined as a system that generates electricity directly
    (photovoltaic systems), or that heats, cools, or provides hot water in a
    building.  It also includes equipment that illuminates the inside of a structure
    using fiber-optic distributed sunlight. Solar property used for heating a
    swimming pool is not eligible for the solar credit. Geothermal equipment
    includes systems used to produce, distribute, or use energy from a natural
    underground deposit of hot water, heat, or steam (such as geysers). In the case
    of geothermal equipment used to generate electricity, only equipment up to
    the transmission stage qualifies for the credit. A qualified fuel cell power
    plant is an integrated system comprised of a fuel cell stack assembly and
    associated balance of plant components that converts a fuel (usually natural
    gas) into electricity using electrochemical means, and which has an
    electricity-only generation efficiency of greater than 30%. The 10% credit for
    microturbines applies to the purchase of stationary microturbine power plants,
    including secondary components located between the existing infrastructure
    for fuel delivery and the existing infrastructure for power distribution.

    The 30% credit for solar, and the credits for fuel cells and microturbines,
    are effective for property placed in service periods after December 31, 2005,
    and before January 1, 2009. On January 1, 2009, the credit for solar reverts
    back to 10% - the credit rate for solar and geothermal before expansion
    under the Energy Policy Act of 2005 (P.L. 109-58).

    Investment in solar and wind energy equipment may also be recovered
    over 5 years, which provides for more accelerated  depreciation deductions,
    and, therefore, lower effective tax rates, than under the more standard
    depreciation guidelines. However, the taxpayer's property costs for purposes
    of depreciation would be reduced by the amount of the investment tax credit
    claimed. As of January 1, 2005, electricity generated by solar and geothermal
    technologies has qualified for the section 45 production tax credit (as
    described in a separate entry in the Energy section of this compendium).
    However, if an investment tax credit is claimed under sections 46 and 48,
    then rules against double-dipping prevent a section 45 production tax credit
    from being claimed for power generated from the equipment that would
    receive the investment tax credit.

    The business tax credits for solar, geothermal, fuel cell, and microturbine
    technologies are components of the general business credits  and are thus
    subject to the restrictions, limitations, and carryover provisions of those
    credits.

    	Impact

    The energy tax credits lower the cost of, and increase the rate of return to,
    investing in solar and geothermal equipment, whose return is generally much
    lower due to significantly higher capital costs, as compared to conventional
    energy equipment. Even with a 10% credit, and the recent technological
    innovations that have reduced costs, solar, geothermal, and other renewable
    energy technologies require relatively high and stable real oil prices in order
    to realize rates of return high enough to justify private investment. However,
    the quality of, and access to, a geothermal deposit can, in specialized cases,
    lower the production costs to below the costs of conventional energy.
    Sustained high real crude oil prices -  both in nominal and real terms such
    prices have, recently, been the highest since the early 1980s - would render
    these technologies more competitive.

    Even during the early 1980s, when oil prices were higher than today in real
    terms, and effective tax rates on these types of equipment were sometimes
    negative (due to the combined effect of the energy tax credits, the regular
    10%  investment tax credit, and accelerated depreciation), business
    investment in these technologies was negligible. It is not clear how much
    these credits encourage additional investment as opposed to subsidizing
    investment that would have been made anyway.

    Renewable energy resources are, by definition,  naturally replenished in a
    relatively short period of time. They include biomass, hydro power,
    geothermal energy, wind energy, and solar energy. In 2005, about 6% of all
    energy consumed, and about 9% of total electricity production was from
    renewable energy sources.  About half of renewable energy is consumed by
    the electric power sector to generate electricity, derived mostly from
    hydroelectric (45%), wood (31%), geothermal (6%), and wind (2.5%).
    According to the Energy Information Administration (EIA), solar power
    accounts for 1% of total renewable energy consumption,  used mostly in
    personal residences. Due primarily to high capital costs and low (or even
    negative) rates of return of solar systems, this still accounts for a negligible
    fraction of total residential energy use.  Most solar thermal collectors are used
    for heating water and pools in residences. Geothermal energy consumption
    increased slightly from 2004 to 2005 (about 3%). Electricity generated from
    wind turbines has recently increased, mostly in response to a combination of
    federal and state incentives, but also due to the recent high energy prices.
    Wind power, which is virtually all electric, has been rising rapidly recently,
    increasing from negligible amounts in 1988 to about 15 kWhrs in 2005.
    However, EIA says wind still accounts for only 2.5% of  renewable energy,
    and for only 0.36% of total U.S. electricity generation. Electricity from wind
    receives a production tax credit, but wind equipment does not qualify for an
    investment tax credit. There is little  energy generated from fuel cells or
    microturbines, as these technologies are in their infancy. But these
    technologies - particularly microturbines - are frequently mentioned
    among the newly emerging high-efficiency advanced energy technologies.

    Despite this, however, production and use of solar thermal collectors and
    photovoltaic systems has increased significantly over the last 20 years. 2005
    was a big year for photovoltaic (PV) cells and modules, returning to the
    pattern of strong growth seen between 2000 and 2002. For 2005, EIA reports
    that total shipments of PV cells and modules reached a record high of
    226,916 peak kilowatts, a 25% increase from the 2004 level (181,116 peak
    kilowatts), but 108% more than the 2003 level (109,357 peak kilowatts). The
    total value of photovoltaic cell and module shipments grew around 40% to
    $702 million in 2005. The average price for modules and cells (dollars per
    peak watt) has declined significantly over the years. The impressive gains in
    production and use of photovoltaic systems, some of which are exported, has
    been driven primarily by declines in manufacturing costs, and the high price
    of conventional energy, but government policies promoting renewable energy
    have undoubtedly also played a significant role.

    The demand for solar thermal collectors (measured in square feet) has also
    increased in recent years, although demand is still below the levels of the late
    1970s and early 1980s  - both the number of  manufacturers and their
    shipments of collectors reached a peak in the early 1980s coincident with the
    peak in oil prices.  The 1986 drop in oil prices and the termination of the
    original residential solar credit in 1985 led to a decline in solar collector
    shipments for the next 10 years. Total shipments began to increase again in
    1997 and in 2005 were more than double the amount in 1996. The residential
    sector continued to be the prime market for solar thermal collectors, totaling
    14.7 million square feet in 2005, or 92% of total shipments. The largest end
    use for solar collectors shipped in 2004 was for heating swimming pools,
    consuming 15 million square feet in 2005 (94% of total shipments). As a
    result, the vast majority of solar thermal collector shipments were  not eligible
    for the tax credits. The most recent data available shows that geothermal heat
    pump manufacturers shipped 43,806 geothermal heat pumps in 2004, a 20%
    increase over the 2003 total of 36,439. The total rated capacity of heat pumps
    shipped in 2004 was 144,301 tons of capacity (one ton of capacity = 12,000
    Btu's per-hour), compared to 124,438 tons in 2003. The average unit size
    shipped in 2004 was 3.29 tons, compared to an average unit size of 3.41 tons
    in 2003.

    	Rationale

    The business energy tax credits were established as part of the Energy Tax
    Act of 1978 (P.L. 95-618), which was one of five public laws enacted as part
    of President Carter's National Energy Plan. The rationale behind the credits
    was primarily to reduce U.S. consumption of oil and natural gas by
    encouraging the commercialization of renewable energy technologies, to
    reduce dependence on imported oil and enhance national security. The larger
    credit for solar and the fuel cell credit were extended through 2008 by H.R.
    6111 enacted in December 2006.

    Under the original 1978 law, which also provided for tax credits for solar
    and geothermal equipment used in residences, several other types of
    equipment qualified for tax credits: shale oil equipment, recycling equipment,
    wind energy equipment, synthetic fuels equipment, and others.  For some
    types of equipment, the credits expired on December 31, 1982; others were
    extended by the Crude Oil Windfall Profit Tax Act of 1980 (P.L. 96-223)
    through 1985.

    The 1980 Windfall Profit Tax Act extended the credit for solar and
    geothermal equipment, raised their credit rates from 10% to 15%, repealed
    the refundability of the credit for solar and wind energy equipment, and
    extended the credit beyond 1985 for certain long-term projects.  The Tax
    Reform Act of 1986 (P.L. 99-514) retroactively extended the credits for solar,
    geothermal, ocean thermal, and biomass equipment through 1988, at lower
    rates.

    The Miscellaneous Revenue Act of 1988 (P.L. 100-647) extended the
    solar, geothermal, and biomass credits at their 1988 rates - ocean thermal
    was not extended. The Omnibus Budget Reconciliation Act of 1989 (P.L.
    101-239) extended the credits for solar and geothermal and reinstated the
    credit for ocean thermal equipment, through December 31, 1991. The credit
    for biomass equipment was not extended. The Tax Extension Act of 1991
    (P.L. 102-227) extended the credits for solar and geothermal through June 30,
    1992.  The Energy Policy Act of 1992 (P.L. 102-486) made the credits for
    solar and geothermal equipment permanent.  The American Jobs Creation Act
    of 2004 (P.L. 108-357) allowed solar, geothermal, and other types of
    renewable energy technologies to qualify for the section 45 electricity
    production tax credit.

    Thus, the credits for solar and geothermal equipment are what remained of
    the business energy tax credits enacted under the Energy Tax Act of 1978.
    Prior to the Energy Policy Act of 2005, and with the reforestation credit and
    the rehabilitation credit, they were the sole exceptions to the repeal of the
    investment tax credits under the Tax Reform Act of 1986.  The Energy Policy
    Act of 2005 raised the credit rate for solar equipment from 10% to 30%, and
    expanded it to fiber optic distributed sunlighting, fuel cells, and
    microturbines.

    	Assessment

    The business energy tax credits encourage investments in technologies that
    rely on clean, abundant, and, in the case of solar energy, unlimited renewable
    energy as substitutes for conventional fossil-fuel technologies that pollute the
    environment and contribute to dependence on imported petroleum. A major
    policy question is the cost -  in terms of foregone federal tax revenue and
    distortions to the allocation of resources - in relation to the relatively small
    fossil fuels savings and environmental gains.

    In the aggregate, the credits don't lose much federal tax revenue, but in
    relation to the small amounts of fossil energy they save the revenue loss per
    barrel of displaced energy response to the credits is low.  They also subsidize
    two specific technologies where others arguably might provide greater benefit
    if they were subsidized instead.  The environmental and security problems
    associated with production and consumption of fossil fuels could also be
    addressed with emissions taxes or emissions trading rights - such as those in
    the Clean Air Act - in lieu of tax subsidies which are not only costly, but
    distortionary.

    The high capital costs for renewable and alternative energy technologies,
    and market uncertainty, are not evidence of energy market failure, although
    they do act as barriers to the development and commercialization of these
    technologies. However, the incentive effects of the investment tax credits
    might lead to technological innovations that may reduce the costs of the
    subsidized technologies and (eventually) make them more competitive (or at
    least, less uneconomical).

    	Selected Bibliography

    Congressional Budget Office. Prospects for Distributed Electricity
    Generation. A CBO Paper.  Washington, DC: September 2003.
    Fisher, Anthony C., and Michael H. Rothkopf. "Market Failure and Energy
    Policy: A Rationale for Selective Conservation,"  Energy Policy, v. 17.
    August 1989, pp. 397-406.
    Hoerner, J. Andrew and Avery P. Gilbert.  Assessing Tax Incentives for
    Clean Energy Technologies:  A Survey of Experts Approach.  Center for a
    Sustainable Economy.  Washington, DC: April 2000.
    Inyan,S., L. Sunganthi, and Anand A. Samuel. "Energy Models for
    Commercial Energy Production and Substitution of Renewable Energy
    Resources." Energy Policy, v.34. November 2006, pp. 26-40.
    Kobos, Peter H., Jon D. Erickson, and Thomas E. Drennen.
    "Technological Learning and Renewable Energy Costs: Implications for US
    Renewable Energy Policy."  Energy Policy, v. 34, September 2006, pp.16-45.
    Lazzari, Salvatore.  Energy Tax Policy: History and Current Issues.
    Library of Congress, Congressional Research Service Report RL33578.
    Washington, DC: July 28, 2006.
    Lazzari, Salvatore. Energy Tax Policy: An Economic Analysis. Library of
    Congress, Congressional Research Service Report RL 30406.  Washington,
    DC: June 28, 2005.

    Sav, G. Thomas.  "Tax Incentives for Innovative Energy Sources:
    Extensions of E-K Complementarity," Public Finance Quarterly, v. 15.
    October 1987, pp. 417-427.
    Rich, Daniel, and J. David Roessner.  "Tax Credits and U.S. Solar
    Commercialization Policy," Energy Policy, v. 18.  March 1990, pp. 186-198.
    -. House Committee on Ways and Means.  Tax Credits for Electricity
    Production from Renewable Energy Resources. Hearing Before the
    Subcommittee on Select Revenue Measures, 109th Congress, 1st session,
    May 24, 2005.
    -. Senate Committee on Energy and Natural Resources. Power Generation
    Resource Incentives and Diversity.  Hearings, 109rd Congress, 1st session.
    Washington, DC: U.S. Government Printing Office, March 8, 2005.
    Sissine, Fred.  Renewable Energy Policy: Tax Credit, Budget, and
    Regulatory Issues.  Congressional Research Service Report RL33588.
    Washington, DC:  July 28, 2006
           U.S. Department of Energy. Energy Information Administration. Survey
    of Geothermal Heat Pump Shipments: 2004.  Spring 2006.
    U.S. Department of Energy. Energy Information Administration.
    Renewable Energy Annual: 2004.  June 2006.
    U.S. Department of Energy. Energy Information Administration. Solar
    Thermal and Photovoltaic Collector Manufacturing Activities: 2005.  August
    2006.
    U.S. Department of Energy. Energy Information Administration.
    Legislation Affecting the Renewable Energy Marketplace: 2006.

    Energy

    TAX CREDITS FOR ELECTRICITY PRODUCTION
    FROM RENEWABLE RESOURCES

    Estimated Revenue Loss

     [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.9

    (1)

    0.9

    2007

    0.9

    (1)

    3.8

    2008

    1.0

    (1)

    5.6

    2009

    1.6

    0.1

    6.1

    2010

    1.2

    0.1

    5.9

    (1) Positive tax expenditure less than $50,000.  H.R. 6111 adopted in
    December 2006 extended deadlines, adding a revenue cost for fiscal years
    2008, 2009, and 2010 of $0.1, $0.3, and $0.3 billion respectively.

    	Authorization

    Section 45.

    	Description

    Taxpayers are allowed a 1.9� credit for 2006 per kilowatt-hour of
    electricity produced from qualified wind energy, "closed-loop" biomass,
    geothermal, and solar. Taxpayers are also allowed a 1.0�/kWh. credit for
    electricity produced from open-loop biomass (including poultry and other
    livestock waste), small irrigation power, and municipal solid waste. In
    addition, section 45 provides a tax credit of $5.68/ton in 2006 ($4.375/ton, in
    1992 dollars), for production of refined coal - not for the electricity
    produced from the coal. Municipal solid waste covers two types of power
    facilities: trash combustion facilities that burn trash directly to generate
    power, and  landfill gas facilities that first produce methane, which is then
    burned to generate electricity.  The 1.9� and 1.0� tax credits are values for
    2006, which equal the  to 1992 base credits of 1.5� and 0.75� adjusted for
    inflation. In the case of both types of municipal waste facilities, small
    irrigation power, and open-loop biomass facilities, the credit was established
    at half, in base 1992 dollars, the credit for the other types of renewables.  The
    electricity must be produced from a facility owned by a taxpayer and it must
    be sold to an unrelated third party.

    Closed-loop biomass involves the use of plant matter, where plants are
    grown solely as fuel to produce electricity, and can be combined with either
    coal or open-loop biomass in a co-fired system. Open-loop biomass refers to a
    variety of  waste materials and by-product sources, such as scrap wood or
    agricultural livestock waste and crop wastes, or timber wastes such as mill
    and harvesting residues, pre-commercial thinnings, slash, and brush. Poultry
    waste is defined as poultry manure and litter, but it also includes wood
    shavings, straw, rice hulls, and other bedding materials for the disposition of
    manure.  Small irrigation power is a hydro-power system without a dam or
    water impoundment ranging in size between 150 kilowatts and 5 megawatts
    of power.  It uses ditches and canals to generate power. The definition of
    municipal solid waste is taken from the Solid Waste Disposal Act. This
    basically includes most types of organic waste or garbage in landfills and
    municipal biosolids, sludge, and other residues removed by a municipal
    wastewater treatment facility.  Refined coal is defined as a liquid, gaseous, or
    solid synthetic fuel produced from coal (and lignite) or high carbon fly ash,
    including such fuel used as a feedstock. Qualifying coal must emit 20% less
    sulfur dioxide, and either 20% less mercury or nitrous oxide, than comparable
    coal sources.

    Generally, the credits are available for ten years beginning on the date the
    facility is first placed into service, which varies by type of qualifying property.
     However, in the case of open-loop biomass, geothermal energy, solar energy,
    small irrigation power, landfill gas facilities, and trash combustion facilities,
    the credit is available for only 5 years from the placed-in-service date. The
    property must be placed in service by December 31, 2008.

    Both the 1.5� electricity credit and the $4.375 coal credit are phased out as
    reference energy prices exceed certain thresholds. The 1.5� electricity credit
    (adjusted for post-1992 inflation) is phased out as the reference price of
    electricity - the average annual contract price of electricity from the
    renewable source -  rises over a 3� range, beginning with an inflation-
    adjusted threshold of 8� per kilowatt hour (kWh). For example, if the
    reference price of electricity were 9.5�, the 1.5� tax credit would be reduced
    by � [( .095-.08)/3 = .5] to .75�/ kWh. Each of these amounts, except the 3�,
    have been adjusted for inflation since 1992. For 2006, the reference price for
    wind electricity was 2.89� per kWh; the reference price for such electricity
    was 8� x 1.2981 (the inflation adjustment), which equals10.4�.  Because the
    reference price (2.89�) was less than 10.4�, there was no phase-out and the
    full credit of 1.5� x 1.2981 = 1.95�/ kWh is available in 2006. For
    comparison, the IRS said the credit for 2004 was 1.8�. For electricity
    produced from all other renewables other than wind, the full credit is also
    available, although the IRS has not yet calculated reference prices. IRS is
    currently working on determining reference prices and phase-out calculations
    for 2007.

    The $4.375 refined coal credit is phased out as the market price of refined
    coal exceeds certain threshold levels. The threshold levels are defined by
    reference to the price of feedstock fuel used to produce the refined coal,
    which has been annually adjusted for inflation beginning in 2002. Thus, if a
    producer of refined coal uses Powder River Basin coal as a feedstock, the
    threshold price is determined by reference to the price of that coal; if the
    producer uses Appalachian coal, the threshold price is determined by
    reference to prices of Appalachian coal. The $4.375 refined coal credit is also
    adjusted for inflation since 1992. With an inflation-adjusted factor of 1.2981
    for 2006, the credit is $5.68 per ton (it was $5.84/ton in 2005). Because the
    reference price of $42.78/ton was less than the inflation-adjusted base price,
    the full credit was available in 2006.

    Cooperatives that are eligible for the 45 credit may elect to pass through
    any portion of the credit to their patrons. To be eligible for this election, the
    cooperative would have to be more than 50%-owned by agricultural
    producers or entities owned by agricultural producers. The election would be
    made on an annual basis, and it would be irrevocable once made.

    A facility that qualifies for the section 45 credit may also claim other
    government benefits, including the business energy credit or investment credit
    and the tax benefits under the tax-exempt clean renewable energy bond
    provisions. However, in all cases except for co-fired facilities, the section 45
    credits are reduced by half - no such reduction is required of co-fired
    facilities, which means that qualifying systems may "double dip." In all cases,
    the credit is available to the owner of the facilities that produce the electricity
    or refined coal. In two exceptions - in the case of open-loop biomass, and
    co-firing facilities - the lessee operator may also claim the tax credit in lieu
    of the facility's owner.

    The section 45 tax credits are components of the general business credit,
    and are subject to the rules governing the restrictions and carry-overs of that
    section of the tax code.  Additionally, the section 45 tax credits may be
    claimed against the alternative minimum tax.

    	Impact

    Both the renewable electricity credit and the new refined coal credit are
    production incentives - the former  reduce the marginal and average costs of
    generating electricity from renewable energy resources, and latter costs for
    producing refined coal. The renewable electricity credit was originally
    intended to encourage the generation of electricity from wind and biomass by
    making such electricity more competitive with electricity generated from coal
    fired power plants and other sources. Until recently, very little electricity was
    actually generated from wind and closed-loop (energy coop) biomass,
    although substantial electricity is generated from wood, wastes, and other
    open-loop biomass - bu this is still a relatively small fraction of  total
    electricity generation.

    Renewable energy resources are, by definition,  naturally replenished in a
    relatively short period of time. They include biomass, hydro power,
    geothermal energy, wind energy, and solar energy. In 2005, about 6% of all
    energy consumed, and about 9% of total electricity production was from
    renewable energy sources.  About half of renewable energy is consumed by
    the electric power sector to generate electricity, derived mostly from
    hydroelectric (45%), wood (31%), geothermal (6%), and wind (2.5%).
    According to the Energy Information Administration (EIA), solar power
    accounts for 1% of total renewable energy consumption,  used mostly in
    personal residences. Due primarily to high capital costs and low (or even
    negative) rates of return of solar systems, this still accounts for a negligible
    fraction of total residential energy use.  Most solar thermal collectors are used
    for heating water and pools in residences. Geothermal energy consumption
    increased slightly from 2004 to 2005 (about 3%). Electricity generated from
    wind turbines has recently increased, mostly in response to a combination of
    federal and state incentives, but also due to the recent high energy prices.
    Wind power, which is virtually all electric, has been rising rapidly recently,
    increasing from negligible amounts in 1988 to about 15 kWhrs in 2005.
    However, EIA says wind still accounts for only 2.5% of  renewable energy,
    and for only 0.36% of total U.S. electricity generation. Electricity from wind
    receives a production tax credit, but wind equipment does not qualify for an
    investment tax credit The extension and broadening of the renewable
    electricity production tax credit will likely support further growth in
    generation from wind turbines and may also stimulate biomass co-firing with
    coal.

    In general,  energy from biomass has been declining in recent years
    although some types of biomass - landfill gas, and energy from waste - are
    used in greater quantities to generate power. Still most biomass electricity is
    generated from open-loop sources such as forest/lumber waste, accounting for
    70% of the total electricity generated from biomass. There is little, if any,
    electricity generated from closed-loop biomass as it is uneconomic to grow
    plants exclusively under a "closed-loop" system, but the expansion of  the
    45 tax credit to "open-loop" biomass, i.e., to various types of agricultural
    waste and other biomass products, will likely further increase electricity from
    this renewable resource. By allowing existing power plants to claim the
    electricity credit for burning open-loop biomass, significant co-firing of
    existing coal facilities is possible.  Some coal facilities are able to rapidly
    convert to co-firing with biomass, while others would take a couple of years
    to make the required capital investment for conversion at a cost of about
    $200/kilowatt hour, which is lower than most alternatives.

    The credit phase-outs are designed to remove the subsidy when the price of
    electricity (and refined coal) becomes sufficiently high that a subsidy is no
    longer needed.  The tonnage credit for refined coal is also a production tax
    credit, which reduces the marginal and average costs of producing refined
    coal as compared with conventional coal for electricity generation.

    	Rationale

    This provision was adopted as part of the Energy Policy Act of 1992 (P.L.
    102-486). Its purpose was to encourage the development and utilization of
    electric generating technologies that use specified renewable energy
    resources, as opposed to conventional fossil fuels. The Ticket to Work and
    Work Incentive Improvement Act of 1999 (P.L. 106-170) extended the
    placed-in-service deadline from July 1, 1999, to January 1, 2002.  It also
    added poultry waste as a qualifying energy resource. The Job Creation and
    Worker Assistance Act of 2002 (P.L. 107-147) extended the placed-in-service
    deadline to January 1, 2004. The Working Families Tax Relief Act of 2004
    (P.L. 108-311) extended the placed-in-service dates for wind, closed-loop
    biomass, and poultry waste facilities so that those placed into service after
    December 31, 2003, would also qualify for the tax credit.  The American Jobs
    Creation Act of 2004 (P.L. 108-357) expanded the renewable electricity
    credit to  open-loop biomass, geothermal, solar, small irrigation power, and
    municipal solid waste facilities, and created the production tax credit for
    refined coal.  (The refined coal tax credit was originally part of the proposed
    expansion of the nonconventional fuels production tax credit under initial
    comprehensive energy legislation.  That provision was dropped from
    comprehensive energy legislation and established as part of the American
    Jobs Creation Act of 2004.)

    The Energy Policy Act of 2005 (P.L. 109-58) extended the placed-in-
    service deadline  for all facilities except for solar energy facilities described in
    45(d)(4) and refined coal production facilities described in 45(d)(8) by two
    years to December 31, 2007. In addition, P.L. 109-58 extended the credit
    period to 10 years for all qualifying facilities placed in service after the date
    of enactment (August 8, 2005), eliminating the five-year credit period to
    which some facilities had been subject.  Also, the definition of qualified
    energy resources that can receive the credit was expanded to include qualified
    hydropower production, although a qualified hydroelectric facility would be
    entitled to only 50% of the usual credit. P.L. 109-58 also added Indian coal
    production facilities to the list of those facilities eligible for the credit. The
    credit is available for sales of Indian coal to an unrelated party from a
    qualified facility beginning January 1, 2006, and ending December 31, 2012.
    The credit is $1.50 per ton during 2006-2009 and increases to $2.00 per ton
    in 2110- 2012; the credit amount for Indian coal is to be adjusted for inflation
    in calendar years after 2006.  H.R. 6111 adopted in December 2005 extended
    the placed-in-service date for facilities other than solar, qualified coal and
    Indian coal to the end of 2008 for .

    Assessment

    Federal tax policy, and other federal energy policy, has been critical to the
    development of renewable electricity, particularly wind power.  In the late
    1970's and 1980's the investment tax credits established under President
    Carter's National Energy Act (NEA), along with California state tax credits,
    helped establish the first installations of wind power generation capacity.
    There was a slowdown in wind power investments  in response to the sunset
    of these investment incentives, and the decline in real oil prices, but a lagged
    response after the enactment of the 45 production tax credit in 1992. The
    evidence also suggests that termination of the 45 tax credit to wind power
    due to the expiration of the placed-in-service date on January 1, 2004, created
    policy uncertainty, and probably adversely affected (if only temporarily)
    investment in the technology.

    In addition to the 45 production tax credit, two other federal policies have
    contributed to the development of electricity from wind: PURPA, the Public
    Utility Regulatory Policies Act of 1978 (P.L. 95-617, Section 210) as
    amended by the Energy Policy Act of 2005, and REPI, the renewable energy
    production incentive. PURPA, which was also enacted as part of President
    Carter's NEA, required electric utilities to buy electricity from "qualifying
    facilities" at the utilities' avoided cost, the cost to the utility to generate or
    otherwise purchase electricity from another source. PURPA has been one of
    the most significant laws for the development of wind power, landfill gas, and
    other renewable energy resources. The Energy Policy Act of 2005 repealed
    the mandatory purchase requirement for new contracts if the Federal Energy
    Regulatory Commission finds that a competitive electricity market exists and
    a qualifying facility has access to independently administered, auction-based,
    day-ahead, real-time wholesale markets and long-term wholesale markets.
    This amendment may adversely affect renewable energy markets. The REPI,
    introduced in 1992 as part of the Energy Policy Act of 1992, is a financial
    incentive provided to tax exempt entities - tax exempt utilities
    (cooperatives), and state and local governments - for electricity generated
    from certain types of renewable energy resources. The incentive, which is
    1.9�/kWh of electricity generated, is the grant or spending subsidy equivalent
    of the 45 tax credit available for private taxable businesses.

    The electricity production tax credit might be justified on the basis of
    reducing pollution - generating power from non-polluting energy resources,
    such as wind, which emit no pollutants. Generally, however,  special tax (as
    well as other types of government) subsidies in one market to address external
    costs (pollution) created by other markets (the market for conventional fossil
    fuels) are seen as being inefficient and costly.  Also, providing tax credits and
    deductions for certain types of investment or consumption, even if for
    environmentally clean energy technologies, depending on other market
    distortions and failures, may result in a misallocation of resources. An
    alternative way to reduce pollution is by directly taxing either the emissions,
    or the conventional energy resources that produce the emissions.  Economic
    theory holds that this would allow the markets to choose the optimal response.

    The provision cannot be justified on the grounds of reducing dependence
    on imported oil since virtually none of the renewable electricity substitutes for
    petroleum - most of it would substitute for either coal or cleaner, but still
    polluting, natural gas. Also, there are more effective and efficient alternatives
    to address petroleum import dependence, such as stockpiling.

    	Selected Bibliography

    Dallas Morning News. "U.S. Wind Energy Business Hindered by Federal
    Energy Bill Delay." March 2, 2004.
    DeCarolis, Joseph F. and David W. Keith.  "The Economics of Large-Scale
    Wind Power in a Carbon-Constrained World." Energy Policy, v. 34, March
    2006, pp. 395-410.
    Fisher, Anthony C., and Michael H. Rothkopf.  "Market Failure and
    Energy Policy: A Rationale for Selective Conservation," Energy Policy, v. 17.
     August 1989, pp. 397-406.
    Hill, Lawrence J. and Stanton W. Hadley. "Federal Tax Effects on the
    Financial Attractiveness of Renewable vs. Conventional Power Plants,"
    Energy Policy, v. 23.  July 1995, pp. 593-597.
    Hoerner, J. Andrew and Avery P. Gilbert.  Assessing Tax Incentives for
    Clean Energy Technologies:  A Survey of Experts Approach.  Center for a
    Sustainable Economy.  Washington, DC: April 2000.
    Inyan,S., L. Sunganthi, and Anand A. Samuel. "Energy Models for
    Commercial Energy Production and Substitution of Renewable Energy
    Resources." Energy Policy, v.34. November 2006, pp. 26-40.
    Klass, Donald L.  "Biomass Energy in North American Policies," Energy
    Policy, v. 23.  December 1995, pp. 1035-1048.
    Kobos, Peter H., Jon D. Erickson, and Thomas E. Drennen. "Technological
    Learning and Renewable Energy Costs: Implications for US Renewable
    Energy Policy."  Energy Policy, v. 34, September 2006, pp.16-45.
    Lazzari, Salvatore. Energy Tax Policy: An Economic Analysis. Library of
    Congress, Congressional Research Service Report RL 30406.  Washington,
    DC: June 28, 2005.
    - .  Energy Tax Policy: History and Current Issues. Library of Congress,
    Congressional Research Service Report RL33578. Washington, DC: July 28,
    2006.

    -.  Energy Tax Subsidies: Biomass vs. Oil and Gas, Library of Congress,
    Congressional Research Service Report 93-19 E, Washington, DC: January 5,
    1993.
    -. "Federal Tax Policy Toward Biomass Energy: History, Current Law, and
    Outlook," Biologue.  July/August 1989, pp. 8-11.
    Grobman, Jeffrey H. and Janis M. Carey.  "The Effect of Policy
    Uncertainty on Wind-Power Investment." The Journal of Energy And
    Development, v. 28, Autumn 2002. pp. 1-14.
    Owen, Anthony D.  "Environmental Externalities: Market Distortions and
    the Economics of Renewable Energy Technologies." The Energy Journal, v.
    25. Fall, 2004, pp. 127-156.
    Petersilk, Thomas W. Modeling the Costs of U.S. Wind Supply. U.S.
    Department of Energy. Energy Information Administration. EIA/DOE-
    0607(99).
    Price, Jeff.  The Production Tax Credit: Getting More Credit Than It's
    Due?  Public Utilities Fortnightly, May 15, 2002.  p. 38-41.
    Sissine, Fred.  Renewable Energy Policy: Tax Credit, Budget, and
    Regulatory Issues. Congressional Research Service Report RL33588.
    Washington, DC:  July 28, 2006.
    Schnepf, Randy. Agriculture-Based Renewable Energy Production.
    Congressional Research Service Report RL32712.  Washington, DC: August
    4, 2006.
    Spath, Pamela L., Margaret K. Mann, and Stefanie A. Woodward.  "Life
    Cycle Assessment of a Biomass-to-Electricity System," Biologue, v. 16, 1st Q,
    1998, pp. 16-21.
    U.S. Department of Energy.  Lawrence Berkeley National Laboratory.
    Analyzing the Interaction Between State Tax Incentives and the Federal
    Production Tax Credit for Wind Power.  [by Wiser, Ryan, et al.] September
    2002.  11 p.
    U.S. Department of Energy. Energy Information Administration. Summary
    Impacts of Modeled Provisions of the 2003 Conference Energy Bill.
    SR/OIAF/2004-02. February 2004.
    U.S. Department of Energy. Energy Information Administration.
    Renewable Energy Annual: 2004.  June 2006.
    U.S. Department of Energy. Energy Information Administration. Solar
    Thermal and Photovoltaic Collector Manufacturing Activities: 2005.  August
    2006.
    U.S. Department of Energy. Energy Information Administration.
    Legislation Affecting the Renewable Energy Marketplace: 2006.

    Energy

    TAX CREDIT AND DEDUCTION FOR SMALL REFINERS
    WITH CAPITAL COSTS ASSOCIATED WITH
    EPA SULFUR REGULATION COMPLIANCE

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    -

    (1)

    (1)

    2007

    -

    (1)

    (1)

    2008

    -

    (1)

    (1)

    2009

    -

    (1)

    (1)

    2010

    -

    (1)

    (1)

    (1) Less than $50 million.

    	Authorization

    Sections 45H and 179B.

    	Description

    Section 45H allows a small refiner to claim a tax credit for the production
    of low-sulfur diesel fuel that is  in compliance with Environmental Protection
    Agency (EPA) sulfur regulations (the Highway Diesel Fuel Sulfur Control
    Requirements). The credit is $2.10/barrel of low sulfur diesel fuel produced;
    it is limited to 25% of the capital costs incurred by the refiner to produce the
    low sulfur diesel fuel. The 25% limit is phased out proportionately as a
    refiner's capacity increases from 155,000 to 205,000 barrels per day.

    Section 179B allows a small refiner to also claim a current year tax
    deduction, i.e., expensing, in lieu of depreciation, for up to 75% of the capital
    costs incurred in producing low-sulfur diesel fuel that is in compliance with
    EPA sulfur regulations. This incentive is also pro-rated for refining capacity
    between 155,000 and 205,000 barrels per day. The taxpayer's basis in the
    property that receives the exemption is reduced by the amount of the
    production tax credit. In the case of a refinery organized as a cooperative,
    both the credit and the expensing deduction may be passed through to
    patrons.

    For both incentives, a small business refiner is a taxpayer who 1) is in the
    business of refining petroleum products, 2) employs not more than 1,500
    employees directly in refining, and 3) has less than 205,000 barrels per day
    (averaged over the year) of total refining capacity. The incentives took effect
    retroactively beginning on January 1, 2003.

    	Impact

    The low-sulfur diesel tax credit lowers the average and marginal cost of
    producing low sulfur diesel fuel.  Expensing allows capital costs to be
    deducted fully in the year incurred rather than over the useful life of the asset
    - the time period in which the asset generates returns.  Under the current
    depreciation system (the Modified Cost Recovery System) refinery assets
    have a class life of 16 years and a recovery period - that they would
    otherwise be depreciated over - of 10 years. Immediate deduction
    (expensing) of capital costs has the effect of deferring tax liability. For any
    given expenditure, total tax deductions are the same whether expensed or
    capitalized but deductions that are taken immediately, rather than spread out
    over time, are more valuable: The present value of the deductions is greater
    than the present value of deductions that are capitalized over the production
    horizon of the oil or gas well. Expensing rather than capitalizing refinery
    costs allows taxes on income to be effectively eliminated - it is equivalent to
    a marginal effective tax rate of zero on the returns to the expenditures.
    Without expensing (i.e., assuming accelerated depreciation over 10 years), the
    marginal effective tax rate on refineries is estimated at about 25%, still below
    the marginal statutory rate of 35%.  Expensing of refinery capital investments
    lowers its cost, and increases the rate of return to, investing in refinery
    equipment for refining low sulfur diesel fuel.

    The combined effect of these two tax incentives is to increase the demand
    for refinery capital, and the supply of low-sulfur diesel fuel. According to
    industry figures, refiners currently produce about 2.4 million barrels per day
    of low-sulfur diesel fuel, about 90% of total demand (the regulations required
    that by October 15, 2006, 80% of diesel fuel had to meet the stringent
    standards of 15 parts per million or less for sulfur content).  However,
    refinery capacity and production is highly concentrated, and most of this is
    held by  major integrated refiners that do not qualify for the tax incentives;
    there are many domestic refineries below the qualification thresholds, but they
    refine a small fraction of the total supply of low-sulfur diesel fuel.

    	Rationale

    Both incentives were introduced as part of the energy tax provisions in
    comprehensive energy legislation; they were enacted as part of the American
    Jobs Creation Act of 2004 (P.L. 108-357).  The incentives compensate small
    refiners for the costs of complying with EPA's new tougher standards for
    diesel fuel under the Highway Diesel Fuel Sulfur Control Requirements,
    which begin to take effect in 2006. All refiners of diesel fuel, including
    imported diesel, have to comply with the new standards. By reducing
    production costs and capital costs of domestic refiners that meet the
    standards, the two tax incentives reduce the probability that small refiners
    would be forced out of business.

    The Energy Policy Act of 2005 (P.L. 109-58) provides that cooperative
    refineries that qualify for 179B expensing of capital costs incurred in
    complying with EPA sulfur regulations could elect to allocate all or part of
    the deduction to their owners, determined on the basis of their ownership
    interests. The election would be made on an annual basis and would be
    irrevocable once made. This provision was effective retroactively, as if it had
    been included in 338(a) of the American Jobs Creation Act of 2004.

    	Assessment

    Under an income tax system, there would be no production tax credits, and
    the appropriate method of capital cost recovery would require the taxpayer to
    spread out depreciation deductions for the cost of the asset based on its
    economic depreciation, i.e., the rate at which the asset depreciates in value
    over its useful life.  Neither of the tax subsidies correct for market distortions
    and are intended only to compensate through the tax system for regulatory
    costs imposed by the EPA. They are thus distortionary. In theory, the
    distortions resulting from pollution externalities - the damages (health and
    environmental) resulting from the production and use of high-sulfur diesel
    fuel - would be more efficiently corrected with a tax on the producer of
    high-sulfur diesel fuel rather than a subsidy to producers of low-sulfur fuel.

    	Selected Bibliography

    Cordes, Joseph J.  "Expensing," in the Encyclopedia of Taxation and Tax
    Policy, Joseph J. Cordes, Robert D. Ebel, and Jane G. Gravelle, eds
    (Washington: Urban Institute Press, 2005).
    Environmental Protection Agency.  Summary and Analysis of the 2005
    Highway and Non-Road Diesel  Fuel Pre-Compliance Reports. EPA 420-R-
    06-012. June 2006.

    Federal Register. Control of Air Pollution From New Motor Vehicles:
    Heavy Duty Engine and Vehicle Standards, and Highway Diesel Fuel Sulfur
    Control Requirements; Final Rule. Thursday, January 18, 2001.
    Guenther, Gary.  Small Business Expensing Allowance: Current Status,
    Legislative Proposals, and Economic Effects.  CRS Report RL31852,
    October 3, 2006.
    Sterner, Thomas. Policy Instruments for Environmental and Natural
    Resource Management.  Resources for the Future, Washington, D.C. 2003.
    	U.S. Congress, Joint Committee on Taxation. Description and Technical
    Explanation of the Conference Agreement of H.R. 6, Title XIII, "The Energy
    Tax Incentives Act of 2005."  July 27, 2005.
    U.S. General Accounting Office.  EPA Could Take Additional Steps to
    Help Maximize the Benefits from the 2007 Diesel Emissions Standards.
    Report to Congressional Requester, GAO-04-313, March 2004.
    Yacobucci, Brent D., James E. McCarthy, John W. Fischer, Alejandro E.
    Segarra, and Lawrence C. Kumins. Diesel Fuel and Engines: An Analysis of
    EPAs New Regulations.  CRS Report RL30737, May 1, 2001.

    Energy

    DEFERRAL OF GAIN FROM THE DISPOSITION OF
    ELECTRIC TRANSMISSION PROPERTY TO IMPLEMENT
    FEDERAL ENERGY REGULATORY COMMISSION
    RESTRUCTURING POLICY

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    -

    0.6

    0.6

    2007

    -

    0.5

    0.5

    2008

    -

    (4)

    (4)

    2009

    -

    -0.3

    -0.3

    2010

    -

    -0.3

    -0.3

    (4) Negative tax expenditure of less than $50 million.

    	Authorization

    Section 451.

    	Description

    Section 451 permits taxpayers to elect to recognize any capital gain from
    the sale of qualifying electricity transmission property to an independent
    transmission company (ITC), pursuant to a Federal Energy Regulatory
    Commission (FERC) restructuring policy, evenly over eight years beginning
    with the year of the sale. The sale proceeds must be reinvested in other
    electricity assets within four years. This special tax incentive is available for
    sales through December 31, 2007.

    	Impact

    Generally a taxpayer selling property recognizes any profits for tax
    purposes in the year of the sale.  The recognition of gain over eight years,
    rather than in the year of sale, is a deferral, rather than a complete
    forgiveness, of tax liability - it is a delay in the recognition of income, hence
    in the payment of tax. The economic benefit derives from the  reduction in the
    present value of the tax owed below what the tax would otherwise be if it
    were required to be recognized in the year of sale. Transmission property is
    also depreciated over 15 years, which means that depreciation deductions are
    taken somewhat faster than economic depreciation.  This lowers effective tax
    rates on the return to such investments.

    	Rationale

    The deferral of gain on the sale of transmission assets to an ITC is intended
    to foster a more competitive industry by facilitating the unbundling of
    transmission assets held by vertically integrated utilities. Under restructuring,
    states and Congress have considered rules requiring the separate ownership of
    generation and distribution and transmission assets. However, vertically
    integrated electric utilities still own a large segment of the nation's
    transmission infrastructure. The tax provision encourages the sale of
    transmission assets by vertically integrated electric utilities - the unbundling
    of electricity assets - to independent system operators or regional
    transmission organizations, who would own and operate the transmission
    lines. The provision is intended to improve transmission management and
    service, and facilitate the formation of competitive electricity markets.
    Without this incentive, any gain from the forced sale of transmission assets,
    pursuant to a FERC (or other regulatory body) restructuring policy would be
    taxed as ordinary income (i.e., at the highest rates) all in the year of sale.

    This provision is intended to promote restructuring of the electric utility
    industry away from the traditional monopoly structure and toward increased
    competition. The incentive was introduced as part of the energy tax
    provisions in comprehensive energy legislation; it  was enacted as part of the
    American Jobs Creation Act of 2004 (P.L. 108-357). The Energy Policy Act
    of 2005 (P.L. 109-58) extended deferral treatment from December 31, 2006,
    to December 31, 2007.

    	Assessment

    The restructuring of the electric power industry has, and may continue to
    result in significant reorganization of power assets. In particular, it may result
    in a significant disposition of transmission assets and possibly, depending on
    the nature of the transaction, trigger an income tax liability and interfere with
    industry restructuring.  Under an income tax system, the sale for cash of
    business assets subject to depreciation deductions triggers a tax on taxable
    income in the year of sale to the extent of any gain.  Corporations pay capital
    gains on sales of capital assets, such as shares of other corporations. But gains
    on the sale of depreciable assets involve other rules. For example, sales of
    personal property, such as machinery, are taxed partly as capital gains and
    partly as ordinary income. The overall taxable amount is the difference
    between the sales price and basis, which is generally the original cost minus
    accumulated depreciation. That amount is taxed as ordinary income to the
    extent of previous depreciation allowances (depreciation is "recaptured").

    	Selected Bibliography

    Abel, Amy. Electric Reliability: Options for Electric Transmission
    Infrastructure Improvements.  Library of Congress.  Congressional Research
    Service Report RL32075.  Washington, DC:  September 20, 2006.
    Abel, Amy. Energy Policy Act of 2005, P.L. 109-58: Electricity
    Provisions. Congressional Research Service Report  RL33248.  Washington,
    DC: January 24, 2006.
    Boyce, John R. and Aidan Hollis. "Governance of Electricity Transmission
    Systems." Energy Economics, v. 27, March 2005.
    Desay, Mihir and William Gentry.  "The Character and Determinants of
    Corporate Capital Gains," The National Bureau of Economic Research,
    NBER Working Paper #w10153, December 2003.
    Joskow, Paul L. "Competitive Electricity Markets and Investment in New
    Generating Capacity," MIT Research Paper. April, 28, 2006.
    Joskow, Paul L. Transmission Policy in the United States.  AEI-Brookings
    Joint Center for Regulatory Studies.  October 2004.
    Joskow, Paul L. "Restructuring, Competition, and Regulatory Reform in
    the U.S. Electricity Sector," Journal of Economic Perspectives. Summer
    1997. pp. 119-138.
    U.S. Congress, Joint Committee on Taxation. Federal Tax Issues Relating
    to Restructuring of the Electric Power Industry. Hearing before the
    Subcommittee on Long-Term Growth and Debt Reduction of the Senate
    Finance Committee, October 15, 1999. JCX 72-99.
    Vogelsang, Ingo. "Electricity Transmission Pricing and Performance-based
    Regulation." Energy Journal, v.27, 2006, pp. 97-127.

    Energy

    TAX CREDIT FOR HOLDERS OF
    CLEAN RENEWABLE ENERGY BONDS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    (1)

    (1)

    (1)

    2007

    (1)

    (1)

    (1)

    2008

    (1)

    (1)

    (1)

    2009

    (1)

    (1)

    (1)

    2010

    (1)

    (1)

    (1)

    (1) Less than $50 million.

    	Authorization

    Section 54.

    	Description

    Clean renewable energy bonds (CREBs) are available for the finance of
    qualified energy production projects which include: (1) wind facilities, (2)
    closed-loop bio-mass facilities, (3) open-loop bio-mass facilities, (4)
    geothermal or solar energy facilities, (5) small irrigation power facilities, (6)
    landfill gas facilities, (7) trash combustion facilities, and (8) refined coal
    production facilities.  Holders of CREBs can claim a credit equal to the dollar
    value of the bonds held multiplied by a credit rate determined by the
    Secretary of the Treasury.  The credit rate is equal to the percentage that will
    permit the bonds to be issued without discount and without interest cost to the
    issuer.  The national limit on the bonds was $1.2 billion, of which a
    maximum of $750 million could be granted to governmental bodies (the
    remainder would go to utilities).  The bonds must be issued before January 1,
    2009.  The credit rate is equal to the rate that will permit the bonds to be
    issued without discount and without interest cost to the issuer.  The maximum
    maturity of the bonds is that which will set the present value of the obligation
    to repay the principal equal to 50 percent of the face amount of the bond
    issue.  The discount rate for the calculation is the average annual interest rate
    on tax-exempt bonds issued in the preceding month, having a term of at least
    10 years.  CREBs are subject to arbitrage rules that require the issuer to spend
    95 percent of the proceeds within five years of issuance.

    	Impact

    The interest income on bonds issued by State and local governments
    usually is excluded from Federal income tax (see the entry "Exclusion of
    Interest on Public Purpose State and Local Debt").  Such bonds result in the
    Federal government paying a portion (approximately 25 percent) of the
    issuer's interest costs.  CREBs are structured to have the entire interest cost of
    the State or local government paid by the Federal Government in the form of
    a tax credit to the bond holders.  CREBs are not tax-exempt bonds.  The cost
    has been capped at the value of Federal tax credits generated by the $800
    million volume cap.

    	Rationale

    Proponents of CREBs argue that the Federal subsidy is necessary because
    private investors are unwilling to accept the risk and relatively low return
    associated with renewable energy projects.  Proponents argue that the market
    has failed to produce investment in renewable energy because the benefits of
    these projects extend well beyond the service jurisdiction to the surrounding
    community and to the environment more generally.  The rate payers of the
    utility are not compensated for these external benefits, and it is unlikely,
    proponents argue, that private investors would agree to provide them without
    some type of inducement.  The program was introduced in 2005 (P.L. 109-
    58); H.R. 6111, adopted in December of 2006, increased the amount to be
    issued by $400 billion and extended issuance authority through 2008.

    	Assessment

    The legislation (P.L. 109-58) that created these bonds was enacted on
    August 8, 2005, and  the potential success of the program is still uncertain.
    One way to think of this alternative subsidy is that investors can be induced to
    purchase these bonds if they receive the same after-tax return from the credit
    that they would from the purchase of tax-exempt bonds.  The value of the
    credit is included in taxable income, but is used to reduce regular or
    alternative minimum tax liability.  Assuming the taxpayer is subject to the
    regular corporate income tax, the credit rate should equal the ratio of the
    purchaser's forgone market interest rate on tax-exempt bonds divided by one
    minus the corporate tax rate.  For example, if the tax-exempt interest rate is 6
    percent and the corporate tax rate is 35 percent, the credit rate would have to
    be equal to .06/(1-.35), or about 9.2 percent to induce investment.  Thus, an
    investor purchasing a $1 million CREB would need to receive a $92,000
    annual tax credit each year.

    With CREBs, the Federal Government pays 100 percent of interest costs.
    One alternative, government issued tax-exempt bonds, have only a portion of
    interest costs subsidized by the Federal Government.  For example, if the
    taxable bond rate is 9.2 percent and the tax-exempt rate is 6 percent, the
    issuer of the tax-exempt bond receives a subsidy equal to 3.2 percentage
    points of the total interest cost, the difference between 9.2 percent and 6
    percent.  The CREB receives a subsidy equal to all 9.2 percentage points of
    the interest cost.  Thus, CREBs reduce the price of investing in renewable
    energy projects compared to investing in other public services provided by
    governments.  In addition, with CREBS, the entire subsidy (the cost to the
    Federal taxpayer) is received by the issuing government (or utility) through
    reduced interest costs.  In contrast, with tax-exempt bonds, part of the Federal
    revenue loss is a windfall gain for some wealthy investors.  The Federal
    revenue loss, and thus benefit, is not fully captured by the issuing
    government.

    	Selected Bibliography

    Congressional Budget Office, Tax Credit Bonds and the Federal Cost
    Financing Public Expenditures, July 2004.
    Davie, Bruce, "Tax Credit Bonds for Education: New Financial
    Instruments and New Prospects," Proceedings of the 91st Annual Conference
    on Taxation, National Tax Association.
    Joint Committee on Taxation, General Explanation of Tax Legislation
    Enacted in 1997, Joint Committee Print JCS-23-97, December 17, 1997, 40-
    41.
    Joint Committee on Taxation, Present Law and Background Related to
    State and Local Government Bonds, Joint Committee Print JCX-14-06,
    March 16, 2006.
    Maguire, Steven.  Tax Credit Bonds: A Brief Explanation.  Library of
    Congress, Congressional Research Service Report RS20606.  August 21,
    2006.
    -.   Tax-Exempt Bonds: A Description of State and Local Government Debt.
    Library of Congress, Congressional Research Service Report RL30638.
    March 10, 2006.

    	Energy

    	TAX CREDITS FOR INVESTMENTS IN CLEAN
    	COAL POWER GENERATION FACILITIES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    -

    (1)

    (1)

    2007

    -

    0.1

    0.1

    2008

    -

    0.1

    0.1

    2009

    -

    0.2

    0.2

    2010

    -

    0.2

    0.2

    (1) Less than $50 million.

    	Authorization

    Sections 48A and 48B.

    	Description

    An investment tax credit is provided for selected types of clean coal
    technologies: (1) integrated gasification combined cycle technologies (IGCC)
    and other advanced clean coal systems, and (2) qualifying gasification
    systems.  The credit for IGCC systems is 20 percent of the investment subject
    to a total limit of $800 million on the aggregate credits claimed. The credit for
    other advanced clean coal systems is 15 percent of the investments subject to
    a total credit limit of $300 million. The credit for qualifying gasification
    systems is also 20percent of the investment cost, but the aggregate lifetime
    limit is $350 million. Each of the credits would be allocated by the Secretary
    based on the amount invested. These credits are effective for investments
    made after August 8, 2005.

    	Impact

    Clean coal technologies are technologically feasible strategies for
    generating electric power from coal efficiently and cleanly.  Clean-coal
    technologies include the pressurized fluidized-bed combustion-combined
    cycle, IGCC, the indirect-fired cycle repowering, the coal diesel-combined
    cycle, and slagging  technology.  Such technologies are significantly more
    energy efficient than the conventional coal-fired power plants currently in use,
    which have an operating efficiency of about 34 percent (meaning that 66
    percent of the energy used is lost in the generation process). Currently, some
    of the clean-coal technologies can achieve  45 percent efficiency.  Some
    clean-coal technologies also reduce emissions of one or more of 4 air
    pollutants (NOx SO2,PM, Hg) with CO2, to a greater degree than conventional
    coal plants.  This technology development is occurring as the Environmental
    Protection Agency (EPA) has regulations to further reduce emissions of NOx
    and SO2, and to begin reducing Hg emissions.  Subbituminous coal can be
    used if 99% of the SO2 emissions are removed or an emission limit of 0.04
    pounds of SO2 per million Btus over 30 days.

    Clean coal systems are, however, very capital intensive and require
    relatively large  investments in  construction and development costs -
    basically fixed capital costs. Per kilowatt of capacity, such technologies
    currently cost between $2,000 and $3,000. Because of high capital costs, rates
    of return are very low or even negative, even with existing accelerated
    depreciation provisions. Thus, although clean coal technologies have been
    successfully demonstrated, none are commercially viable at the present time,
    and none would be commercially viable without additional tax incentives.
    The investment tax credits may reduce the after-tax cost of the qualifying
    technologies and increase the rates of return sufficiently to overcome the high
    fixed capital cost and higher operating costs. This lowers effective tax rates
    on the return to such investments. Combined with existing accelerated
    depreciation benefits, the investment tax credit would improve the financial
    attractiveness of clean coal technologies relative to these alternatives.  In
    addition, with global warming becoming an important concern, clean coal
    technologies, combined with carbon capture and storage (CCS) technology
    may be an important option in reducing greenhouse gases. In particular,
    IGCC, the one technology targeted by the investment tax credits, may become
    (combined with CCS) a cost-effective option for limiting CO2 in the future.

    Also, the additional commercialization that may result from the generous
    investment tax credits may engender further technological improvements that
    could lower the cost of clean coal technologies sufficiently to overcome the
    hurdle rate of return (basically the cost of capital) and make them competitive
    with advanced combined-cycle natural gas units, the most competitive, and
    relatively clean, current generating technology.  According to the Coal
    Utilization Research Council, by the year 2020 clean coal technologies could
    achieve an efficiency of 49 percent and cost an average of $800/KW,
    suggesting at least a potential downward trend in cost. If cost declines occur
    - or  if the capital costs of the next best alternative technology (probably the
    advanced natural gas combined cycle units) were to increase in the long term
    (or both) - some clean coal technologies might become more competitive
    without tax credits.

    Clean coal technologies might also become more competitive if, for
    example, the price of natural gas were to increase either as a result of the
    additional use of advanced natural gas technologies or due to some unrelated
    market factor. However, electric utilities would have to make investment
    decisions based on current technologies and reasonable assessment of relative
    fuel prices in the near future. Without the investment tax credits, these
    considerations would seem to favor advanced natural gas combined-cycle
    units, and possibly some types of renewables such as wind power.

    Uncertainty in commercial viability is another key factor inhibiting
    investment in these technologies.  Costs are not likely to decline if risk
    remains high. Even if capital costs would fall, there is the additional problem
    of the risk of clean-coal technologies.

    	Rationale

    The investment tax credits for clean coal technologies were established by
    the Energy Policy Act of 2005 (P.L. 109-58). Congress has, since 1986,
    authorized billions of dollars to the Department of Energy (DOE) to
    demonstrate emerging clean coal technologies, particularly those that can
    substantially reduce SO2 and NOx to further control acid rain. The Energy
    Policy Act of 2005 also created a new loan guarantee program for clean coal
    technologies, and other clean energy technologies. They were intended to
    promote a technologically feasible electric generating technology that is
    efficient, is environmentally less harmful than conventional coal fired
    generators, and relies on an abundant domestic energy resource.  The
    provision relating to subbituminous coal was added by H.R. 6111 in
    December 2006.

    	Assessment

    The 20 percent investment tax credit reduces the levelized costs of the
    IGCC clean coal technology from $4.80/kWh to $4.15/kWh (in 2004 dollars).
    This is somewhat lower than the levelized costs of many other types of
    generating technologies, including conventional coal-fired units ($4.32/kWh).
    Despite some successful demonstrations, clean coal technologies are still
    generally economically unproven technologies in the sense that none have
    become commercial without significant subsidies. As a result, utilities may
    not have the confidence in them as compared to conventional systems or
    advanced natural gas combined cycle systems, which have a proven track
    record.  Even if capital costs were lower, the unpredictability of the clean coal
    systems increases risks and possibly operating and maintenance costs to the
    utility, which may inhibit investment. Thus, even after they become
    competitively priced, it may take time - some estimate 5-10 years or more -
    to penetrate the market. Finally, even if the tax credits were to be effective in
    stimulating investment in clean coal technologies, such subsidies are an
    economically inefficient way of addressing either energy or environmental
    externalities.

    	Selected Bibliography

    Brown, Marilyn, Benjamin K. Sovacool, and Richard F. Hirsh. "Assessing
    U.S. Energy Policy."   Daedalus v. 135.  Summer 2006. Boston:  pp. 5- 12.
    Fri, Robert W. "From Energy Wish Lists to Technological Realities."
    Issues in Science and Technology, v. 23, Fall 2006;  Washington: pp. 63-69.
    Metcalf, Gilbert E.  Federal Tax Policy Towards Energy.  Paper prepared
    for the NBER conference on Tax Policy and the Economy.  September 14,
    2006.
    Lackner Klaus F.  "The Conundrum of Sustainable Energy: Clean Coal as
    One Possible Answer." Asian Economic Papers v. 4. Fall 2005.
    Lazzari, Salvatore.  Energy Tax Policy: History and Current Issues.
    Library of Congress, Congressional Research Service Report RL33578.
    Washington, DC: July 28, 2006.
    _. Energy Tax Policy: An Economic Analysis.  Library of Congress,
    Congressional Research Service Report RL30406.  Washington, DC: June 28,
    2005.
    U.S. Congress, Joint Committee on Taxation. Description and Technical
    Explanation of the Conference Agreement of H.R. 6, Title XIII, "The Energy
    Tax Incentives Act of 2005."  July 27, 2005.
    U.S. Department of Energy.  Office of Fossil Energy.  Clean Coal Today.
    DOE/FE-0215P.  Summer, 1998.
    U.S. General Accounting Office.  Outlook for Utilities' Potential Use of
    Clean Coal Technologies.  GAO/RCED-90-165, May 1990, p.3.
    U.S. Treasury Department.  Internal Revenue Service.  "Establishing
    Qualifying Advanced Coal Project Program." IRS Notice 2006-24.  Internal
    Revenue Bulletin. March 13, 2006.

    	Energy

    EXPENSING OF THE COST OF PROPERTY USED IN THE
    REFINERS OF LIQUID FUELS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    -

    (1)

    (1)

    2007

    -

    (1)

    (1)

    2008

    -

    0.1

    0.1

    2009

    -

    0.2

    0.2

    2010

    -

    0.3

    0.3

    (1) Less than $50 million.

    	Authorization

    Section 168(l), 179C.

    	Description

    Oil refineries are allowed to irrevocably elect to expense 50 percent of the
    cost of qualified refinery property, with no limitation on the amount of the
    deduction. The deduction would be allowed in the taxable year in which the
    refinery property is placed in service. The remaining 50 percent of the cost
    would remain eligible for regular cost recovery provisions. To qualify for the
    deduction: (1) original use of the property must commence with the taxpayer;
    (2) construction must be pursuant to a binding construction contract entered
    into after June 14, 2005, and before January 1, 2008, (ii) in the case of
    self-constructed property, construction began after June 14, 2005, and before
    January 1, 2008, or (iii) the refinery property is placed in service before
    January 1, 2008; (3) the property must be placed in service before January 1,
    2012; (4) the property must meet certain production capacity requirements if
    it is an addition to an existing refinery; and (5) the property must meet all
    applicable environmental laws when placed in service. Certain types of
    refineries, including asphalt plants, would not be eligible for the deduction,
    and there is a special rule for sale-leasebacks of qualifying refineries. If the
    owner of the refinery is a cooperative, it may elect to allocate all or a part of
    the deduction to the cooperative owners, allocated on the basis of ownership
    interests.  This provision is effective for qualifying refineries placed in service
    after date of enactment.

    Small refiners are also allowed two other tax incentives (which are
    discussed elsewhere in this compendium): a $2.10/barrel tax credit for the
    production of low-sulfur diesel fuel that is  in compliance with Environmental
    Protection Agency (EPA) sulfur regulations (IRC 45H); and expensing, in
    lieu of depreciation, for up to 75 percent of the capital costs incurred in
    producing low-sulfur diesel fuel that is in compliance with EPA sulfur
    regulations.

    This benefit is also allowed for property used to produce cellulosic biomass
    ethanol through 2012.

    	Impact

    Under current depreciation rules (the Modified Accelerated Cost Recovery
    System) refinery assets are generally depreciated over 10 years using the
    double declining balance method.  Allowing 50 percent of the cost of the
    refinery to be deducted immediately (expensed) rather than depreciated over
    the normal 10 year life reduces the cost of constructing a refinery by slightly
    under 5 percent for a taxpayer in the 35 percent  tax bracket. The present
    value of a 10-year, double declining balance depreciation per dollar of
    investment is $0.74 with an 8 percent nominal discount rate. For every dollar
    expensed, the benefit of expensing is to increase the present value of
    deductions by $0.26, and since half of the investment is expensed, the value is
    $0.13.  Multiplying this value by 35 percent leads to a 4.6 percent benefit as a
    share of investment.  The value would be larger with a higher discount rate.
    For example, at a 10 percent discount rate, the benefit would be 5.4 percent.
    The benefit is smaller for firms with limited tax liability or lower tax rates.

    Since the provision is temporary, there is an incentive to speed up the
    investment in refinery capacity so as to qualify it, unless the tax benefit is
    expected to be made permanent.  Nevertheless, the incentive to speed up
    investment is limited, because the effective price discount is small. Investing
    in excess capacity that would not otherwise be desirable would either leave
    the plant  idle or provide too much output and lower prices and profits for a
    period of time.  The latter cost should be at least as big as the cost of
    remaining idle.  With a five percent price discount, the interest cost of
    carrying excess capacity or losing profits would roughly offset the tax credit's
    value within a year.

    Refiners will, however, receive a windfall benefit on construction that
    would have taken place in the absence of the subsidy.

    	Rationale

    This provision was enacted in the Energy Policy Act of 2005 (P.L. 109-
    58).  Its purpose is to increase investments in existing refineries so as to
    increase petroleum product output, and reduce prices.  The provision
    extending the benefit to cellulosic biomass ethanol was added by H.R. 6111
    in February of 2006.

    	Assessment

    Economic theory suggests that investments should be treated in a neutral
    fashion to maximize economic well being. There is no obvious reason that the
    price of refined liquids should be subsidized, even for a temporary time.
    Indeed, there are pollution, congestion, and other external negative effects of
    the consumption of petroleum products that might suggest the reverse of a
    subsidy.

    The transitory subsidy, if indeed it remains transitory, would not have
    lasting effects and would lead to investments being made more quickly,
    resulting either in wasted investment or temporarily lower prices.  If the
    subsidy is continued, as has been the case with other tax provisions, then,
    absent other market distortions, overconsumption of petroleum products
    would occur.

    The effect on refinery construction is difficult to estimate. The precise
    effect depends on the price elasticity of investment with respect to changes in
    costs.  To illustrate, if such an elasticity were 1, then a 5.4 percent reduction
    in costs could be expected to increase refinery capital by 5.4 percent, which
    would translate into  a roughly 900 thousand barrels per day.  Such an
    increase, if it were to materialize, would increase domestic petroleum output
    and reduce prices.   However, recent evidence regarding a similar provision
    for equipment in general including refineries (bonus depreciation), which
    applied from 2002 through 2004, indicated that the response was not as large
    as hoped for and that, indeed, many firms did not appear to take advantage of
    the provision.  In addition, most estimates of the elasticity of investment
    response to a permanent change in the cost of capital goods suggest a fairly
    low response, on the order of 0.25, although one study has found a higher
    response of about 0.66.

    	Selected Bibliography

    Chirinko, Robert S., Steven M. Fazzarri, and Andrew P. Meyer.  "How
    Responsive is Business Capital Formation to its User Cost?  An Exploration
    with Micro Data?"  Journal of Public Economics vol. 74 (1999), pp. 53-80.
    	Cohen Darryl and Jason Cummins.  A Retrospective Evaluation of the
    Effects of Temporary Partial Expensing. Federal Reserve Board Staff
    Working Paper 2006-19, April 2006.
    Cordes, Joseph J.  "Expensing," in the Encyclopedia of Taxation and Tax
    Policy, Joseph J. Cordes, Robert D. Ebel, and Jane G. Gravelle, eds
    (Washington: Urban Institute Press, 2005).
    Jason G. , Kevin A. Hassett, and R. Glen Hubbard, "A Reconsideration of
    Behavior Using Tax Reforms as Natural Experiments."  Brookings Papers on
    Economic Activity, 1994, no. 1, pp. 1-72.
    Guenther, Gary.  Small Business Expensing Allowance: Current Status,
    Legislative Proposals, and Economic Effects.  CRS Report RL31852,
    October 3, 2006.
    Lazzari, Salvatore.  Energy Tax Policy: History and Current Issues.
    Library of Congress, Congressional Research Service Report RL33578.
    Washington, DC: July 28, 2006.
    _. Energy Tax Policy: An Economic Analysis.  Library of Congress,
    Congressional Research Service Report RL30406.  Washington, DC: June 28,
    2005.
    Pirog, Robert L. Petroleum Refining: Economic Performance and
    Challenges for the Future. Congressional Research Service Report RL32248.
     Washington: May 9, 2005
    Sterner, Thomas. Policy Instruments for Environmental and Natural
    Resource Management.  Resources for the Future, Washington, D.C. 2003.
    	U.S. Congress, Joint Committee on Taxation. Description and Technical
    Explanation of the Conference Agreement of H.R. 6, Title XIII, "The Energy
    Tax Incentives Act of 2005."  July 27, 2005.

    Energy

    DEDUCTION OF EXPENDITURES ON ENERGY-EFFICIENT
    COMMERCIAL BUILDING PROPERTY

    Estimated Revenue Loss

     [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    (1)

    (1)

    (1)

    2007

    0.1

    0.1

    0.2

     2008

    (1)

    (1)

    (1)

    2009

    (2)

    (2)

    (2)

    2010

    (2)

    (2)

    (2)

    (1)Less than $50 million.
    (2) Positive tax expenditure of less than $50 million.
    This provision was extended through 2008 by H.R. 6111 in December
    2006 with a revenue cost in fiscal years 2008 and 2009 of $0.1 billion.

    	Authorization

    Section 179D.

    	Description

    A new formula-based tax deduction is available for energy-efficient
    commercial building property expenditures made by the taxpayer, subject to a
    limit of $1.80 per square foot of commercial building space. The property
    must be installed as part of a plan to reduce the energy and power
    consumption of a commercial building by 50 percent. In the case of a building
    that does not meet the 50 percent energy savings target, a partial deduction is
    allowed. For some property, e.g., lighting systems, the deduction is pro-rated
    based on cuts in lighting power density. Qualifying property includes property
    installed as part of interior lighting systems, heating, cooling, ventilation and
    hot water systems, or the building envelope, to the extent certified as energy
    efficient. The cost basis of  the property, for purposes of depreciation, would
    be reduced by the amount of the deduction.
    The provision allows designers of the commercial building to claim this
    deduction if the energy efficiency items are installed in the buildings of
    nontaxable entities such as public schools. This provision is effective for
    property placed in service after December 31, 2005, and prior to January 1,
    2009.

    Impact

    Under current law there is no special tax advantage or break for
    expenditures on energy efficiency property used in a business. In general
    these types of expenses are part of businesses' assets, and hence are
    depreciable in accordance with the guidelines established by law and
    regulation, which vary by type of business. Under current depreciation rules
    (the Modified Accelerated Cost Recovery System), structures and structural
    components - such as heating/cooling systems and lighting - are
    depreciated over 39 years using the straight line method. Allowing a current
    deduction for energy efficient capital goods that would otherwise be
    depreciated over such a long period of time - that is, allowing expensing of
    the costs of such property - greatly accelerates, and increases the present
    value of, the deductions. This reduces effective tax rates and would normally
    encourage investment.  However, this deduction is in place for a relatively
    short period of time, just over 2 years, and given the 1) the long lead time for
    constructing commercial buildings, and 2) the complexity of determining the
    deduction, there is some question of its effectiveness in inducing investment
    in qualifying property.

    	Rationale

    This deduction was introduced by the Energy Policy Act of 2005 (P.L.
    109-58), to encourage  businesses to retrofit their commercial buildings with
    energy conserving components and equipment.  The goal was to enhance the
    energy efficiency of commercial buildings. The Energy Tax Act of 1978 (P.L.
    96-518) provided for a 10 percent investment tax credit for certain categories
    of property that conserved energy in industrial processes, which generally
    applied to the manufacturing and agricultural sectors. These types of property
    -  there were actually 13 categories -  were called specially defined energy
    property, but none included property for conserving energy in commercial
    buildings. These credits generally expired at the end of 1982.
    H.R. 6111 in December 2006 extended eligibility through 2008

    Assessment

    Commercial buildings include a wide variety of building types - such as
    offices, hospitals, schools, police stations, places of worship, warehouses,
    hotels, barber shops, libraries, shopping malls. These different commercial
    activities all have unique energy needs but, as a whole, commercial buildings
    use more than half their energy for heating and lighting. Electricity and
    natural gas are the most common energy sources used in commercial
    buildings, accounting for 90 percent of total commercial sector energy use.
    The commercial sector in the United States uses almost as much energy as the
    residential sector, about 18 percent in 2005, but yet it has not generally been
    the target of energy conservation incentives. As noted above, the (now
    expired) energy tax credits of 1978 targeted the industrial energy sector.

    There is no generally acknowledged market failure in the use of energy in
    commercial buildings or the production and investment in energy
    using/saving capital goods in such buildings that requires government
    intervention via subsidies. The business profit maximizing (and cost
    minimizing) objective is generally sufficient to invest in energy-saving capital
    when the rate of return on such investments is above the opportunity cost.
    From an economic perspective, allowing special tax benefits for certain types
    of investment or consumption can result in a misallocation of resources. The
    deduction under IRC  179D might be justified on the grounds of
    conservation, if consumption of energy resulted in negative effects on society,
    such as pollution. In general, however, it would be more economically
    efficient to directly tax energy fuels than to subsidize a particular method of
    achieving conservation.

    There may be a market failure in tenant-occupied homes, if the tenant pays
    for electricity separately.  In rental housing, the tenant and the landlord lack
    strong financial incentives to invest in energy conservation equipment and
    materials, even when the benefits clearly outweigh the costs, because the
    benefits from such conservation may not entirely accrue to the party
    undertaking the energy-saving expenditure and effort. Builders and buyers
    may also lack sufficient information, a problem which is discussed below.

    As a general rule, tenants are not going to improve the energy efficiency of
    a residence that does not belong to them, even if the unit is metered.  They
    sometimes make such improvements if the rate of return (or payback) is
    sufficiently large, but most tenants do not occupy rental housing long enough
    to reap the full benefits of the energy conservation investments. Part of the
    problem is also that it is not always easy to calculate the energy savings
    potential (hence rates of return) from the various retrofitting investments.
    Landlords may not be able to control the energy consumption habits of renters
    to sufficiently recover the full cost of the energy conservation expenditures,
    regardless of whether the units are individually metered. If the units are
    individually metered, then the landlord would generally not undertake such
    investments since all the benefits therefrom would accrue to the renters,
    unless a landlord could charge higher rents on apartments with lower utility
    costs.  If the units are not individually metered, but under centralized control,
    the benefits of conservation measures may accrue largely to the landlord, but
    even here the tenants may have sufficient control over energy use to subvert
    the accrual of any gains to the landlord.  In such cases, from the landlord's
    perspective, it may be easier and cheaper to forgo the conservation
    investments and simply pass on energy costs as part of the rents. Individual
    metering can be quite costly, and while it may reduce some of the distortions,
    it is not likely to completely eliminate them, because even if the landlord can
    charge higher rents, he may not be able to recover the costs of energy
    conservation efforts or investments.

    These market failures may lead to underinvestment in conservation
    measures in rental housing and provide the economic rationale for gross
    income exclusion under Internal Revenue Code (IRC) 136, as discussed
    elsewhere in this compendium.  Without such explicit exclusion, such
    subsidies would be treated as gross income and subject to tax. This exclusion,
    however, applies both to owner-occupied and to rental housing.

    	Selected Bibliography

    Brown, Marilyn  "Market Failures and Barriers as a Basis for Clean Energy
    Policies," Energy Policy, v. 29.  November 2001, pp. 1197-1207.
    Fisher, Anthony C., and Michael H. Rothkopf. "Market Failure and Energy
    Policy: A Rationale for Selective Conservation," Energy Policy, v. 17.
    August 1989, pp. 397-406.
    Hahn, Robert W. "Energy Conservation: An Economic Perspective."
    American Enterprise Institute, October 2005.
    Hassett, Kevin A., and Gilbert E. Metcalf.  "Energy Conservation
    Investment: Do Consumers Discount the Future Correctly?"  Energy Policy,
    v. 21.  June 1993, pp. 710-716.
    Howarth, Richard B. and Bo Anderson. "Market Barriers to Energy
    Efficiency." Energy Economics, October, 1993. pp. 262-292.
    Lazzari, Salvatore.  Energy Tax Policy: History and Current Issues.
    Library of Congress, Congressional Research Service Report RL33578.
    Washington, DC: July 28, 2006.
    _. Energy Tax Policy: An Economic Analysis.  Library of Congress,
    Congressional Research Service Report RL 30406.  Washington, DC: June
    28, 2005.
    Loskamp, Wendy. "Energy, Water Efficiencies and Savings Come From
    Meter Data Management." Energy Pulse.  Insight Analysis and Commentary
    on the Global Power Industry. 2006
    Metcalf, Gilbert E.  "Economics and Rational Conservation Policy."
    Energy Policy, v. 22.  October 1994, pp. 819-825.
    Sutherland, Ronald J.  "Energy Efficiency or the Efficient Use of Energy
    Resources."  Energy Sources, v. 16, pp. 257-268.

    Sutherland, Ronald J.  "The Economics of Energy Conservation Policy."
    Energy Policy, v. 24.  April 1996, pp. 361-370.
     U.S. Congress.  House. Committee on Energy and Commerce.  National
    Energy Policy: Conservation and Energy Efficiency. Hearings Before the
    Subcommittee on Energy and Air Quality. Washington, DC: U.S.
    Government Printing Office, June 22, 2001.
    U.S. Department of Energy. Lawrence Berkeley National Laboratory.
    "Energy Efficiency, Market Failures, and Government Policy."  Levine, Mark
    D. et al.  March 1994.
    U.S. Department of Energy.  Energy Information Administration. 1999
    Commercial Buildings Energy Consumption Survey-Commercial Buildings
    Characteristics. May 2006.
    U.S. Department of Energy.  Energy Information Administration. 2003
    Commercial Buildings Energy Consumption Survey-Overview of
    Commercial Buildings Characteristics. May 2002.
    U.S. Department of Energy. Monthly Energy Review.  October 2006.
    U.S. Department of Treasury.  Internal Revenue Service. "Deduction for
    Energy Efficient Commercial Buildings." Internal Revenue Bulletin.  Notice
    2006-52, June 26, 2006.

    Energy

    TAX CREDIT FOR THE PURCHASE OF QUALIFIED ENERGY
    EFFICIENCY IMPROVEMENTS TO EXISTING HOMES

    Estimated Revenue Loss

     [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.1

    -

    0.1

    2007

    0.3

    -

    0.3

     2008

    0.2

    -

    0.2

    2009

    (1)

    -

    (1)

    2010

    (1)

    -

    (1)

    (1)Less than $50 million.

    	Authorization

    Section 25C, 25D, and 45L.

    	Description

    A 10% tax credit is provided to home owners for the installation of
    qualified energy efficiency improvements and residential energy property
    expenditures. The maximum credit for a taxpayer with respect to the same
    dwelling is $500 for all taxable years, of which no more than $200 may be
    attributable to expenditures on windows. Qualified improvements are defined
    as any energy efficient building envelope component that meets the criteria
    set by the 2000 International Energy Conservation Code and is installed in or
    on a dwelling unit owned and used as the taxpayer's principal residence.
    Building envelope components include: (1) insulation materials or other
    systems designed to reduce the heat loss or gain, (2) exterior windows
    (including skylights), (3) exterior doors, and (4) any metal roof that has
    coatings designed to reduce heat gain.

    There are also tax credits for residential energy efficient property,
    including: a  $50 credit for each advanced main air circulating fan; a $150 tax
    credit for each qualified natural gas, propane, or oil furnace or hot water
    boiler; and a $300 credit each for qualifying electric heat pump water heaters,
    electric heat pumps, geothermal heat pumps, central air conditioners, and
    natural gas, propane or oil water heaters.

    The basis of the property would be required to be reduced by the amount
    of the credit. Special proration rules are applied for jointly owned property,
    condominiums, and cooperative housing corporations, and where less than
    80% of the property is used for nonbusiness purposes. Also, certain
    expenditures for labor are eligible.

    A 30% credit, not to exceed $2,000, is provided for home owners that
    purchase photovoltaic property used exclusively for residential purposes. A
    separate 30% credit is provided for residential solar water heating property
    other than property heating swimming pools and hot tubs. At least half of the
    energy produced by the solar water heating property must be derived from the
    sun. Also a 30% tax credit is provided for fuel cell power plants, not to
    exceed $1,000 for each kilowatt of capacity. The power equipment must have
    a  generation efficiency greater than 30% and a capacity of at least 0.5
    kilowatts. The power plant must also be installed on or in connection with a
    dwelling unit located in the United States and that is used by the taxpayer as a
    principal residence. The depreciable basis of the property must be reduced by
    the amount of the credit.  In addition, the credit applies to the basis remaining
    after subtracting any state subsidies (such as grants) or utility incentives
    claimed on the same property. Expenditures for labor costs are included.
    Certain equipment safety requirements must be met to qualify for the credit
    and special proration rules apply for jointly owned property, condominiums,
    and cooperative housing corporations, and where less than 80 percent of the
    property is used for nonbusiness purposes. All residential energy tax credits
    are effective for periods after December 31, 2005, and before January 1,
    2009.

    Finally, a new general business tax credit is available for the construction
    of qualified new energy-efficient homes if the homes achieve an energy
    savings of 50% over the 2003 International Energy Conservation Code. For
    manufactured homes, the required standard is a 30% energy savings. A
    $1,000 credit would be available for each manufactured home that is certified
    as having an annual heating and cooling energy consumption level that is at
    least 30% below the annual energy consumption level of a comparable
    dwelling unit, and $2,000 for a new home that has an annual heating and
    cooling energy consumption level that is at least 50% below the annual
    energy consumption level of a comparable dwelling unit. This credit is
    available only to contractors, and it is effective for homes whose construction
    is substantially completed after December 31, 2005, and which are purchased
    after December 31, 2005, and prior to January 1, 2009.

    Impact

    These tax credits provide an investment subsidy to  homeowners who
    invest in a variety of home energy conserving equipment and materials,
    including (1) more energy-efficient heating or cooling systems, water heaters,
    or envelope component materials such as insulation and storm windows or (2)
    energy production  systems such as solar or fuel cell systems. This subsidy
    helps to offset some of the purchase cost, which is generally higher than
    conventional energy equipment. The idea is to reduce the purchase price of
    qualifying equipment and thereby increase the rate of return or reduce its
    payback time. If the credits are to be effective, then the net present value of
    expected energy savings should equal the purchase price, net of the tax credits
    (or equivalently, the rate of return on the net purchase price should be higher
    than the opportunity cost of capital - the rate of return on the best alternative
    use of the capital outlay).

    	Rationale

    These provisions were established by the Energy Policy Act of 2005 (P.L.
    109-58) to encourage homeowners to retrofit their homes with energy
    efficient materials  - materials and property that reduce the heat loss during
    winter and cooling loss during summer -  and replace their energy using
    systems with either more energy efficient conventional systems or with solar
    energy or fuel cell systems.  These tax credits are very similar to those enacted
    under the Energy Tax Act of 1978 (P.L. 96-518) and which expired at the end
    of 1985.  The 1978 tax credits were part of President Carter's National
    Energy Program.  H.R. 6111 extended the 30% credit and the credit for new
    homes through 2008.

    More specifically, residential energy use for heating and cooling
    constitutes a significant fraction of total U.S. energy consumption, and
    therefore, measures to reduce heating and cooling requirements have the
    potential to reduce such consumption. Further, the Congress believed that
    many existing homes are not adequately insulated.  The tax credit for the
    construction of energy efficient homes is premised on the belief that the most
    cost-effective time to equip a home with energy efficient property is when it is
    under construction, and that the most effective mechanism to encourage the
    use of energy-efficient components in the construction of new homes is
    through an incentive to the builder.  Reduced home energy consumption will
    reduce imported oil and pollution.

    Assessment

    From an economic perspective, allowing special tax credits for certain
    targeted activities can distort the allocation of resources, encouraging
    investments that would not otherwise be economical at current and expected
    prices and rates of return.  Conversely, when home energy prices are high,
    many homeowners have sufficient financial incentives to undertake energy
    efficiency improvements without tax credits.  This results in a windfall for
    many households - a financial reward for doing something that the person
    would have done anyway - at taxpayers' expense.  This may not be a good
    use of taxpayer revenues, particularly during times of large budget deficits.
    Some recent data suggest that the demand for building insulation has
    increased rapidly due primarily to higher energy prices.

    The credits for solar and fuel cells tend to favor middle and upper income
    households as the technologies are expensive and require large outlays of
    capital. Thus, they may be questionable on distributional grounds. Generally,
    these technologies require grid backup in most areas where they are installed,
    and their return may be low or even negative. Such tax credits are often
    justified on the grounds of energy conservation, where consumption of energy
    results in negative effects on society, such as pollution. In general, however, it
    would be more economically efficient to directly tax energy fuels than to
    subsidize a particular method of achieving conservation measures.

    There are generally no acknowledged market failures in personal decisions
    to invest in energy efficient  capital goods or property for the home; nor is
    there a market failure to provide or supply such goods or property by the
    business sector.  The market generally works to supply such products and
    consumers readily invest in them as long as the rate of return is sufficient,
    which tends to be the case when home energy prices are high. There may be a
    market failure in decisions by builders to invest in appliances and other
    energy-using systems that  equip a new home or building. The builder's
    incentive is to use the least costly, i.e., what may be the least energy efficient,
    appliance since this leads to a lower price and more profit for each dwelling
    unit sold; this could leave the home buyer or investor with higher monthly
    energy bills. Such a  buyer of the new home might otherwise invest in the
    more expensive, but more energy saving appliances.

    There may be a market failure in tenant-occupied homes, if the tenant pays
    energy bills separately.  In rental housing, the tenant and the landlord lack
    strong financial incentives to invest in energy conservation equipment and
    materials, even when the benefits clearly outweigh the costs, because the
    benefits from such conservation may not entirely accrue to the party
    undertaking the energy-saving expenditure and effort.  Builders and buyers
    may also lack sufficient information (a problem which is discussed in more
    detail in Lazzari, CRS Report RL30406).

    	Selected Bibliography

    Brown, Marilyn.  "Market Failures and Barriers as a Basis for Clean
    Energy Policies," Energy Policy, v. 29.  November 2001, pp. 1197-1207.
    Clinch, J. Peter, and John D. Healy.  "Cost-Benefit Analysis of Domestic
    Energy Efficiency." Energy Policy, v. 29.  January 2000. pp.113-124.
    Fisher, Anthony C., and Michael H. Rothkopf.  "Market Failure and
    Energy Policy: A Rationale for Selective Conservation," Energy Policy, v. 17.
     August 1989, pp. 397-406.
    Hahn, Robert W. "Energy Conservation: An Economic Perspective."
    American Enterprise Institute, October 2005.
    Hassett, Kevin A., and Gilbert E. Metcalf.  "Energy Conservation
    Investment: Do Consumers Discount the Future Correctly?"  Energy Policy,
    v. 21.  June 1993, pp. 710-716.
    Howarth, Richard B., and Bo Anderson.  "Market Barriers to Energy
    Efficiency." Energy Economics, October, 1993. pp. 262-292.
    Lazzari, Salvatore.  Energy Tax Policy: History and Current Issues.
    Library of Congress, Congressional Research Service Report RL33578.
    Washington, DC: July 28, 2006.
    _. Energy Tax Policy: An Economic Analysis.  Library of Congress,
    Congressional Research Service Report RL 30406.  Washington, DC: June
    28, 2005.
    _. Energy Tax Provisions in the Energy Policy Act of 1992. Library of
    Congress, Congressional Research Service Report 94-525. Washington, DC:
    June 22, 1994.
    Metcalf, Gilbert E.  "Economics and Rational Conservation Policy."
    Energy Policy, v. 22.  October 1994, pp. 819-825.
    Pimental, D., A. Pleasant, et al.  "U.S. Energy Conservation and
    Efficiency: Benefits and Costs." Energy, Development, and Sustainability. v.
    6, September 2004. pp. 279-306.
    Scafidi, Catina M., and Anthony P. Curatola. "ETIA of 2005 and New
    Energy-Efficient Appliances." Strategic Finance. V. 87, June 2006.
    Montvale: pp. 16-18.
    Stern, Paul C. "Blind Spots in Policy Analysis: What Economics Doesn't
    Say About Energy Use."  Journal of Policy Analysis and Management, v.5.
    April 1986.  Pp200-227.
    Sutherland, Ronald J.  "Energy Efficiency or the Efficient Use of Energy
    Resources."  Energy Sources, v. 16, 1996. pp. 257-268.
    Sutherland, Ronald J.  "The Economics of Energy Conservation Policy."
    Energy Policy, v. 24.  April 1996, pp. 361-370.
    U.S. Congress, House. Report to Accompany H.R. 776, the Comprehensive
    Energy Policy Act.  Washington, DC: U.S. Government Printing Office,
    Report 102-474, Part 6,  pp. 35-37.
    -. House. Committee on Energy and Commerce.  National Energy Policy:
    Conservation and Energy Efficiency. Hearings Before the Subcommittee on
    Energy and Air Quality. Washington, DC: U.S. Government Printing Office,
    June 22, 2001.

    U.S. Department of Energy. Lawrence Berkeley National Laboratory.
    "Energy Efficiency, Market Failures, and Government Policy."  Levine, Mark
    D. et al.  March 1994.
    U.S. Department of the Treasury.  Internal Revenue Service.  Credit for
    Nonbusiness Energy Property.  Notice 2006-26.  March 13, 2006.

    Energy

    TAX CREDIT FOR THE PRODUCTION OF ENERGY-
    EFFICIENT APPLIANCES

    Estimated Revenue Loss

     [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    (1)

    0.1

    0.1

    2007

    (1)

    0.1

    0.1

     2008

    (1)

    -

    (1)

    2009

    (1)

    -

    (1)

    2010

    (1)

    -

    (1)

    (1)Less than $50 million.

    	Authorization

    Section 45M.

    	Description

    Internal Revenue Code section 45M provides a tax credit for the eligible
    production (manufacture) of certain energy-efficient dishwashers, clothes
    washers, and refrigerators. The credit for dishwashers is $3/dishwasher
    multiplied by the percentage by which the energy efficiency of the 2007
    standards (not yet known) exceeds that of the 2005 standards. The maximum
    credit is $100 per dishwasher. For example, if the 2007 standards exceed the
    2005 standards by 30%, the credit would be $90 per dishwasher.  The credit
    for dishwashers would apply to dishwashers produced in 2006 and 2007 that
    meet the Energy Star standards for 2007. Any residential dishwasher that
    exceeds the energy conservation standards established by the Department of
    Energy qualifies for the credit.

    The credit for clothes washers ranges from $50 to $200 per unit,
    depending on when the units were manufactured and the average water and
    energy savings.  The credits would be at least $100 for washers manufactured
    in 2006 and 2007 that meet the requirements of the Energy Star program in
    effect for clothes washers in 2007. A clothes washer would be any residential
    clothes washer, including a residential style coin operated washer, that
    satisfies the relevant efficiency standard.

    The credit for refrigerators ranges from $75-$150 each based on the
    amount of energy savings and the year of manufacture. The energy savings
    are determined relative to the energy conservation standards promulgated by
    the Department of Energy that took effect on July 1, 2001. Refrigerators that
    achieve a 15 percent to 20 percent energy saving and that are manufactured in
    2006 receive a $75 credit. Refrigerators that achieve a 20 percent to 25
    percent energy saving receive a $125 credit if manufactured in 2006 or 2007.
    Refrigerators that achieve at least a 25 percent energy saving receive a $175
    credit if manufactured in 2006 or 2007. A refrigerator must be an automatic
    defrost refrigerator-freezer with an internal volume of at least 16.5 cubic feet
    to qualify for the credit.

    In all cases, appliances eligible for the credit would include only those that
    exceed the average amount of production from the three prior calendar years
    for each category of appliance. Eligible production of refrigerators would be
    production that exceeds 110 percent of the average amount of production
    from the three prior calendar years. An eligible manufacturer (the taxpayer)
    may not claim credits in excess of $75 million for all taxable years, and may
    not claim credits in excess of $20 million with respect to refrigerators eligible
    for the $75 credit.  The credit allowed in a taxable year for all appliances may
    not exceed 2% of the average annual gross receipts of the taxpayer for the
    three taxable years preceding the taxable year in which the credit is
    determined. The appliance credit is part of the general business credit. It is
    claimed in concert with a variety of other business tax credits, and it is subject
    to the limits of those credits as well. This provision became effective for
    appliances produced after December 31, 2005, and it ends on December 31,
    2007.

    Impact

    The appliance tax credits provide a per-unit subsidy to those domestic
    companies (Whirlpool, General Electric, etc.) that manufacture energy-
    efficient appliances that qualify for the Energy Star program.  Appliances and
    other energy using items receive an Energy Star label from the Department of
    Energy if they use less energy than the minimum federal standard for that
    item. This subsidy helps to offset some of the cost of manufacturing such
    appliances, which are generally more costly than less energy efficient ones. In
    general, most of the energy saving appliances are also the more expensive and
    purchased more by relatively higher income households. The credit thus
    lowers the marginal and average costs of producing the more energy efficient
    appliances, which shifts production of such upscale appliances (and producers
    of such appliances) at the expense of the lower end models. This would
    generally lead to a lower market price to consumers - i.e., part of the
    production subsidy is shifted forward to consumers as a lower price net of the
    subsidy - but an increase in the total resource costs of producing the
    appliances inclusive of the  subsidy. This may raise questions about the
    distributional impacts of the appliance tax credits. It also shifts what are
    otherwise private production costs onto taxpayers.

    While not directly affecting consumers, manufacturers of energy efficient
    clothes washers, dishwashers and refrigerators are eligible for tax breaks
    themselves. The combination of production credits and energy savings from
    use of the more energy efficient products might spur additional sales and use.
    For example, homeowners might be induced to upgrade to the more energy-
    efficient appliances that qualify for the credit.

    	Rationale

    Section 45M was established by the Energy Policy Act of 2005 (P.L. 109-
    58) to encourage production of appliances that exceed the minimum federal
    energy-efficiency standards, and thus qualify for the federal Energy Star
    energy-efficiency program.

    Assessment

    From an economic perspective, allowing special tax credits for certain
    targeted activities distorts the allocation of resources, encouraging companies
    to undertake certain types of investments and production that would not
    otherwise be economical at current and expected prices and rates of return.
    For instance, the credits are targeted for only three of the many home
    appliances - they exclude, for instance, clothes dryers and range ovens.
    Studies have shown that clothes dryers consume four  times as much energy
    (in kilowatts per hour) than a refrigerator and 10 times more energy than a
    clothes washer. Also, since appliance manufacturers also have to comply with
    federal energy efficiency standards, the tax credits act as incentives to shift
    resources toward the more expensive and least economical appliance.  Some
    of the tax credits accrue to the manufacturer as increased profits and
    economic rents. The credits, thus, may be viewed as a form of corporate
    welfare, and are questionable on distributional grounds - they may provide
    more benefits to upper income households than to lower income ones. Such a
    program is often justified on the grounds of energy conservation, if
    consumption of energy resulted in negative effects on society, such as
    pollution. In general, however, it would be more efficient to directly tax
    energy fuels than to subsidize a particular method of achieving conservation.

    There are no generally acknowledged market failures in the production of
    energy efficient appliances and other capital goods. There may be a market
    failure in decisions by builders to invest in appliances and other energy using
    equipment to equip a building. The builder's incentive is to use the least
    costly, i.e., what may be the least energy efficient, appliance since this leads
    to a lower price and more profit for each dwelling unit sold, but whereas the
    builder does not have to pay the energy bills, the home buyer or investor has
    to make such monthly payments.  Such a  buyer of the new home might
    otherwise invest in the more expensive, but more energy saving, appliances.
    There are market failures in research and development and which serve as the
    economic rationale for the various tax subsidies for R&D expenditures as
    discussed elsewhere in this compendium.  R&D for energy-saving devices
    also qualifies for such subsidies.

    	Selected Bibliography

    Brown, Marilyn.  "Market Failures and Barriers as a Basis for Clean
    Energy Policies," Energy Policy, v. 29.  November 2001, pp. 1197-1207.
    Fisher, Anthony C., and Michael H. Rothkopf.  "Market Failure and
    Energy Policy: A Rationale for Selective Conservation," Energy Policy, v. 17.
     August 1989, pp. 397-406.
    Hahn, Robert W. "Energy Conservation: An Economic Perspective."
    American Enterprise Institute, October 2005.
    Hassett, Kevin A., and Gilbert E. Metcalf.  "Energy Conservation
    Investment: Do Consumers Discount the Future Correctly?"  Energy Policy,
    v. 21.  June 1993, pp. 710-716.
    Howarth, Richard B. and Bo Anderson.  "Market Barriers to Energy
    Efficiency." Energy Economics, October, 1993. pp. 262-292.
    Lazzari, Salvatore.  Energy Tax Policy: History and Current Issues.
    Library of Congress, Congressional Research Service Report RL33578.
    Washington, DC: July 28, 2006.
    _. Energy Tax Policy: An Economic Analysis.  Library of Congress,
    Congressional Research Service Report RL 30406.  Washington, DC: June
    28, 2005.
    _. Energy Tax Provisions in the Energy Policy Act of 1992. Library of
    Congress, Congressional Research Service Report 94-525. Washington, DC:
    June 22, 1994.
    Loskamp, Wendy. "Energy, Water Efficiencies and Savings Come From
    Meter Data Management.  Energy Pulse."  Insight Analysis and Commentary
    on the Global Power Industry.  http\www.energypulse.net.
    Metcalf, Gilbert E.  "Economics and Rational Conservation Policy."
    Energy Policy, v. 22.  October 1994, pp. 819-825.

    Pimental, D., A. Pleasant, et al.  "U.S. Energy Conservation and
    Efficiency." Energy, Development, and Sustainability.  V. 6, September 2004.
    pp. 279-306.
    Scafidi, Catina M., and  Anthony P. Curatola. "ETIA of 2005 and New
    Energy-Efficient Appliances." Strategic Finance. V. 87, June 2006.
    Montvale: pp. 16-18.
    Sutherland, Ronald J.  "Energy Efficiency or the Efficient Use of Energy
    Resources."  Energy Sources, v. 16, 1994.  pp. 257-268.
    Sutherland, Ronald J.  "The Economics of Energy Conservation Policy."
    Energy Policy, v. 24.  April 1996, pp. 361-370.
    U.S. Congress, House.  Committee on Energy and Commerce.  National
    Energy Policy: Conservation and Energy Efficiency. Hearings Before the
    Subcommittee on Energy and Air Quality. Washington, DC: U.S.
    Government Printing Office, June 22, 2001.
    U.S. Department of Energy. Lawrence Berkeley National Laboratory.
    "Energy Efficiency, Market Failures, and Government Policy."  Levine, Mark
    D. et al.  March 1994.

    Energy

    TAX CREDITS FOR ALTERNATIVE TECHNOLOGY
    VEHICLES

    Estimated Revenue Loss

     [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.2

    0.1

    0.3

    2007

    0.2

    0.1

    0.3

     2008

    0.1

    (1)

    0.1

    2009

    0.1

    (1)

    0.1

    2010

    (1)

    (1)

    (1)

    (1)Less than $50 million.

    	Authorization

    Section 30 and 30B.

    	Description

    Section 30B provides for a new system of nonrefundable tax credits for
    four types of so-called alternative technology motor vehicles: hybrid vehicles,
    advanced lean-burn technology vehicles,  alternative fuel vehicles, and fuel
    cell vehicles. Advanced technology vehicles (ATVs) may use either an
    alternative fuel or a conventional fuel (such as diesel) more efficiently. In
    general, they are less polluting than standard (non- advanced) motor vehicles.
     For each of the four vehicle types, the amount of the credits depend on
    vehicle weight class (passenger and light truck vs. heavy duty trucks) and
    either estimated lifetime fuel savings or the incremental (marginal) cost of the
    technology.

    Hybrid Vehicles and Advanced Lean-Burn Technology Vehicles. For
    hybrid and advanced lean- burn technology vehicles weighing less than 8,500
    pounds (i.e., for passenger cars or light trucks), the total credit consists of two
    components: a fuel economy credit, which ranges from $400-$2,400
    depending on the rated city fuel economy of the vehicle, and a conservation
    credit, which ranges from $250-$1,000 depending on estimated lifetime fuel
    savings. For both components, the comparison is made with a comparable
    2002 model year standard  gasoline powered vehicle. In addition, the
    conservation credit is based on the estimated lifetime fuel savings between the
    two vehicles  assumed to travel 120,000 miles.

    For qualified hybrid and advanced lean-burn technology vehicles weighing
    8,500 lbs or more, the credit is either 20, 30, or  40 percent of the marginal
    cost of the vehicle's advanced technology, subject to certain limits based on
    the precise vehicle weight. The precise percentage depends on the vehicle's
    fuel economy relative to a comparable gasoline or diesel powered vehicle.
    The marginal cost of the hybrid vehicle is the difference in the suggested
    manufacturer selling price between the hybrid vehicle and a gasoline or diesel
    powered vehicle comparable in weight, size, and use, as determined and
    certified by the manufacturer.

    In the case of hybrids and advanced lean-burn vehicles, there is a
    cumulative 60,000 limit imposed on the number of vehicles (all models of the
    hybrid or lean-burn type) sold by each manufacturer that are eligible for the
    credit. Once the cumulative limit is reached for either technology, the credit
    for that manufacturer begins to phase out during the second quarter after the
    limit is reached and is completely phased out - no credit is available - after
    the sixth quarter (the fourth quarter after the phase-out begins).  The credit is
    available for imported vehicles, but no credit is allowed for any vehicle used
    outside of the United States.

    Hybrid vehicles are defined as motor vehicles that draw propulsion energy
    from two onboard sources of stored energy: an internal combustion or heat
    engine using consumable fuel, and a rechargeable energy storage system. A
    qualifying hybrid vehicle must meet the applicable regulations under the
    Clean Air Act. For a vehicle with a gross vehicle weight rating of 6,000
    pounds or less (passenger cars and many light trucks), the applicable
    emissions standards are the Bin 5 Tier II emissions standards of the Clean Air
    Act. For a vehicle with a gross vehicle weight rating greater than 6,000
    pounds and less than or equal to 8,500 pounds, the applicable emissions
    standards are the Bin 8 Tier II emissions standards. The tax credit for hybrid
    vehicles is available for vehicles purchased after December 31, 2005, and
    before January 1, 2010.  A qualifying advanced lean-burn technology motor
    vehicle is one that incorporates direct injection, and achieves at least 125
    percent of the 2002 model year city fuel economy.  The 2004 and later model
    vehicles must meet or exceed certain Environmental Protection Agency
    emissions standards. A qualifying advanced lean- burn technology motor
    vehicle must be placed in service before January 1, 2011.

    Alternative Fuel Vehicles. The credit for new qualified alternative fuel
    motor vehicles is generally equal to 50 percent of the incremental cost of the
    technology, relative to a conventionally powered vehicle of the same class and
    size. The incremental cost depends on the vehicle's weight. However, a bonus
    credit of 30 percent is also provided for alternative fuel vehicles that also
    meet certain EPA emission standards. In all cases, the credit cannot exceed
    $4,000-$32,000 per vehicle depending on vehicle weight. A new qualified
    alternative fuel motor vehicle is defined as a motor vehicle that is capable of
    operating on an alternative fuel, defined as compressed natural gas, liquefied
    natural gas, liquefied petroleum gas, hydrogen, and any liquid at least 85
    percent of the volume of which consists of methanol. A reduced credit is
    available for mixed-fuel (flexible fuel) vehicles. The vehicle must be new and
     acquired by the taxpayer for use or lease, but nor for resale. The new credit
    for alternative fuel vehicles applies to purchases made between January 1,
    2006, and December 31, 2010. Alternative fuels also receive favorable tax
    treatment - a 50�/gallon equivalent of gasoline tax credits - against the
    federal excise tax.  Automakers also get credit toward meeting fuel economy
    standards by producing alternative fuel vehicles.

    Fuel Cell Vehicles. The credit for fuel cell vehicles ranges from $8,000
    ($4,000 if placed in service after 2009) to $40,000, depending on vehicle
    weight. If the new qualified fuel cell motor vehicle is a passenger automobile
    or light truck, the amount of the credit is increased if certain fuel efficiencies
    are met based on the 2002 model year city fuel economy for specified weight
    classes. A new qualified fuel cell motor vehicle is defined as a motor vehicle:
    (1) that is propelled by power derived from one or more cells that convert
    chemical energy into electricity by combining oxygen and hydrogen fuel that
    is stored on board the vehicle in any form; (2) that, in the case of a passenger
    automobile or light truck, receives an EPA certification; (3) the original use of
    which commences with the taxpayer; (4) that is acquired for use or lease by
    the taxpayer and not for resale; and (5) is made by a manufacturer.  The new
    credit for fuel cell vehicles applies to purchases made between January 1,
    2006, and December 31, 2014.

    For all of the above ATV types, businesses may qualify for the credits and
    the vehicles also qualify for depreciation treatment, although there are limits
    on the annual depreciation deductions, and the cost basis is reduced by the
    credit. Also, while the credits are available for the purchaser, in the event of a
    sale to a governmental agency or a tax-exempt organization - entities that
    pay no income tax, and therefore cannot benefit from the credits - the seller
    of the vehicle would receive the credit.

    Electric Vehicles. Finally, a 10 percent tax credit is available for the cost
    of an electric vehicle up to a maximum credit of $4,000. However, under
    phase-out provisions, only 25 percent of this credit ($1,000) is available in
    2006.  No credit is available after 2006.  This credit has been available since
    1992; the above advanced technology vehicles credits were enacted in 2005.

    Impact

    Substantial economic research over the years has demonstrated that lack of
    consumer demand for ATVs is the primary reason for the lack of market for
    these types of vehicles. This lack of consumer demand for ATVs, in turn, is
    generally due to five variables: 1) the high fixed, up-front costs (or purchase
    price) for the vehicle itself relative to the price of conventional vehicles; 2)
    the historically low price (real, inflation adjusted prices) of conventional fuels
    generally, and in relevant cases, the price of conventional fuels in relationship
    to the price of alternative fuels; 3) the variability in the price of oil, which
    translates into variability in the price of gasoline and diesel, and which
    increases the risk of alternative fuel investment and development,
    independent of the level of conventional fuels prices; 4) the additional risks
    associated with investing in or purchasing a relatively new, unknown, and
    unproven technology; and 5) the utility that consumers derive from an
    automobile's features that ATVs generally cannot provide at this time (due in
    various cases to poorer acceleration, smaller capacity, fewer refueling
    locations, possibly higher maintenance costs, and fewer model options).

    The new tax credits for the purchase of ATVs attempt to address one of
    these variables: the price of the vehicles. The credits should lead to a
    reduction in the price of the vehicles, relative to the price of conventional
    vehicles and increase the demand for them. The magnitude of the potential
    increase in consumer demand depends upon the magnitude of the price
    decline in response to the tax incentives and the price elasticity of demand for
    ATVs. These are basically unknown parameters at this time, but it seems
    reasonable that given the currently high costs of ATVs, current consumer
    demand is probably relatively elastic, which implies a sizeable responsiveness
    to potential price declines, if they actually take place.

    The new tax credits may also stimulate business investments in ATVs. A
    business's decision to invest is determined by three variables: 1) the rate of
    depreciation of its existing capital; 2) the demand for its output; and 3) the
    rate of return, after tax, on prospective investments. Assuming a given rate of
    depreciation and a continued market for its product, the decision to invest in
    any particular machine, equipment, or even a vehicle is determined by the
    after-tax rate of return on that prospective investment as compared to the cost
    of capital (which is basically the opportunity cost of capital, or the return on
    the best foregone investment alternative). Tax policy variables - the
    marginal statutory tax rate (including the alternative minimum tax), the
    effective investment tax credit, the system of depreciation, including any
    accelerated depreciation; the fraction of interest payments that are tax
    deductible; and effective tax rate on capital gains - all affect investment
    decisions through their effect on the marginal effective tax rate. The ATV
    credits are thus one of several variables that could affect the effective income
    tax rate on the marginal investment. The credit  increases the after-tax returns,
    which tends to stimulate investment demand, other things being equal. (Note
    that in both personal and business ATVs, future price declines in response to
    R&D tax incentives could increase the degree of responsiveness to the
    demand curve for ATVs.) However, under current depreciation rules there are
    two limitations as they apply to automobiles that may reduce the incentive
    effects of the ATV credits for businesses. First, there is a limit on the amount
    of a passenger vehicle that may be expensed under IRC section 179.  Second,
    there is a limit on the amount of a luxury automobile - ATVs would be
    classified as passenger automobiles for this purpose - that does not apply to
    a truck or SUV.  Thus, a business taxpayer that buys an SUV is not subject to
    these depreciation limits, while one that buys an ATV is.

    Finally, to the extent that the credits are effective in increasing demand for
    ATVs, there is a decline in petroleum use and importation. Fuel consumed in
    conventional motor vehicles accounts for the largest fraction of total
    petroleum consumption and is a leading source of dependence on foreign oil.
     ATVs are also generally less polluting, producing significantly lower total
    fuel cycle emissions when compared to equivalently sized conventional
    vehicles.

    	Rationale

     Section 30B was enacted as part of the Energy Policy Act of 2005 (P.L.
    109-58) to stimulate the demand for more fuel efficient and environmentally
    clean automobiles. The Congress believed that further investments in
    alternative fuel and ATVs are necessary to transform the mode of
    transportation in the United States toward more clean fuel efficient vehicles,
    relying less on petroleum. This would reduce petroleum consumption and
    importation, which endangers U. S. energy and economic security. In this
    regard, hybrids and alternative fueled vehicles (e.g., ethanol fueled vehicles)
    were viewed as the short term options; advanced lean-burn and fuel cell
    vehicles were viewed as the long-term options. The Energy Policy Act of
    1992 (P.L. 102-486) introduced a $2,000 tax deduction for passenger vehicles
    that run on alternative fuels (up to a $50,000 for heavy duty trucks), and also
    established a tax credit for electric vehicles. Under an administrative ruling by
    the Internal Revenue Service (Revenue Procedure 2002-42), purchasers of
    model year 2000-2006 hybrid vehicles were allowed to claim the clean-fuel
    vehicle deduction, which expired on January 1, 2006.

    Both the $4,000 electric car credit, and the alternative fuel vehicle
    deduction were subject to a phase out evenly over a 3-year period beginning
    in  2004 and ending in 2006.  This original phase-down schedule was
    modified in the Job Creation and Worker Assistance Act of 2002, which
    extended it from the 2002-2004 period to the 2004-2006 period. Early
    versions of the Jobs and Growth Tax Relief Reconciliation Act of 2003
    proposed to further extend the phase-down period to the 2005-2007 three-
    year period, but the provision was dropped from the bill. The Energy Policy
    Act of 2005 allowed the deduction to sunset at the end of 2005; the electric
    vehicle tax credit sunsets in 2006.

    Assessment

    From 2000-2006 the demand for hybrid passenger automobiles
    (particularly, the demand for the Toyota Prius and Honda Insight) increased
    rapidly, mostly in response to the rapid runup of gasoline prices but also at
    least in part due to the incentive effects of the $2,000 federal deduction.
    Hybrid vehicles are priced somewhat higher than gasoline-powered cars of
    comparable size and quality, but the $2,000 tax deduction reduced the net
    price to the point that they became competitive. Also, there are numerous
    federal, state, and local government programs (such as fleet requirements) that
    have stimulated the use of hybrids (and, in some cases, alternative fuel
    vehicles).

    As to the effects of the new tax credits, which replaced the deduction, the
    presumption is that they have had some stimulative effect. Toyota, for
    example, reached the 60,000 vehicle limit by the second quarter of 2006,
    three and one-half years before the expiration of the hybrid credit. Still, while
    the ATV tax credits had some effect on demand for hybrids, it is difficult (and
    probably premature) to assess the relative effects of the tax credits and the
    recent high petroleum prices on the demand for hybrids. The importance of
    petroleum prices is further suggested, however, by the following evidence: 1)
    despite the phase-down of the deduction, which began on January 1, 2004,
    the demand for hybrids stayed at fairly sustained levels, and even increased
    before January 1, 2006, the date that the new tax credits became effective;
    and 2) the demand for the larger, and less fuel efficient, hybrids such as
    hybrid Sport Utility Vehicles has been less than the smaller hybrids. With the
    exception of hybrid cars, relatively few AFVs have been sold that qualify for
    the deduction. The limited availability of fuel cell, advanced lean-burn
    vehicles, and other ATVs, and the 60,000 output limit on the number of
    creditable hybrids means that the tax credits will likely have little direct
    impact on the total U.S. demand for transportation petroleum demand. With
    the exception of Toyota, other hybrid manufacturers are nowhere near the
    60,000 limit, which means that the tax credits for the purchasers of their
    hybrid should continue to be available.

     There is also a concern that the credits have favored foreign at the expense
    of domestic auto manufactures, because the demand for hybrids has been met
    primarily by imports.  Very few of the hybrid vehicles receiving the tax
    credits have been manufactured by domestic auto companies. In the short run,
    domestic automobile companies have favored production of flexible-fuel
    vehicles (particularly vehicles that can use E85 - mixtures of 15 percent
    gasoline and 85 percent ethanol) rather than hybrids; in the long run they
    appear to be putting their research and development efforts (and spending)
    into hydrogen fuel-cell technologies, which create electricity through an
    electrochemical reaction between hydrogen and oxygen. Given the current
    rudimentary state of development of fuel cell vehicles and hydrogen fueling
    infrastructure required for their use, and given the many technological and
    cost barriers to this development, however, it is unlikely that the tax credit for
    fuel cell vehicles will stimulate much demand. However, if these problems
    could be addressed, then tax credits that reduce the price of fuel cell vehicles
    to the comparable gasoline vehicle price could stimulate demand for fuel cells
    and reduce petroleum consumption. To the extent that the ATV credits accrue
    to flexible fuel vehicles there is some concern that consumers will continue to
    use gasoline in those vehicles rather than E85.  Available data suggest that
    very few such vehicles actually use E85, which is not only more expensive
    than gasoline, but is scarce due to the lack of supply infrastructure.  This
    means that, in effect, the ATV tax credits are actually encouraging the
    demand for conventionally powered domestic vehicles.

    From an economic perspective, allowing special tax credits for selected
    technologies (and not others)  distorts the allocation of resources - it creates
    economic inefficiencies and distortions. It encourages investments in high
    cost technologies, ones that would not otherwise be economical at current and
    expected prices and rates of return. For businesses this requires retooling and
    the cost of commercialization. Some data indicate that the cost of hybrids is
    greater than the retail selling price - that manufacturers are losing money on
    hybrids. This cost premium is, in part, due to the higher cost of hybrid power
    train components.  Conversely, when motor fuel  prices are high, many
    motorists have sufficient financial incentives to purchase more fuel efficient
    vehicles, such as hybrids, without tax credits. This results in a windfall for
    many consumers - a financial reward for undertaking investments that
    would have been undertaken even without the credits - at taxpayer's
    expense. This may not be a good use of taxpayer revenues, particularly during
    times of large federal budget deficits.

    Some of the ATVs that qualify for the tax credits are not only imported but
    are very expensive and would tend to be purchased by upper income
    households or businesses, which raise questions of the distributional effects of
    the credits: For example, such an imported vehicle may sell for $55,000 or
    more. The credits might tend to favor middle and upper income households,
    or businesses that have the income and wealth to invest in such expensive
    ATVs. Such tax credits are often justified on the grounds of energy
    conservation, if consumption of energy resulted in negative effects on society,
    such as pollution. In general, however, it would be more efficient to directly
    tax energy motor fuels or gas guzzlers than to subsidize a particular method of
    achieving conservation measures.

    	Selected Bibliography

    Bearden, David M.  EPA's Tier 2 Emission Standards for New Motor
    Vehicles: A Fact Sheet, U.S. Library of Congress.  Congressional Research
    Service. CRS Report RS20247.  June 12, 2000.
    European Commission. Urban Transport: Options for Propulsion Systems
    and Instruments for Analysis.  March 22, 2001.  (Contract No. UR-97-SC-
    2076), p. 64, 65.
    Fisher, Anthony C., and Michael H. Rothkopf.  "Market Failure and
    Energy Policy: A Rationale for Selective Conservation," Energy Policy, v. 17.
     August 1989, pp. 397-406.
    Graham, R.  Comparing the Benefits and Impact of Hybrid Electric
    Vehicle Options.  EPRI Report # 1000349.  July 2001.
    Hahn, Robert W. "Energy Conservation: An Economic Perspective."
    American Enterprise Institute, October 2005.
    Hassett, Kevin A., and Gilbert E. Metcalf.  "Energy Conservation
    Investment: Do Consumers Discount the Future Correctly?"  Energy Policy,
    v. 21.  June 1993, pp. 710-716.
    Lazzari, Salvatore.  Energy Tax Policy: History and Current Issues.
    Library of Congress, Congressional Research Service Report RL33578.
    Washington, DC: July 28, 2006.
    _. Energy Tax Policy: An Economic Analysis.  Library of Congress,
    Congressional Research Service Report RL 32265. Washington, DC: March
    10, 2004.
    _. Expired and Expiring Energy Tax Incentives. Library of Congress,
    Congressional Research Service Report 94-525. Washington, DC: June 22,
    1994.
    Metcalf, Gilbert E. "Economics and Rational Conservation Policy."
    Energy Policy, v. 22. October 1994, pp. 819-825.
    Pimental, D. and A. Pleasant, et al.  "U.S. Energy Conservation and
    Efficiency." Energy, Development, and Sustainability. v. 6, September 2004.
    pp. 279-306.
    Sutherland, Ronald J.  "Energy Efficiency or the Efficient Use of Energy
    Resources."  Energy Sources, v. 16, 1994. pp. 257-268.
    Sutherland, Ronald J.  "The Economics of Energy Conservation Policy."
    Energy Policy, v. 24.  April 1996, pp. 361-370.
    U.S. Department of Energy. TAFV Alternative Fuels and Vehicle Choice
    Model Documentation.  Prepared for Oak Ridge National Laboratory
    (ORNL/TM-2001/134), by David L. Greene.  July, 2001.
    U.S. Department of the Treasury. Internal Revenue Service. IRS News
    Release: IR-2006-145.  September 20, 2006.
    U.S. Department of the Treasury. Internal Revenue Service. IRS Notice:
    2006-78. Cumulative Bulletin 2006-41.  October 10, 2006.
    Yacobucci, Brent. Alternative Transportation Fuels and Vehicles: Energy,
    Environment, and Developmental Issues. U.S. Library of Congress.
    Congressional Research Service.  CRS Report RL 30758, January 7, 2005.

    Yacobucci, Brent D. Advanced Vehicle Technologies: Energy,
    Environment, and Developmental Issues.  U.S. Library of Congress:
    Congressional Research Service. CRS Report RL 30484, December 17, 2004.
    Yacobucci, Brent D. Tax Incentives for Alternative and Advanced
    Technology Vehicles. U.S. Library of Congress:  Congressional Research
    Service. CRS Report RL 22351, December 19, 2005.

    Energy

    TAX CREDITS FOR CLEAN FUEL VEHICLE
    REFUELING PROPERTY

    Estimated Revenue Loss

     [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    (1)

    (1)

    (1)

    2007

    (1)

    (1)

    (1)

     2008

    (1)

    (1)

    (1)

    2009

    (1)

    (1)

    (1)

    2010

    (1)

    (1)

    (1)

    (1)Less than $50 million.

    	Authorization

    Section 30C.

    	Description

    A 30 percent tax credit is provided for the cost of any qualified alternative
    fuel vehicle refueling property installed in a business or at the taxpayer's
    principal residence. The credit is limited to $30,000 for businesses at each
    separate location, and $1,000 for residences. Clean fuel refueling property is
    basically any tangible equipment (such as a pump) used to dispense a fuel
    into a vehicle's tank. Qualifying property includes fuel storage and dispensing
    units and electric vehicle recharging equipment. A clean fuel is defined as any
    fuel at least 85 percent of the volume of which consists of ethanol (E85) or
    methanol (M85), natural gas, compressed natural gas (CNG), liquefied
    natural gas, liquefied petroleum gas, and hydrogen, or any mixture of
    biodiesel and diesel fuel, determined without regard to any use of kerosene
    and containing at least 20 percent biodiesel. The taxpayer's basis in the
    property is reduced by the amount of the credit. No credit is available for
    property used outside the United States.

    Only the portion of the credit attributable to property subject to an
    allowance for depreciation would be treated as a portion of the general
    business credit; the remainder of the credit would be allowable to the extent
    of the excess of the regular tax (reduced by certain other credits) over the
    alternative minimum tax for the year. This credit is effective for property
    placed in service after December 31, 2005, and in the case of property
    relating to hydrogen, before January 1, 2015; and in the case of any other
    property, before January 1, 2010.

    Impact

    Under current depreciation rules (the Modified Cost Recovery System) the
    cost of most equipment used in retail gasoline and other fuel dispensing
    stations is generally recovered over five years using the double-declining
    balance method. However, some of the property might be classified
    differently and have a longer recovery period. For example, concrete footings
    and other "land improvements" have a recovery period of nine years.
    Alternatively, under IRC section 179, a small business fuel retailer may elect
    to expense up to $100,000 of such investments. Allowing a 30 percent
    investment tax credit for alternative fuel dispensing equipment greatly
    reduces the after-tax cost, raises the pre-tax return, and reduces the marginal
    effective tax rates significantly. This should increase investment in alternative
    fuel dispensing equipment and increase the supply of alternative fuels.

    To the extent that the credits are effective in increasing the supply of
    alternative fuels, and substitute for petroleum products (gasoline and diesel
    fuel), there is a decline in petroleum use and importation. Fuel consumed in
    conventional motor vehicles accounts for the largest fraction of total
    petroleum consumption and is a leading source of dependence on foreign oil.
    Alternative fuel vehicles are also generally less polluting, producing
    significantly lower total fuel cycle emissions when compared to equivalently
    sized conventional vehicles.

    	Rationale

     Section 30C was enacted as part of the Energy Policy Act of 2005 (P.L.
    109-58) to stimulate the supply of alternative motor fuels such as E85
    (mixtures of 15 percent gasoline and 85 percent ethanol) and CNG. The
    provision complements the two other major tax incentives for alternative
    fuels: the tax credits for advanced technology vehicles, including alternative
    fueled vehicles, under IRC section 30B, and the tax credits for the sale or use
    of the alternative fuel under IRC section 6426 and 6427. The Congress
    believed that further investments in alternative fuel infrastructure are
    necessary to encourage consumers to invest in alternative fuel vehicles. This
    investment, in turn, is necessary to transform the mode of transportation in the
    United States toward more clean fuel efficient vehicles, relying less on
    petroleum, particularly imported petroleum, which endangers U.S. energy and
    economic security. The Energy Policy Act of 1992 (P.L. 102-486) introduced
    a $100,000 tax deduction for business investment in clean fuel refueling
    property. This tax deduction was set to expire on January 1, 2007, but the
    Energy Policy Act of 2005 accelerated the expiration date by one year and
    replaced the deduction with the 30% tax credit.

    Assessment

    Substantial economic research over the years suggests that lack of
    investment in alternative fuel supply is due, at least in part, to lack of
    consumer demand for the vehicles, which was in turn due to the lack of
    alternative fuel infrastructure. The section 30C tax credit for clean fuel
    refueling property was intended to address this market obstacle to alternative
    fuel production and use. In the short run, domestic automobile companies
    have favored production of flexible-fuel vehicles (particularly vehicles that
    can use E85). To the extent that the ATV credits under IRC section 30B
    accrue to flexible fuel vehicles, there is some concern that consumers will
    continue to use gasoline in those vehicles rather than E85.  Available data
    suggest that very few such vehicles actually use E85, which is not only more
    expensive than gasoline, but is scarce due to the lack of supply infrastructure.
    This finding means that, in effect, the ATV tax credits may actually
    encourage the demand for vehicles that end up running on conventional fuels.

    Recent data show, for instance, that of the 120,000 fuel retailers in the
    United States, only about 600 dispense E85. The 30 percent tax credit for
    alternative fuel property at refueling stations could address this shortage and
    market problem to the development of alternative fuels. Given the current
    rudimentary state of development of E85 and other alternative fuel refueling
    infrastructure required for their use, and given the many technological and
    cost barriers to this development, the tax credit might stimulate additional
    investment. Greater (and more convenient) supply of alternative fuels could
    then reduce their price, stimulate demand for alternative fuels, and reduce
    petroleum consumption and importation.

    From an economic perspective, however, allowing special tax credits for
    selected technologies (and not others)  distorts the allocation of resources - it
    creates distortions and economic inefficiencies. It encourages investments in
    high cost technologies, ones that would not otherwise be economical at
    current and expected prices and rates of return.  Economic theory suggests
    that taxes on conventional fuels and conventional fuels using vehicles, such as
    the gas-guzzler tax of IRC section 4064, is more effective and efficient in
    stimulating the development of the least cost alternatives to gasoline and
    diesel fuel. When conventional motor fuel  prices are sufficiently high, many
    motorists have sufficient financial incentives to purchase more fuel efficient
    vehicles, and vehicles fueled by alternative fuels, without tax credits.

    	Selected Bibliography

    European Commission. Urban Transport: Options for Propulsion Systems
    and Instruments for Analysis.  March 22, 2001. (Contract No. UR-97-SC-
    2076), p. 64, 65.
    Boes, Richard F., and G. Michael Ransom. "Clean-Fuel Vehicles and
    Refueling Property in the United States Tax Code." Logistics and
    Transportation Review. March 1994.v.30.  pp. 73-79.
    Chirinko, Robert S., Steven M. Fazzarri, and Andrew P. Meyer.  "How
    Responsive is Business Capital Formation to its User Cost?  An Exploration
    with Micro Data."  Journal of Public Economics vol. 74 (1999), pp. 53-80.
    	Cohen, Darryl, and Jason Cummins.  A Retrospective Evaluation of the
    Effects of Temporary Partial Expensing. Federal Reserve Board Staff
    Working Paper 2006-19, April 2006.
    Cordes, Joseph J.  "Expensing," in the Encyclopedia of Taxation and Tax
    Policy, Joseph J. Cordes, Robert D. Ebel, and Jane G. Gravelle, eds
    (Washington: Urban Institute Press, 2005).
    Cummins, Jason G., Kevin A. Hassett, and R. Glenn Hubbard, "A
    Reconsideration of Investment Behavior Using Tax Reforms as Natural
    Experiments."  Brookings Papers on Economic Activity, 1994, no. 1, pp. 1-
    72.
    Guenther, Gary.  Small Business Expensing Allowance: Current Status,
    Legislative Proposals, and Economic Effects.  CRS Report RL31852,
    October 3, 2006.
    Lazzari, Salvatore.  Energy Tax Policy: History and Current Issues.
    Library of Congress, Congressional Research Service Report RL33578.
    Washington, DC: July 28, 2006.
    _. Energy Tax Policy: An Economic Analysis.  Library of Congress,
    Congressional Research Service Report RL 32265. Washington, DC: March
    10, 2004.
    _. Expired and Expiring Energy Tax Incentives. Library of Congress,
    Congressional Research Service Report 94-525. Washington, DC: June 22,
    1994.
    U.S. Department of Energy. TAFV Alternative Fuels and Vehicle Choice
    Model Documentation.  Prepared for Oak Ridge National Laboratory
    (ORNL/TM-2001/134), by David L. Greene.  July, 2001.
    "Tax Briefing: A Look at the Energy Tax Incentives Act of 2005 and the
    SAFE Transportation Equity Act of 2005." Taxes. September 2005. v. 83.
    pp. 19-27.
    Yacobucci, Brent. Alternative Transportation Fuels and Vehicles: Energy,
    Environment, and Developmental Issues. U.S. Library of Congress.
    Congressional Research Service.  CRS Report RL 30758, January 7, 2005.

    Yacobucci, Brent D. Advanced Vehicle Technologies: Energy,
    Environment, and Developmental Issues.  U.S. Library of Congress:
    Congressional Research Service. CRS Report RL 30484, December 17, 2004.
    Yacobucci, Brent D. Tax Incentives for Alternative and Advanced
    Technology Vehicles. U.S. Library of Congress:  Congressional Research
    Service. CRS Report RL 22351, December 19, 2005.

    Energy

    FIVE-YEAR CARRYBACK PERIOD FOR CERTAIN
    NET OPERATING LOSSES OF
    ELECTRIC UTILITY COMPANIES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    -

    0.1

    0.1

    2007

    -

    (1)

    (1)

    2008

    -

    (1)

    (1)

    2009

    -

    (2)

    (2)

    2010

    -

    (2)

    (2)

    (1) Tax expenditure of less than $50 million.
    (2) Negative tax expenditure of less than $50 million.

    	Authorization

    Section 172.

    	Description

    Certain electric utility companies may elect to extend the Net Operating
    Loss (NOL) carryback period to five years for a portion of NOLs arising in
    2003, 2004 and 2005. The election applies to the 2006-2008 taxable years,
    and is limited to 20 percent of the taxpayer's transmission and pollution
    control investments during the prior taxable year. There are various other
    limitations.

    	Impact

    The net operating loss (NOL) of a business enterprise is generally the
    amount by which tax deductions exceed gross revenue. In general, for most
    businesses, NOLs may be carried back two years and forward 20 years.
    However, special NOL carryback rules apply to (1) casualty and theft losses
    of individual taxpayers, (2) NOLs in a farming or small business due to
    (presidentially declared) disasters, (3) selected types of farm losses, (4) real
    estate investment trusts, (5) special liability losses, (6) excess interest losses,
    and (7) bad debt losses of commercial banks. For these 7 categories of NOLs,
    the carryback period is three years instead of two.

    A carryback is more valuable than a carry-forward, because there is no
    delay in receiving the benefit of the loss deduction.  For example, at a 10%
    discount rate, a dollar received one year into the future is worth only 91 cents;
    a dollar received five years into the future is worth 62 cents, and a dollar
    received 20 years into the future is worth 15 cents.  If the losses were
    expected to never be used, the value of the loss deduction is zero.

    The loss carryback not only provides some cash flow benefits to the firm,
    but also, because it is limited to 20 percent of prior year investment in
    qualified property, provides the equivalent of an investment credit.  For
    example, if the losses are expected to be delayed five years and the taxpayer's
    tax rate is 35 percent, another dollar of qualified investment would yield an
    NOL deduction valued at the equivalent of a 2.7 percent investment tax
    credit, i.e., 2.7 cents [($1-0.62) times 0.2 times 0.35)].  The maximum
    investment tax credit equivalent value for the NOL under this provision (for
    losses that were expected to expire) is 7 percent, i.e., under the most favorable
    assumptions, the five-year carryback of NOLs for electric utilities is
    equivalent to an investment tax credit of 7 percent. The exact nature of the
    investment subsidy is, however, difficult to determine, since the amount of
    losses is limited and can be applied to different years. Which of the two
    ceilings is reached first, therefore, determines the value of the investment
    subsidy.

    	Rationale

    The NOL deduction has been a part of the federal tax code for a long time.
     In general, the rationale for allowing NOLs to be carried forward and back is
    to try to achieve symmetry in tax treatment between businesses with stable
    incomes and those whose incomes are more variable but average the same
    over time.  Without this deduction, there would be disparity in tax treatment
    between these types of businesses. The five year carryback of electric utility
    losses was enacted as part of the Energy Policy Act of 2005 (P.L. 109-58).

    There is no explicit statement of rationale for this provision.  The initial
    provision, which was originally in the Senate bill and limited to all
    investment, appeared in the Joint Tax Committee explanation to be viewed as
    an extension of an earlier relief provision rather than an investment incentive.
     This earlier provision in the Job Creation and Worker Assistance Act of 2002
    (P.L. 107-147) provided for a temporary extension of the carryback period
    from two to five years for all firms, for NOLs generated (or reported) in 2001
    and 2002.  In this case, the special treatment was apparently intended to
    address the economic hardship of many electric utilities at a time of faltering
    restructuring and deregulation.

    	Assessment

    This provision is a combination of a relief provision for firms with tax
    losses and an investment subsidy (due to the investment limit). Both the need
    for utilities to handle restructuring costs and the desirability of an investment
    incentive, as well as their inter-relationship, must be addressed. One could
    make a case that some difficulties facing utilities were the result of changes in
    government regulation, and some relief is warranted. Providing a loss
    carryback is one way to target such relief.

    A case may be made for a subsidy to investment in electric transmission
    assets based on the under supply of transmission services by a natural
    monopoly. However, in this regard, the juxtaposition of the carryback with a
    limit based on investment is difficult to justify as the investment subsidy
    applies only to firms with losses. Those utilities most in need of relief are
    probably least likely to have significant current capital investment, if their
    losses arose from an excess capacity arising from prior investment. Nor is
    there a clear reason to restrict an investment subsidy, if one is desired, to
    firms in loss positions.  Also,  economically efficient pollution control is
    better achieved by a tax on pollution rather than an investment subsidy.

    	Selected Bibliography

    Brumbaugh, David L. Federal Taxes, the Steel Industry, and Net
    Operating Loss Carryforwards.  Library of Congress.  Congressional
    Research Service Report 88-5 E.  Washington, DC: December 18, 1987.
    Abel, Amy. Energy Policy Act of 2005, P.L. 109-58: Electricity
    Provisions. Congressional Research Service Report  RL33248.  Washington,
    DC: January 24, 2006.
    Joskow, Paul L. "Restructuring, Competition, and Regulatory Reform in
    the U.S. Electricity Sector," Journal of Economic Perspectives. Summer
    1997. pp. 119-138.

    Mills, Lillian F., Kaye J. Newberry, and  Garth F. Novack. "How Well Do
    Compustat NOL Data Identify Firms With U.S. Tax Return Loss Carryovers?
     The Journal of the American Taxation Association. v.25, Fall 2003. pp.1-17.
    U.S. Congress, Joint Committee on Taxation. Federal Tax Issues Relating
    to Restructuring of the Electric Power Industry. Hearing before the
    Subcommittee on Long-Term Growth and Debt Reduction of the Senate
    Finance Committee, October 15, 1999. JCX 72-99.

    	Natural Resources and Environment

    	EXCESS OF PERCENTAGE OVER COST DEPLETION:
    	NONFUEL MINERALS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.1

    0.1

    0.2

    2007

    0.1

    0.1

    0.2

    2008

    0.1

    0.1

    0.2

    2009

    0.1

    0.1

    0.2

    2010

    0.1

    0.1

    0.2

    	Authorization

    Sections 611, 612, 613, and 291.

    	Description

    Firms that extract minerals, ores, and metals from mines are permitted a
    deduction to recover their capital investment, which depreciates due to the
    physical and economic depletion of the reserve as the mineral is recovered
    (section 611).

    There are two methods of calculating this deduction: cost depletion, and
    percentage depletion.  Cost depletion allows for the recovery of the actual
    capital investment -  the costs of discovering, purchasing, and developing a
    mineral reserve - over the period during which the reserve produces income.
     Each year, the taxpayer deducts a portion of the adjusted basis (original
    capital investment less previous deductions) equal to the fraction of the
    estimated remaining recoverable reserves that have been extracted and sold.
    Under this method, the total deductions cannot exceed the original capital
    investment.

    Under percentage depletion, the deduction for recovery of capital
    investment is a fixed percentage of the "gross income" -  i.e., sales revenue
    - from the sale of the mineral. Under this method, total deductions typically
    exceed the capital invested.

    Section 613 states that mineral producers must claim the higher of cost or
    percentage depletion. The percentage depletion allowance is available for
    many types of minerals, at rates ranging from 5 percent (for clay, sand, gravel,
    stone, etc.) to 22 percent (for sulphur, uranium, asbestos, lead, etc.).

    Metal mines generally qualify for a 14 percent  depletion, except for gold,
    silver, copper, and iron ore, which qualify for a 15 percent depletion. The
    percentage depletion rate for foreign mines is generally 14 percent.

    Percentage depletion is limited to 50percent of the taxable income from the
    property. For corporate taxpayers, section 291 reduces the percentage
    depletion allowance for iron ore by 20 percent. Allowances in excess of cost
    basis are treated as a preference item and taxed under the alternative
    minimum tax.

    	Impact

    Historically, generous depletion allowances and other tax benefits reduced
    effective tax rates in the minerals industries significantly below tax rates on
    other industries, providing incentives to increase investment, exploration, and
    output, especially for oil and gas. It is possible for cumulative depletion
    allowances to total many times the amount of the original investment.  The
    combination of this subsidy and the deduction of exploration and
    development expenses represents a significant boon to mineral producers that
    are eligible for both.  In addition, 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.

    Issues of principal concern are the extent to which percentage depletion:

    (1) decreases the price of qualifying minerals, and therefore encourages
    their consumption;

    (2) bids up the price of exploration and mining rights; and

    (3) encourages the development of new deposits and increases production.

    Most analyses of percentage depletion have focused on the oil and gas
    industry, which - before the 1975 repeal of percentage depletion for major
    oil companies - accounted for the bulk of percentage depletion. There has
    been relatively little analysis of the effect of percentage depletion on other
    industries. The relative value of the percentage depletion allowance in
    reducing the effective tax rate of mineral producers is dependent on a number
    of factors, including the statutory percentage depletion rate, income tax rates,
    and the effect of the net income limitation.

          		  	Rationale

    Provisions for a depletion allowance based on the value of the mine were
    made under a 1912 Treasury Department regulation (T.D. 1742), but this was
    never effectuated.

    A court case resulted in the enactment, as part of the Tariff Act of 1913, of
    a "reasonable allowance for depletion" not to exceed five percent of the value
    of output. This statute did not limit total deductions; Treasury regulation No.
    33 limited total deductions to the original capital investment.

    This system was in effect from 1913 to 1918, although in the Revenue Act
    of 1916, depletion was restricted to no more than the total value of output,
    and, in the aggregate, to no more than capital originally invested or fair
    market value on March 1, 1913 (the latter so that appreciation occurring
    before enactment of income taxes would not be taxed).

    On the grounds that the newer mineral discoveries that contributed to the
    war effort were treated less favorably, discovery value depletion was enacted
    in 1918.  Discovery depletion, which was in effect through 1926, allowed
    deductions in excess of capital investment because it was based on the market
    value of the deposit after discovery.  In 1921, because of concern with the
    size of the allowances, discovery depletion was limited to net income; it was
    further limited to 50 percent of net income in 1924.

    For oil and gas, discovery value depletion was replaced in 1926 by the
    percentage depletion allowance, at the rate of 27.5percent. This was due to
    the administrative complexity and arbitrariness, and due to its tendency to
    establish high discovery values, which tended to overstate depletion
    deductions.

    For other minerals, discovery value depletion continued until 1932, at
    which time it was replaced by percentage depletion at the following rates:
    23percent for sulphur, 15percent for metal mines, and 5percent for coal.

    From 1932 to 1950, percentage depletion was extended to most other
    minerals.  In 1950, President Truman recommended a reduction in the top
    depletion rates to 15percent, but Congress disagreed. The Revenue Act of
    1951 raised the allowance for coal to 10percent and granted it to more
    minerals.

    In 1954, still more minerals were granted the allowance, and foreign mines
    were granted a lower rate.  In 1969, the top depletion rates were reduced and
    the allowance was made subject to the minimum tax.  The Tax Equity and
    Fiscal Responsibility Act of 1982 reduced the allowance for corporations that
    mined coal and iron ore by 15percent.  The Tax Reform Act of 1986 raised
    the cutback in corporate allowances for coal and iron ore from 15percent to
    20percent.

    	Assessment

    Standard accounting and economic principles state that the appropriate
    method of capital recovery in the mineral industry is cost depletion adjusted
    for inflation.  The percentage depletion allowance permits mineral producers
    to continue to claim a deduction even after all the investment costs of
    acquiring and developing the property have been recovered. Thus it is a
    mineral production subsidy rather than an investment subsidy.  In cases where
    a taxpayer has obtained mining rights relatively inexpensively under the
    provisions of the Mining Law of 1872, it can be argued that such taxpayers
    should not be entitled to the additional benefits of the percentage depletion
    provisions.

    As a production subsidy, however, percentage depletion is economically
    inefficient, encouraging excessive development of existing properties rather
    than exploration of new ones. Although accelerated depreciation for non-
    mineral assets may lower effective tax rates by speeding up tax benefits, these
    assets cannot claim depreciation deductions in excess of investment.

    However, arguments have been made to justify percentage depletion on
    grounds of unusual risks, the distortions in the corporate income tax, and
    national security, and to protect domestic producers. Mineral price volatility
    alone does not necessarily justify percentage depletion.

      Percentage depletion may not be the most efficient way to increase
    mineral output. Percentage depletion may also have adverse environmental
    consequences, encouraging the use of raw materials rather than recycled
    substitutes.

    	Selected Bibliography

    Andrews-Speed, Philip, and Christopher Rogers."Mining Taxation on
    Issues for the Future," Resources Policy, v. 25.  1999, pp. 221-227.
    Anderson, Robert D., Alan S. Miller, and Richard D. Spiegelman.  "U.S.
    Federal Tax Policy: The Evolution of Percentage Depletion for Minerals,"
    Resources Policy, v. 3.  September 1977, pp. 165-176.
    Conrad, Robert F.  "Mining Taxation: A Numerical Introduction,"
    National Tax Journal, v. 33.  December, 1980, pp. 443-449.
    Crowson, Philip.  Inside Mining: The Economics of the Supply and
    Demand of Minerals and Metals.  London: Mining Journal Books, 1998.
    Davidson, Paul.  "The Depletion Allowance Revisited," Natural Resources
    Journal, v. 10.  January 1970, pp. 1-9.
    Dorsey, Christine.  "Clinton Administration Revives Plan to Revoke
    Mining Tax Break." Las Vegas Review - Journal. February 10, 2000. p. 4D.
    Fenton, Edmund D.  "Tax Reform Act of 1986: Changes in Hard Mineral
    Taxation," Oil and Gas Tax Quarterly, v. 36.  September, 1987, pp. 85-98.
    Frazier, Jessica and Edmund D. Fenton. "The Interesting Beginnings of the
    Percentage Depletion Allowance," Oil and Gas Tax Quarterly, v. 38.  June
    1990, pp. 697-712.
    Lagos, Gustavo. "Mining Investment and Compensation - Mineral
    Taxation and Investment." Natural Resources Forum. August 1993.v.17.
    Lazzari, Salvatore.  The Effects of the Administration's Tax Reform
    Proposal on the Mining Industry.  Library of Congress, Congressional
    Research Service Report 85-WP.  Washington, DC: July 29, 1985.
    _. Energy Tax Policy: An Economic Analysis. Library of Congress,
    Congressional Research Service Report RL 30406.  Washington, DC: June
    28, 2005.
    -.  The Federal Royalty and Tax Treatment of the Hard Rock Minerals
    Industry: An Economic Analysis.  Library of Congress, Congressional
    Research Service Report 90-493 E.  Washington, DC: October 15, 1990.
    Muzondo, Timothy R.  "Mineral Taxation, Market failure, and the
    Environment." International Monetary Fund. Staff Papers - International
    Monetary Fund. March 1993.v.40. Washington,  pp. 152-178.
    Randall, Gory.  "Hard Mineral Taxation-Practical Problems," Idaho Law
    Review, v. 19.  Summer 1983, pp. 487-503.
    Tripp, John D., Hugh D. Grove, and Michael McGrath. "Maximizing
    Percentage Depletion in Solid Minerals," Oil and Gas Tax Quarterly, v. 30.
    June 1982, pp. 631-646.
    Updegraft, Kenneth E., and Joel D. Zychnick.  "Transportation of Crude
    Mineral Production by Mine Owners and its Effect on Hard Minerals
    Depletion Allowance," Tax Lawyer, v. 35.  Winter 1982, pp. 367-387.
    U.S. General Accounting Office.  Selected Tax Provisions Affecting the
    Hard Minerals Mining and Timber Industry.  GAO/GGD-87-77 FS. June
    1987.  Washington, DC: U.S. Government Printing Office, June 1987.

    Ward, Frank A., and Joe Kerkvliet. "Quantifying Exhaustible Resource
    Theory: An Application to Mineral Taxation Policy." Resource and Energy
    Economics. June 1993.v.15.  pp. 203-242.

    Natural Resources and Environment

    EXPENSING OF MULTIPERIOD TIMBER-GROWING
    COSTS; AMORTIZATION AND EXPENSING OF
    REFORESTATION EXPENSES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.1

    0.2

    0.3

    2007

    0.1

    0.2

    0.3

    2008

    0.1

    0.2

    0.3

    2009

    0.1

    0.2

    0.3

    2010

    0.1

    0.2

    0.3

    	Authorization

    Sections 194, 263A(c)(5).

    	Description

    Taxpayers may deduct up to $10,000 of reforestation expenditures
    incurred with respect to any qualified timber property in any tax year.
    Expenditures exceeding the cap may be amortized over 84 months.  In most
    other industries, such indirect costs are capitalized under the uniform
    capitalization rules.

    Most of the production costs of maintaining a timber stand after it is
    established are expensed (deducted when incurred), rather than capitalized
    (reducing gain when the timber is sold).  These costs include indirect carrying
    costs, such as interest and property taxes, as well as costs of disease and pest
    control and brush clearing.

    	Impact

    By allowing the deduction of expenses when incurred, the effective tax
    rate on investments in these indirect costs is zero.  These provisions lower the
    effective tax rate on timber growing in general.  The extent of the effect of tax
    provisions on the timber industry is in some dispute.  Most of the benefit goes
    to corporations, and thus is likely to benefit higher-income individuals (see
    discussion in Introduction).

    	Rationale

    The original ability to expense indirect costs of timber growing was
    apparently part of a general perception that these costs were maintenance
    costs, and thus deductible as ordinary costs of a trade or business.  There were
    a series of revenue rulings and court cases over the years distinguishing
    between what expenses might be deductible and what expenses might be
    capitalized (for example, I. T. 1610 in 1923, an income tax unit ruling), Mim.
    6030 in 1946 (a mimeographed letter ruling), Revenue Ruling 55-412 in
    1955, and Revenue Ruling 66-18 in 1966).

    The Tax Reform Act of 1986 included uniform capitalization rules which
    required indirect expenses of this nature to be capitalized in most cases.
    Several exception were provided, including timber.  There is no specific
    reason given for exempting timber per se, but the general reason given for
    exceptions to the uniform capitalization rules is that they are cases were
    application "might be unduly burdensome."

    The expensing of the first $10,000 of reforestation costs was added in
    American Jobs Creation Act of 2004 (P.L. 108-357) and clarified in Gulf
    Opportunity Zone Act of 2005 (P.L. 109-135).  The provision replaced an
    existing reforestation credit.  The change was made to simplify the treatment
    of reforestation costs, and the basic purpose of the incentive was to encourage
    reforestation.  The act also included timber growing in the manufacturing
    activities eligible for the new manufacturing deduction under Sec. 199 of the
    Code.

    	Assessment

    The tax benefit provides a forgiveness of tax on the return to part of the
    investment in timber growing.  While tax subsidy often lead to misallocation
    of resources and a welfare loss, this provision might be different.  Timber
    growing might provide benefits to society in general (called externalities in
    economics), such as improved environment, recreational opportunities, or
    aesthetics.  In general, private investors cannot capture most of these benefits,
    therefore they would tend to invest less than may be socially desirable in
    reforestation and timber growing.  Tax subsidy may help alleviate this
    problem.  Still, some argue that the tax benefit design make it a rather weak
    incentive.  In addition, the tax approach must be weighed against other
    alternatives, such as direct subsidies or direct ownership of timber lands by
    the government.

    	Selected Bibliography

    Society of American Foresters, Study Group on Forest Taxation.  "Forest
    Taxation."  Journal of Forestry, v. 78.  July 1980, pp. 1-7.
    U.S. Congress, Joint Economic Committee.  "The Federal Tax Subsidy of
    the Timber Industry," by Emil Sunley, in The Economics of Federal Subsidy
    Programs.  92nd Congress, 2nd session.  July 15, 1972.
    -, Joint Committee on Taxation.  General Explanation of the Tax Reform
    Act of 1986.  May 4, 1987, pp. 508-509.
    U.S. Department of Agriculture, Forest Service.  A Forest Owner's Guide
    to the Federal Income Tax, Agriculture Handbook No. 708.  Washington,
    DC: U.S. Government Printing Office, October 1995.
    U.S. Department of Treasury.  Special Expensing and Amortization Rules
    in Tax Reform for Fairness, Simplicity, and Economic Growth, v. 2, Nov.
    1984, pp. 299-313.
    U.S. General Accounting Office.  Selected Tax Provisions Affecting the
    Hard Minerals Mining and Timber Industries, Fact Sheet for the Honorable
    John Melcher, United States Senate.  June 1987.
    -. Forest Service: Timber Harvesting, Planting, Assistance Programs and
    Tax Provisions, Briefing Report to the Honorable Sander M. Levin, House of
    Representatives.  April 1990.

    Natural Resources and Environment

    EXPENSING OF EXPLORATION AND DEVELOPMENT COSTS:
    NONFUEL MINERALS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    (1)

    0.1

    (1)

    2007

    (1)

    0.1

    (1)

    2008

    (1)

    0.1

    (1)

    2009

    (1)

    0.1

    (1)

    2010

    (1)

    0.1

    (1)

    (1) Less than $50 million.

    	Authorization

    Sections 263, 291, 616-617, 56, 1254.

    Description

    Firms engaged in mining are permitted to expense (to deduct in the year
    paid or incurred) rather than capitalize (i.e., recover such costs through
    depletion or depreciation) certain exploration and development (E&D) costs.
    This provision is an exception to general tax rules.

    In general, mining exploration costs are those (non-equipment) costs
    incurred to ascertain the existence, location, extent, or quality of any
    potentially commercial deposit of ore or other depletable mineral prior to the
    development stage of the mine or deposit.

    Development costs generally are those incurred for the development of a
    mine or other natural deposits after the existence of ores in commercially
    marketable quantities has been determined. Development expenditures
    generally include those for construction of shafts and tunnels, and in some
    cases drilling and testing to obtain additional information for planning
    operations. There are no limits on the current deductibility of such costs.
    Expensing of mine E&D costs may be taken in addition to percentage
    depletion, but it subsequently reduces percentage depletion deductions (i.e., is
    recaptured). The costs of tangible equipment must be depreciated.

    Expensing of E&D costs applies only to domestic properties;  E&D costs
    on foreign properties must be depreciated. The excess of expensing over the
    capitalized value (amortized over 10 years) is a tax preference item that is
    subject to the alternative minimum tax.

    	Impact

    E&D costs for non-fuels minerals are not as large a portion of the costs of
    finding and developing a mineral reserve as is the case for oil and gas, where
    they typically account for over two-thirds of the costs of creating a mineral
    asset.  Expensing of such costs is also less of a benefit than percentage
    depletion allowances.  The Joint Committee on Taxation estimates total tax
    expenditures from expensing E&D costs at $500 million over the period
    2006-2010.

    Nevertheless they are a capital expense which otherwise would be depleted
    over the income-producing life of the mineral reserve. Combined with other
    tax subsidies, such as percentage depletion, expensing reduces effective tax
    rates in the mineral industry below tax rates on other industries, thereby
    providing incentives to increase investment, exploration, and output. This cost
    reduction increases the supply of the mineral and reduces its price.

    This tax expenditure is largely claimed by corporate producers. The at-risk,
    recapture, and minimum tax restrictions that have since been placed on the
    use of the provision have primarily limited the ability of high-income
    taxpayers to shelter their income from taxation through investment in mineral
    exploration.

          		  	Rationale

    Expensing of mine development expenditures was enacted in 1951 to
    encourage mining and reduce ambiguity in its tax treatment. The provision for
    mine exploration was added in 1966.

    Prior to the Tax Reform Act of 1969, a taxpayer could elect either to
    deduct without dollar limitation exploration expenditures in the United States
    (which subsequently reduced percentage depletion benefits), or to deduct up
    to $100,000 a year with a total not to exceed $400,000 of foreign and
    domestic exploration expenditures without recapture.

    The 1969 act subjected all post-1969 exploration expenditures to
    recapture.  The Tax Equity and Fiscal Responsibility Act of 1982 added
    mineral exploration and development costs as tax preference items subject to
    the alternative minimum tax, and limited expensing for corporations to 85
    percent. The Tax Reform Act of 1986 required that all exploration and
    development expenditures on foreign properties be capitalized.

    	Assessment

    E&D costs are generally recognized to be capital costs, which, according
    to standard accounting and economic principles, should be recovered through
    depletion (cost depletion adjusted for inflation).

    Lease bonuses and other exploratory costs (survey costs, geological and
    geophysical costs) are properly treated as capital costs, although they may be
    recovered through percentage rather than cost depletion.  Immediate
    expensing of E&D costs provides a tax subsidy for capital invested in the
    mineral industry with a relatively large subsidy for corporate producers.

    By expensing rather than capitalizing these costs, the tax code effectively
    sets taxes on the return to such expenditures at zero. As a capital subsidy,
    however, expensing is inefficient because it makes investment decisions
    based on tax considerations rather than inherent economic considerations.

    Arguments have been made over the years to justify expensing on the basis
    of unusual investment risks, the distortions in the corporate income tax,
    strategic materials and national security, and protection of  domestic
    producers (especially small independents).

    Expensing is a costly and inefficient way to increase mineral output and
    enhance energy security.  Expensing may also have adverse environmental
    consequences by encouraging the development of raw materials as opposed to
    recycled substitutes.

    	Selected Bibliography

    Andrews-Speed, Philip, and Christopher Rogers.  "Mining Taxation Issues
    for the Future," Resources Policy, v. 25 (1999), pp. 221-227.
    Congressional Budget Office. Budget Options. Section 28: Repeal the
    Expensing of Exploration and Development Costs for Extractive Industries.
    February 2005.
    Conrad, Robert F.  "Mining Taxation: A Numerical Introduction."
    National Tax Journal, v. 33, December, 1980, pp. 443-449.
    Crowson, Philip.  Inside Mining: The Economics of the Supply and
    Demand of Minerals and Metals. London: Mining Journal Books, 1998.

    Dorsey, Christine.  "Clinton Administration Revives Plan to Revoke
    Mining Tax Break." Las Vegas Review - Journal. February 10, 2000. p. 4D.
    Lagos, Gustavo. "Mining Investment and Compensation - Mineral
    Taxation and Investment." Natural Resources Forum. August 1993. v.17.
    Lazzari, Salvatore.  Energy Tax Policy: An Economic Analysis.  Library of
    Congress, Congressional Research Service Report RL30406. Washington,
    DC: June 28, 2006.
    -.  The Federal Royalty and Tax Treatment of the Hard Rock Minerals
    Industry: An Economic Analysis.  Library of Congress, Congressional
    Research Service Report 90-493E. Washington, DC: October 15, 1990.
    Muzondo, Timothy R. "Mineral Taxation, Market Failure, and the
    Environment." International Monetary Fund. Staff Papers. International
    Monetary Fund. March 1993.v.40. Washington,  pp. 152-178.
    U.S. General Accounting Office.  Selected Tax Provisions Affecting the
    Hard Minerals Mining and Timber Industry.  GAO/GGD-87-77 FS,
    Washington, D.C., Government Printing Office, June 1987.
    U.S. General Accounting Office.  Selected Tax Provisions Affecting the
    Hard Minerals Mining and Timber Industry.  GAO/GGD-87-77 FS. June
    1987.  Washington, DC: U.S. Government Printing Office, June 1987.
    Ward, Frank A., and Joe Kerkvliet. "Quantifying Exhaustible Resource
    Theory: An Application to Mineral Taxation Policy." Resource and Energy
    Economics. June 1993.v.15.  pp. 203-242.
    Wilburn, D.R. "Exploration." Mining Engineering. May 2003. v.55.  pp.
    30-43.

    Natural Resources and Environment

    EXCLUSION OF INTEREST ON STATE AND LOCAL
    GOVERNMENT SEWAGE, WATER, AND
    HAZARDOUS WASTE FACILITIES BONDS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.4

    0.2

    0.6

    2007

    0.4

    0.2

    0.6

    2008

    0.5

    0.2

    0.7

    2009

    0.5

    0.2

    0.7

    2010

    0.5

    0.2

    0.7

    Authorization

    Sections 103, 141, 142, and 146.

    	Description

    Interest income from State and local bonds used to finance the construction
    of sewage facilities, facilities for the furnishing of water, and facilities for the
    disposal of hazardous waste is tax exempt.

    Some of these bonds are classified as private-activity bonds rather than as
    governmental bonds because a substantial portion of their benefits accrues to
    individuals or business rather than to the general public.  For more discussion
    of the distinction between governmental bonds and private-activity bonds, see
    the entry under General Purpose Public Assistance: Exclusion of Interest on
    Public Purpose State and Local Debt.

    The bonds classified as private activity for these facilities are subject to the
    State private-activity bond annual volume cap.

    	Impact

    Since interest on the bonds is tax exempt, purchasers are willing to accept
    lower before-tax rates of interest than on taxable securities.  These low
    interest rates enable issuers to finance the facilities at reduced interest rates.

    Some of the benefits of the tax exemption also flow to bondholders.  For a
    discussion of the factors that determine the shares of benefits going to
    bondholders and users of the sewage, water, and hazardous waste facilities,
    and estimates of the distribution of tax-exempt interest income by income
    class, see the "Impact" discussion under General Purpose Public Assistance:
    Exclusion of Interest on Public Purpose State and Local Debt.

    	Rationale

    Prior to 1968, no restriction was placed on the ability of State and local
    governments to issue tax-exempt bonds to finance sewage, water, and
    hazardous waste facilities.  Although the Revenue and Expenditure Control
    Act of 1968 imposed tests that would have restricted issuance of these bonds,
    it provided a specific exception for sewage and water (allowing continued
    unrestricted issuance).

    Water-furnishing facilities must be made available to the general public
    (including electric utility and other businesses), and must be either operated
    by a governmental unit or have their rates approved or established by a
    governmental unit.  The hazardous waste exception was adopted by the Tax
    Reform Act of 1986.  The portion of a hazardous waste facility that can be
    financed with tax-exempt bonds cannot exceed the portion of the facility to be
    used by entities other than the owner or operator of the facility.  In other
    words, a hazardous waste producer cannot use tax-exempt bonds to finance a
    facility to treat its own wastes.

    	Assessment

    Many observers suggest that sewage, water, and hazardous waste treatment
    facilities will be under-provided by state and local governments because the
    benefit of the facilities extends beyond State and local government
    boundaries.  In addition, there are significant costs, real and perceived,
    associated with siting an unwanted hazardous waste facility.  The federal
    subsidy through this tax expenditure may encourage increased investment as
    well as spread the cost to more potential beneficiaries, federal taxpayers.

    Alternatively, subsidizing hazardous waste treatment facilities reduces the
    cost of producing waste if the subsidy is passed through to waste producers.
    When the cost of producing waste declines, then waste emitters may in turn
    increase their waste output.  Thus, subsidizing waste treatment facilities may
    actually increase waste production.  Recognizing the potential effect of
    subsidizing private investment in waste treatment, Congress eliminated a
    general subsidy for private investment in waste and pollution control
    equipment in the Tax Reform Act of 1986.

    Even if a subsidy for sewage, water, and hazardous waste facilities is
    considered appropriate, it is important to recognize the potential costs.  As
    one of many categories of tax-exempt private-activity bonds, bonds for these
    facilities increase the financing cost of bonds issued for other public capital.
    With a greater supply of public bonds, the interest cost on the bonds
    necessarily increases to lure investors.  In addition, expanding the availability
    of tax-exempt bonds increases the range of assets available to individuals and
    corporations to shelter their income from taxation.

    	Selected Bibliography

    Fredriksson, Per G.  "The Siting of Hazardous Waste Facilities in Federal
    Systems: The Political Economy of NIMBY [Not In My Back Yard],"
    Environmental and Resource Economics v. 15, no. 1 (January 2000), pp. 75-
    87.
    Maguire, Steven.  Private Activity Bonds: An Introduction.  Library of
    Congress, Congressional Research Service Report RL31457.  June 9, 2006.
    -.  Tax-Exempt Bonds: A Description of State and Local Government Debt.
    Library of Congress, Congressional Research Service Report RL30638.
    March 10, 2006.
    U.S. Congress,  Joint Committee on Taxation, Present Law and
    Background Related to State and Local Government Bonds, Joint Committee
    Print JCX-14-06, March 16, 2006.
    U.S. Department of Treasury,  Internal Revenue Service.  Tax-Exempt
    Private Activity Bonds, Publication 4078, June 2004.
    Zimmerman, Dennis.  Environmental Infrastructure and the State-Local
    Sector: Should Tax-Exempt Bond Law Be Changed?  Library of Congress,
    Congressional Research Service Report 91-866 E.  Washington, DC:
    December 16, 1991.
    -.  The Private Use of Tax-Exempt Bonds: Controlling Public Subsidy of
    Private Activities.  Washington, DC: The Urban Institute Press, 1991.

    Natural Resources and Environment

    SPECIAL RULES FOR MINING RECLAMATION RESERVES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    (1)

    (1)

    (1)

    2007

    (1)

    (1)

    (1)

    2008

    (1)

    (1)

    (1)

    2009

    (1)

    (1)

    (1)

    2010

    (1)

    (1)

    (1)

    (1) Less than $50 million.

    Authorization

    Section 468.

    Description

    Firms are generally not allowed to deduct a future expense until "economic
    performance" occurs--that is, until the service they pay for is performed and
    the expense is actually paid.  Electing taxpayers may, however, deduct the
    current-value equivalent of certain estimated future reclamation and closing
    costs for mining and solid waste disposal sites.

    For Federal income tax purposes, the amounts deducted prior to economic
    performance are deemed to earn interest at a specified interest rate.  When the
    reclamation has been completed, any excess of the amounts deducted plus
    deemed accrued interest over the actual reclamation or closing costs is taxed
    as ordinary income.

    Impact

    Section 468 permits reclamation and closing costs to be deducted at the
    time of the mining or waste disposal activity that gives rise to the costs.
    Absent this provision, the costs would not be deductible until the reclamation
    or closing actually occurs and the costs are paid.  Any excess amount
    deducted in advance (plus deemed accrued interest) is taxed at the time of
    reclamation or closing.

    Rationale

    This provision was adopted in 1984.  Proponents argued that allowing
    current deduction of mine reclamation and similar expenses is necessary to
    encourage reclamation, and to prevent the adverse economic effect on mining
    companies that might result from applying the general tax rules regarding
    deduction of future costs.

    Assessment

    Reclamation and closing costs for mines and waste disposal sites that are
    not incurred concurrently with production from the facilities are capital
    expenditures.  Unlike ordinary capital expenditures, however, these outlays
    are made at the end of an investment project rather than at the beginning.

    Despite this difference, writing off these capital costs over the project life
    is appropriate from an economic perspective, paralleling depreciation of up-
    front capital costs.  The tax code does not provide systematic recognition of
    such end-of-project capital costs.  Hence they are treated under special
    provisions that provide exceptions to the normal rule of denying deduction
    until economic performance.  Because the provisions align taxable income
    and economic incomes closer together, it is debatable whether the exceptions
    should be regarded as tax expenditures at all.

    Selected Bibliography

    Halperin, Daniel I.  Interest in Disguise: Taxing the 'Time Value of
    Money,' The Yale Law Journal.  January 1986, pp. 506-552.
    Kiefer, Donald W.  The Tax Treatment of a 'Reverse Investment,' Tax
    Notes.  March 4, 1985, pp. 925-932.
    U.S. Congress, Joint Committee on Taxation.  General Explanation of the
    Revenue Provisions of the Deficit Reduction Act of 1984.  Committee Print,
    98th Congress, 2nd session, December 31, 1984, pp. 273-276.
    Wise, Spence and J. Ralph Byington.  Mining and Solid Waste
    Reclamation and Closing Costs, Oil, Gas & Energy Quarterly, vol. 50, pp.
    47-55, September 2001.

    Natural Resources and Environment

    SPECIAL TAX RATE
    FOR NUCLEAR DECOMMISSIONING RESERVE FUND

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    -

    0.5

    0.5

    2007

    -

    0.6

    0.6

    2008

    -

    0.7

    0.7

    2009

    -

    0.8

    0.8

    2010

    -

    0.8

    0.8

    Authorization

    Section 468A.

    Description

    Taxpayers who are responsible for the costs of decommissioning nuclear
    power plants (e.g., utilities) can elect to create reserve funds to be used to pay
    for decommissioning.  The funds receive special tax treatment: amounts
    contributed to a reserve fund are deductible in the year made and are not
    included in the taxpayer's gross income until the year they are distributed,
    thus effectively postponing tax on the contributed amounts.  Amounts actually
    spent on decommissioning are deductible in the year they are made.  The
    fund's investments, however, are subject to a 20% tax rate - a lower rate than
    that which applies to most other corporate income.  The amount that can be
    contributed to an account is limited to the lesser of the "cost of service"
    amount or an amount the Internal Revenue Service (IRS) determines would
    provide funding for the actual decommissioning costs, when they occur.  The
    "cost of service" amount is the amount charged by utilities to customers as
    representing decommissioning costs.

    Impact

    As noted above, amounts contributed to a qualified fund are deductible in
    the year contributed but are taxed when withdrawn to pay for
    decommissioning costs.  By itself, such treatment would constitute a tax
    deferral.  However, full taxation of the investment earnings of the tax-
    deferred funds (the treatment that applied before 1992) would offset any
    benefit from the deferral.  Accordingly, taken alone, only current law's
    reduced tax rate poses a tax benefit.

    But an additional issue is whether the favorable tax treatment accorded to
    the funds simply compensates for other, unfavorable, tax treatment of
    decommissioning costs.  Under current law there is a tax penalty associated
    with decommissioning because outlays for nuclear decommissioning are not
    permitted to be deducted until they are actually made.  To the extent a
    taxpayer incurs a liability for those costs in advance of the outlays, this
    treatment constitutes a tax penalty similar to a reverse tax deferral; accurate
    treatment would require the costs to be deducted to reflect the loss in value of
    the plant as the required outlay becomes closer in time.

    The likely economic effect of the reduced rates is to encourage outlays on
    nuclear decommissioning because the tax-saving funds are contingent on
    making such outlays.  At the same time, however, to the extent that
    decommissioning costs are required by government regulations to be incurred
    with or without the special tax treatment, the reduced rates pose an incentive
    to invest in nuclear power plants.  The benefit of the favorable tax treatment
    likely accrues to owners of electric utilities that use nuclear power and to
    consumers of the electricity they produce.

    Rationale

    The special decommissioning funds were first enacted by the Deficit
    Reduction Act of 1984 (Public Law 98-369), but the funds' investment
    earnings were initially subject to tax at the highest corporate tax rate (46%, at
    the time).  The funds were established because Congress believed that the
    establishment of segregated reserve funds was a matter of "national
    importance."  At the same time, however, Congress "did not intend that this
    deduction should lower the taxes paid by the owners...in present value terms,"
    and thus imposed full corporate taxes on funds' investment earnings.

    The reduced tax rate was enacted by the Energy Policy Act of 1992 (Public
    Law 102-486).  The rate was reduced  to provide "a greater source of funds"
    for decommissioning expenses.  More recently, Congress in 2000 approved a
    measure that would eliminate the "cost of service" limitation on contributions
    to funds (leaving intact, however, the limit posed by the IRS determination.)
    The Clinton Administration proposed a similar measure in its fiscal year 2001
    budget, but the congressional bill was vetoed for reasons not related to
    decommissioning costs.

    Assessment

    As noted above, the reduced tax rates may provide a tax benefit linked
    with amounts contributed to qualified funds.  The impact of the resulting tax
    benefit on economic efficiency depends in part on the effect of non-tax
    regulations governing decommissioning.  Nuclear powerplants that are not
    appropriately decommissioned might impose external pollution costs on the
    economy that are not reflected in the market price of nuclear energy.  To the
    extent government regulations require plants to be shut down in a manner that
    eliminates pollution, this "market failure" may already be corrected and any
    tax benefit is redundant.  To the extent regulations do not require effective
    decommissioning, the tax benefit may abet economic efficiency by
    encouraging decommissioning outlays.  The equity effect of the tax benefit is
    distinct from regulatory fixes of pollution.  It is likely that decommissioning
    costs required by regulation are borne by utility owners and consumers of
    nuclear energy.  The tax benefit probably shifts a part of this burden to
    taxpayers in general.  Note also, however, that the reduced rates may simply
    compensate for the delayed deduction of decommissioning costs.

    Selected Bibliography

    Khurana, Inder K., Richard H. Pettway, and K.K. Raman.  "The Liability
    Equivalence of Unfunded Nuclear Decommissioning Costs."  Journal of
    Accounting and Public Policy, vol. 20, no. 2, Summer 2001.
    Palmer, Stephen L.  "A Suggestion for Federal Tax Treatment of Accrued
    Nuclear Power Plant Decommissioning Expenses." Tax Lawyer 35 (Spring
    1982), pp. 779-797.
    U.S. Congress, Joint Committee on Taxation.  Federal Tax Issues Relating
    to Restructuring of the Electric Power Industry.  Joint Committee Print, 106th
    Congress, 1st session.  Washington, DC: Government Printing Office, October
    15, 1999, pp. 39-43.
    -.  General Explanation of the Revenue Provisions of the Deficit
    Reduction Act of 1984.  Joint Committee Print, 98th Congress, 2d Session.
    Washington, DC: Government Printing Office, 1971, pp.  270-272.
    U.S. Department of the Treasury.  General Explanations of the
    Administration's Fiscal Year 2001  Revenue Proposals.  Washington, DC:
    2000, pp. 117-118.
    U.S. General Accounting Office, Nuclear Regulation: NRC Needs More
    Effective Analysis to Ensure Accumulation of Funds to Decommission
    Nuclear Power Plants.  Report GAO-04-32, October 2003.

    Zimmerman, Raymond A. and Jeri Farrow.  "Decommissioning Funds:
    Snagged on Tax Law?"  Public Utilities Fortnightly 139 (April 1, 2001), pp.
    34.

    Natural Resources and Environment

    EXCLUSION OF CONTRIBUTIONS IN AID OF CONSTRUCTION
    FOR WATER AND SEWER UTILITIES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    -

    (1)

    (1)

    2007

    -

    (1)

    (1)

    2008

    -

    (1)

    (1)

    2009

    -

    (1)

    (1)

    2010

    -

    (1)

    (1)

    (1)Less than $50 million.

    	Authorization

    Section 118(c),(d).

    	Description

    Contributions in aid of construction are charges paid by utility customers,
    usually builders or developers, to cover the cost of installing facilities to
    service housing subdivisions, industrial parks, manufacturing plants, etc.  In
    some cases, the builder/developer transfers completed facilities to the utility
    rather than paying cash to the utility to finance construction of the facilities.

    Qualifying contributions in aid of construction received by regulated water
    and sewage disposal utilities which provide services to the general public in
    their service areas are not included in the utilities' gross income if the
    contributions are spent for the construction of the facilities within 2 years
    after receipt of the contributions.  Service charges for starting or stopping
    services do not qualify as nontaxable capital contributions.  Assets purchased
    with (or received as) qualifying contributions have no basis (hence, cannot be
    depreciated by the utility) and may not be included in the utility's rate base for
    rate-making purposes.

    	Impact

    Before the Tax Reform Act of 1986 (TRA86), the special treatment
    described above applied to contributions in aid of construction received by
    regulated utilities that provide steam, electric energy, gas, water, or sewage
    disposal services.  This treatment effectively exempted from taxation the
    services provided by facilities financed by contributions in aid of
    construction.  The treatment was repealed by TRA86 but reinstated by the
    Small Business Job Protection Act of 1996 for water and sewage facilities
    only.

    Repeal of the special treatment resulted in increases in the amounts utilities
    charge their customers as contributions in aid of construction.  Before
    TRA86, a utility would charge its customers an amount equal to the cost of
    installing a facility.  After TRA86, utilities had to charge an amount equal to
    the cost of the facility plus an amount to cover the tax on the contribution in
    aid of construction.  This parallels the pricing of most other business services,
    for which companies must charge customers the actual cost of providing the
    service plus an amount to cover the tax on the income.

    The higher cost associated with contributions in aid of construction as a
    result of the change in the TRA86 led to complaints from utility customers
    and proposals to reverse the change.  The special treatment of contributions in
    aid of construction was reinstated - but only for water and sewage utilities -
    in the Small Business Job Protection Act of 1996.  As a result of this
    reinstatement, water and sewage utility charges for contributions in aid of
    construction are lower than they would be if the contributions were still
    taxable.  The charge now covers only the cost of the financed facility; there is
    no markup to cover taxes on the charge.

    To the extent that the lower charges to builders and developers for
    contributions in aid of construction are passed on to ultimate consumers
    through lower prices, the benefit from this special tax treatment accrues to
    consumers.  If some of the subsidy is retained by the builders and developers
    because competitive forces do not require it to be passed forward in lower
    prices, then the special tax treatment also benefits the owners of these firms.

    	Rationale

    The stated reason for reinstating the special treatment of contributions in
    aid of construction for water and sewage utilities was concern that the
    changes made by the Tax Reform Act of 1986 may have inhibited the
    development of certain communities and the modernization of water and
    sewage facilities.

    	Assessment

    The contribution in aid of construction tax treatment allows the utility to
    write off or expense the cost of the financed capital facility in the year it is put
    in place rather than depreciating it over its useful life.  This treatment, in
    effect, exempts the services provided by the facility from taxation and thereby
    provides a special subsidy.  Absent a public policy justification, such
    subsidies distort prices and undermine economic efficiency.

    In repealing the special tax treatment of contributions in aid of construction
    in TRA86, Congress determined that there was no public policy justification
    for continuing the subsidy.  In reinstating the special tax treatment for water
    and sewage utilities in the Small Business Job Protection Act of 1996,
    Congress determined that there was an adequate public policy justification for
    providing the subsidy to these particular utilities.

    	Selected Bibliography

    Committee on Finance, Small Business Job Protection Act of 1996, Report
    104-281, U.S. Senate, 104th Congress, 2d Session, June 18, 1996, p. 136-
    137.
    Conference Report, Small Business Job Protection Act of 1996, Report
    104-737, U.S. House of Representatives, 104th Congress, 2d Session, August
    1, 1996, p. 158-160.
    Joint Committee on Taxation, General Explanation of the Tax Reform Act
    of 1986, Joint Committee Print, JCS-10-87, May 4, 1987, p. 544-547.

    	Energy

    	AMORTIZATION OF CERTIFIED POLLUTION
    	CONTROL FACILITIES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    -

    (1)

    (1)

    2007

    -

    (1)

    (1)

    2008

    -

    0.1

    0.1

    2009

    -

    0.1

    0.1

    2010

    -

    0.1

    0.1

    (1) Negative tax expenditure of less than $50 million.

    	Authorization

    Section 169(d)(5).

    	Description

    This provision makes the pre-1976 5 year option to amortize investments in
    pollution control equipment for coal-fired electric generation plants available
    to those plants placed in service on or after January 1, 1976.  Before
    enactment of IRC section 169(d)(5), 5-year amortization of  pollution control
    equipment applied only to older coal-fired power plants - those placed in
    service before January 1, 1976.  However, investments in pollution control
    equipment made in connection with post-1975 power plants now qualify for
    amortization over 7 years rather than 5 years. The 5-year amortization
    incentive for pre-1976 plants applies only to pollution control equipment with
    a useful life of 15 years or less.  In that case 100% of the cost can be
    amortized over five years. If the property or equipment has a useful life
    greater than 15 years, then the proportion of the costs that can be amortized
    over 5 years is less than 100%.

    Qualifying pollution control equipment means any technology that is
    installed in or on a qualifying facility to reduce air emissions of any pollutant
    regulated by the Environmental Protection Agency (EPA) under the Clean Air
    Act. This includes scrubber systems, particulate collectors and removal
    equipment (such as electrostatic precipitators), thermal oxidizers,  vapor
    recovery systems, low nitric oxide burners, flare systems, bag houses,
    cyclones, and continuous emission monitoring systems. The pollution control
    equipment needs to have been placed in service after April 11, 2005.

    	Impact

    In the federal tax code, amortization is a method of depreciation that
    recovers the total cost basis evenly (i.e., straight line depreciation) over the
    recovery period, in this case either 5 or 7 years depending on the age of the
    power plant. In either case, however, because the two recovery periods are
    substantially less than the economic life of the assets, such amortization
    provides more accelerated depreciation deductions for pollution control
    equipment than would otherwise be the case under the Modified Accelerated
    Cost Recovery System ( MACRS ), in which the recovery period for the
    conventional type of electric generating equipment is either 15 or 20 years,
    depending on the type of equipment. The recovery period is 15 years for
    generating equipment that uses internal combustion, jet, or diesel engines; 20
    years for  most types of conventional electric utility tangible property such as
    steam or gas turbines, boilers, combustors, condensers, combustion turbines
    operated in a combined cycle with a conventional steam unit, and related
    assets. The shorter period for internal combustion engines is because this type
    of equipment typically deteriorates faster than conventional coal-fired
    equipment. Also the recovery method is one of the more accelerated types:
    either the double-declining balance method or the 150% declining balance
    method.  Amortization in this way thus provides more accelerated
    depreciation deductions for pollution control equipment than does MACRS.
    Because of the time value of money, the earlier deduction is worth more in
    present value terms, which reduces the cost of capital and the effective tax
    rates on the investment returns. This should provide an incentive for power
    plant companies (primarily the tax paying investor-owned utilities, or IOUs)
    to invest in pollution control equipment.

    This provision targets electric utilities,  a major source of the
    disproportionate amount of air pollution.  And while older coal plants still
    emit a disproportionate amount of pollution among all  coal-fired plants, the
    provision complements prior law by also targeting emissions from newer
    plants.  The incentive will facilitate utilities in meeting a new suite of EPA
    mandates to reduce  emissions of sulfur dioxide (SO2 ), nitrous oxide (NO2),
    and mercury (Hg)

    	Rationale

    This provision was part of the Energy Policy Act of 2005 (P.L. 109-58).
    Before that investments in pollution control equipment for pre-1976 coal-fired
    plants were amortizable over 5 years. Before the 2005 act, pollution control
    equipment added to "newer" plants  (those placed in service after 1975) was
    depreciated using the same MACRS methods that apply to other electric
    generating equipment on the date they are placed in service (15- or 20-year
    recovery period using the 150% declining balance method, as discussed
    below).  The 5-year amortization of pollution control equipment was added by
    the Tax Reform Act of 1969 to compensate for the loss of the investment tax
    credit, which was repealed by the same act. Prior to 1987, pollution control
    equipment could be financed by tax-exempt bonds. This benefitted all types
    of electric utilities and not just public power companies, because although the
    state or local government would issue the bonds, the facilities were leased
    back to the IOUs or  cooperatives. Billions of dollars of pollution control
    equipment were financed in this way until the safe-harbor leasing tax rules
    were repealed by the Tax Reform Act of 1986.

    	Assessment

    Pollution control equipment used in connection with coal-fired power
    plants is a significant fraction of a plant's cost. Thus, the tax treatment of this
    type of equipment is important in determining the investment decisions of the
    electric utility.  The Clean Air Act's "New Source Review" provisions require
    the installation of state-of-the-art pollution-control equipment whenever an
    air-polluting plant is built or when a "major modification" is made on an
    existing plant.  By creating a more favorable (in some cases much more
    favorable) regulatory environment for existing facilities than new ones,
    grandfathering creates an incentive to keep old, grandfathered facilities up
    and running.

    The federal tax code has also provided an unintended incentive to retain -
     a disincentive to scrap - equipment and other business assets. One of these
    tax provisions is the 5-year amortization of  pollution control equipment
    connected with older (pre-1976) power plants. This, and other provisions
    under prior law (such as accelerated depreciation and investment tax credits),
    and   current tax penalties for premature dispositions of capital equipment
    under the recapture provisions and the alternative minimum tax) may have
    provided a disincentive to invest in new equipment and other  new assets.

    	Selected Bibliography

    Abel, Amy. Energy Policy Act of 2005, P.L. 109-58: Electricity
    Provisions. Congressional Research Service Report  RL33248.  Washington,
    DC: January 24, 2006.
    Hsu, Shi-Ling. "What's Old Is New: The Problem with New Source
    Review." Regulation. Spring 2006. v. 29.  Washington: pp. 36-43.
    Joskow, Paul L. "Competitive Electricity Markets and Investment in New
    Generating Capacity," MIT Research Paper. April, 28, 2006.
    Joskow, Paul L. Transmission Policy in the United States.  AEI-Brookings
    Joint Center for Regulatory Studies.  October 2004.
    Joskow, Paul L. "Restructuring, Competition, and Regulatory Reform in
    the U.S. Electricity Sector," Journal of Economic Perspectives. Summer
    1997. pp. 119-138.
    Lee, Amanda I., and  James Alm. "The Clean Air Act Amendments and
    Firm Investment in Pollution Abatement Equipment."  Land Economics.
    August 2004. v. 80.  pp. 433.
    McCarthy, James E., and Larry Parker. Costs and Benefits of Clear Skies:
    EPA's Analysis of Multi-Pollutant Clean Air Bills. U.S. Library of Congress.
    Congressional Research Service Report  RL33165. November 23, 2005.
    Parker, Larry, and John Blodgett. Air Quality and Electricity: Enforcing
    New Source Review. U.S. Library of Congress.  Congressional Research
    Service Report  RL30432.  January 31, 2000.
    Popp, David. "Pollution Control Innovations and the Clean Air Act of
    1990." Journal of Policy Analysis and Management. Fall 2003. v. 22. pp.
    641.
    Sterner, Thomas. Policy Instruments for Environmental and Natural
    Resource Management.  Resources for the Future, Washington. 2003.
    U.S. Congress, Joint Committee on Taxation. Federal Tax Issues Relating
    to Restructuring of the Electric Power Industry. Hearing before the
    Subcommittee on Long-Term Growth and Debt Reduction of the Senate
    Finance Committee, October 15, 1999. JCX 72-99.

    	Agriculture

    	EXCLUSION OF COST-SHARING PAYMENTS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    (1)

    (1)

    (1)

    2007

    (1)

    (1)

    (1)

    2008

    (1)

    (1)

    (1)

    2009

    (1)

    (1)

    (1)

    2010

    (1)

    (1)

    (1)

    (1)Less than $50 million

    Authorization

    Section 126.

    	Description

    There are a number of programs under which both the Federal and State
    Governments make payments to taxpayers which represent a share of the cost
    of certain improvements made to the land.  These programs generally relate to
    improvements which further conservation, protect the environment, improve
    forests, or provide habitats for wildlife.  Under Section 126, the grants
    received under certain of these programs are excluded from the recipient's
    gross income.

    To qualify for the exclusion, the payment must be made primarily for the
    purpose of conserving soil and water resources or protecting the environment,
    and the payment must not produce a substantial increase in the annual income
    from the property with respect to which the payment was made.

    	Impact

    The exclusion of these grants and payments from tax provides a general
    incentive for various conservation and land improvement projects that might
    not otherwise be undertaken.

    	Rationale

    The income tax exclusion for certain cost-sharing payments was part of the
    tax changes made under the Revenue Act of 1978.  The rationale for this
    change was that in the absence of an exclusion many of these conservation
    projects would not be undertaken.  In addition, since the grants are to be spent
    by the taxpayer on conservation projects, the taxpayer would not necessarily
    have the additional funds needed to pay the tax on the grants if they were not
    excluded from taxable income.

    Assessment

    The partial exclusion of certain cost-sharing payments is based on the
    premise that the improvements financed by these grants benefit both the
    general public and the individual landowner.  The portion of the value of the
    improvement financed by grant payments attributable to public benefit should
    be excluded from the recipient's gross income while that portion of the value
    primarily benefitting the landowner (private benefit) is properly taxable to the
    recipient of the payment.

    The problem with this tax treatment is that there is no way to identify the
    true value of the public benefit.  In those cases where the exclusion of cost-
    sharing payment is insufficient to cover the value of the public benefit, the
    project probably would not be undertaken.

    On the other hand, on those projects that are undertaken the exclusion of
    the cost-sharing payment probably exceeds the value of the public benefit and
    hence, the excess provides a subsidy primarily benefitting the landowner.

    	Selected Bibliography

    U.S. Department of the Treasury,  Internal Revenue Service,  Farmer's Tax
    Guide,  Publication 225, 2005,  pp. 11-12.
    U.S. Congress.  Joint Committee on Taxation.  Study of the Overall State
    of the Federal Tax System and Recommendations for Simplification,
    Pursuant to Section 8022(3)(B) of the Internal Revenue Code of 1986,
    Volume II.  JCS-3-01, April 2001, pp. 460-462.

    -,   Present Law and Description of Proposals Relating to Federal Income
    Tax Provisions That Impact Energy, Fuel, and Land Use Conservation and
    Preservation.  July 24, 2000.
    -, Senate Committee on Finance.  Technical Corrections Act of 1979, 96th
    Congress, 1st session.  December 13, 1979, pp. 79-81.
    -,  General Explanation of the Revenue Act of 1978.

    Agriculture

    EXCLUSION OF CANCELLATION
    OF INDEBTEDNESS INCOME OF FARMERS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.1

    -

    0.1

    2007

    0.1

    -

    0.1

    2008

    0.1

    -

    0.1

    2009

    0.1

    -

    0.1

    2010

    0.1

    -

    0.1

    Authorization

    Sections 108 and 1017.

    	Description

    This provision allows farmers who are solvent to treat the income arising
    from the cancellation of certain indebtedness as if they were insolvent
    taxpayers.  Under this provision, income that would normally be subject to
    tax, the cancellation of a debt, would be excluded from tax if the discharged
    debt was "qualified farm debt" discharged or canceled by a "qualified
    person."

    To qualify, farm debt must meet two tests: it must be incurred directly from
    the operation of a farming business, and at least 50 percent of the taxpayer's
    previous three years of gross receipts must come from farming.

    To qualify, those canceling the qualified farm debt must participate
    regularly in the business of lending money, cannot be related to the taxpayer
    who is excluding the debt, cannot be a person from whom the taxpayer
    acquired property securing the debt, or cannot be a person who received any
    fees or commissions associated with acquiring the property securing the debt.
     Qualified persons include federal, state, and local governments.

    The amount of canceled debt that can be excluded from tax cannot exceed
    the sum of adjusted tax attributes and adjusted basis of qualified property.
    Any canceled debt that exceeds this amount must be included in gross
    income.  Tax attributes include net operating losses, general business credit
    carryovers, capital losses, minimum tax credits, passive activity loss and
    credit carryovers, and foreign tax credit carryovers.  Qualified property
    includes business (depreciable) property and investment (including farmland)
    property.

    Taxpayers can elect to reduce the basis of their property before reducing
    any other tax benefits.

    	Impact

    This exclusion allows solvent farmers to defer the tax on the income
    resulting from the cancellation of a debt.  Generally, the exclusion of
    cancellation of indebtedness is not available to other taxpayers unless they are
    insolvent or unless they were living in the core disaster area or the Hurricane
    Katrina disaster area on August 25, 2005, and suffered economic loss as the
    result of the hurricane.

    	Rationale

    The exclusion for the cancellation of qualified farm indebtedness was
    enacted as part of the Tax Reform Act of 1986.  At the time, the intended
    purpose of the provision was to avoid tax problems that might arise from
    other legislative initiatives designed to alleviate the credit crisis in the farm
    sector.

    For instance, Congress was concerned that pending legislation providing
    Federal guarantees for lenders participating in farm-loan write-downs would
    cause some farmers to recognize large amounts of income when farm loans
    were canceled.  As a result, these farmers might be forced to sell their
    farmland to pay the taxes on the canceled debt.  This tax provision was
    adopted to mitigate that problem.

    Assessment

    The exclusion of cancellation of qualified farm income indebtedness does
    not constitute a forgiveness of tax but rather a deferral of tax. By electing to
    offset the canceled debt through reductions in the basis of property, a taxpayer
    can postpone the tax that would have been owed on the canceled debt until
    the basis reductions are recaptured when the property is sold or through
    reduced depreciation in the future.  Since money has a time value (a dollar
    today is more valuable than a dollar in the future), however, the deferral of
    tax provides a benefit in that it effectively lowers the tax rate on the income
    realized from the discharge of indebtedness.

    	Selected Bibliography

    U.S. Congress, Joint Committee on Taxation.  General Explanation of the
    Tax Reform Act of 1986.
    -, House Committee on the Budget Conference Report.  Omnibus Budget
    Reconciliation Act of 1993.  Washington, DC, 1993.
    -, Joint Committee on Taxation.  Technical Explanation of H.R. 3768, The
    "Katrina Emergency Tax Relief Act of 2005" as passed by the House and the
    Senate on September 21, 2005.  JCX-69-05.  September 22, 2005.
    U.S. Treasury.  Internal Revenue Service.  Farmer's Tax Guide.
    Publication 225, 2005.  pp. 15-17.
    -, Internal Revenue Service.  Reduction of Tax Attributes Due to Discharge
    of Indebtedness.  Federal Register, Vol. 69, No. 91, Tuesday May 11, 2004.
    pp. 26038-26040.

    Agriculture

    CASH ACCOUNTING FOR AGRICULTURE

    Estimated Revenue Loss*

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    --

    --

    --

    2007

    --

    --

    --

    2008

    --

    --

    --

    2009

    --

    --

    --

    2010

    --

    --

    --
    * Estimated to produce a negative tax expenditure over the forecast period.
    	Disaggregated estimates available from the Joint Committee on Taxation.

    Authorization

    Sections 162, 175, 180, 446, 447, 448, 461, 464, and 465.

    	Description

    Most farm businesses (with the exception of certain farm corporations and
    partnerships or any tax shelter operation) may use the cash method of tax
    accounting to deduct costs attributable to goods held for sale and in inventory
    at the end of the tax year.  These businesses are also allowed to expense some
    costs of developing assets that will produce income in future years.  Both of
    these rules thus allow deductions to be claimed before the income associated
    with the deductions is realized.

    Costs that may be deducted before income attributable to them is realized
    include livestock feed and the expenses of planting crops for succeeding
    year's harvest.  Costs that otherwise would be considered capital expenditures
    but that may be deducted immediately by farmers include certain soil and
    water conservation expenses, costs associated with raising dairy and breeding
    cattle, and fertilizer and soil conditioner costs.

    	Impact

    For income tax purposes, the cash method of accounting is less
    burdensome than the accrual method of accounting and also provides benefits
    in that it allows taxes to be deferred into the future.  Farmers who use the cash
    method of accounting and the special expensing provisions receive tax
    benefits not available to taxpayers required to use the accrual method of
    accounting.

    	Rationale

    The Revenue Act of 1916 established that a taxpayer may compute
    personal income for tax purposes using the same accounting methods used to
    compute income for business purposes.  At the time, because accounting
    methods were less sophisticated and the typical farming operation was small,
    the regulations were apparently adopted to simplify record keeping for
    farmers.

    Specific regulations relating to soil and water conservation expenditures
    were adopted in the Internal Revenue Code of 1954.  Provisions governing
    the treatment of fertilizer costs were added in 1960.

    The Tax Reform Act of 1976 required that certain farm corporations and
    some tax shelter operations use the accrual method of accounting rather than
    cash accounting.  The Tax Reform Act of 1986 further limited the use of cash
    accounting by farm corporations and tax shelters and repealed the expensing
    rules for certain land clearing operations.  The Act also limited the use of cash
    accounting for assets that had preproductive periods longer than two years.
    These restrictions, however, were later repealed by the Technical and
    Miscellaneous Revenue Act of 1988.

    Assessment

    The effect of deducting costs before the associated income is realized
    understates income in the year of deduction and overstates income in the year
    of realization.  The net result is that tax liability is deferred which results in an
    underassessment of tax.  In addition, in certain instances when the income is
    finally taxed, it may be taxed at preferential capital gains rates.

    	Selected Bibliography

    U.S. Department of the Treasury.  Internal Revenue Service.  Farmer's Tax
    Guide.  Publication 225, 2005, pp. 5-6.
    -, Internal Revenue Service.  Accounting Periods and Methods.
    Publication 538.  2004.

    U.S. Congress, Joint Committee on Taxation.  General Explanation of Tax
    Legislation Enacted in the 107th Congress.  JCS-1-03, January 2003, pp. 240-
    242.
    -, Joint Committee on Taxation.  Overview of Present Law and Selected
    Proposals Regarding the Federal Income Taxation of Small Business and
    Agriculture.  JCX-45-02, May 2002, pp. 37-39.
    -, Joint Committee on Taxation.  General Explanation of the Revenue Act
    of 1978.
    U.S. Senate, Committee on Finance.  Technical Corrections Act of 1979.
    96th Congress, 1st session, December 13, 1979, pp. 79-81.
    U.S. Congress.  Congressional Budget Office.  Budget Options.  February
    2001, p. 439.

    Agriculture

    INCOME AVERAGING FOR FARMERS AND FISHERMEN

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    (1)

    -

    (1)

    2007

    (1)

    -

    (1)

    2008

    (1)

    -

    (1)

    2009

    (1)

    -

    (1)

    2010

    (1)

    -

    (1)

    (1)Less than $50 million.

    	Authorization

    Section 1301.

    	Description

    For taxable years beginning after December 31, 1997, taxpayers have the
    option to calculate their current year income tax by averaging over the prior 3-
    year period, all or a portion of their income from farming or commercial
    fishing.  The taxpayer can designate all or a part of his current year income
    from farming as "elected farm income" or from fishing as "fishing business"
    income.  The taxpayer then allocates 1/3 of the "elected farm income" or
    "fishing business" income to each of the prior 3 taxable years.

    The current year income tax for a taxpayer making this election is
    calculated by taking the sum of his current year tax calculated without
    including the "elected farm income" or "elected fishing business" income and
    the extra tax in each of the three previous years that results from including 1/3
    of the current year's  "elected farm income" or "fishing business" income.

    "Elected farm income" can include the gain on the sale of farm assets with
    the exception of the gain on the sale of land.

    The tax computed using income averaging for farmers and fisherman does
    not apply for purposes of computing the regular income tax and subsequent
    determination of alternative minimum tax liability.

    	Impact

    This provision  provides tax relief primarily to taxpayers whose main
    source of income derives from agricultural production or commercial fishing.
     It allows these taxpayers to exert some control over their taxable incomes and
    hence, their tax liabilities in those years that they experience fluctuations in
    their incomes.

    	Rationale

    Income averaging for farmers was enacted as part of the Taxpayer Relief
    Act of 1997.  Congress believed that the income from farming can fluctuate
    dramatically from year to year and that these fluctuations are outside the
    control of the taxpayers.  To address this problem, Congress felt that
    taxpayers who derive their income from agriculture should be allowed an
    election  to average farm income and mitigate the adverse tax consequences
    of fluctuating incomes under a progressive tax structure.

    Assessment

    Under an income tax system with progressive tax rates and an annual
    assessment of tax, the total tax assessment on an income that fluctuates from
    year to year will be greater than the tax levied on an equal amount of income
    that is received in equal annual installments.  Under pre-1986 income tax law,
    income averaging provisions were designed to help avoid the over assessment
    of tax that might occur under a progressive tax when a taxpayer's income
    fluctuated from year to year.  These pre-1986 tax provisions were especially
    popular with farmers who, due to market or weather conditions, might
    experience significant fluctuations in their annual incomes.

    The Tax Reform Act of 1986 repealed income averaging.  At the time, it
    was argued that the reduction in the number of tax brackets and the level of
    marginal tax rates reduced the need for income averaging.  Farmers argued
    that even though the tax brackets had been widened and tax rates reduced, the
    fluctuations in their incomes could be so dramatic that without averaging they
    would be subject to an inappropriately high level of income taxation.

    As marginal income tax rates were increased in 1990 and 1993, Congress
    became more receptive to the arguments for income averaging and reinstated
    limited averaging in the Taxpayer Relief Act of 1997.  Under this Act,
    income averaging for farmers was a temporary provision and was to expire
    after January 1, 2001.  The Omnibus Consolidated and Emergency
    Supplemental Appropriations Act of 1998 made income averaging for
    farmers permanent.

    The American Jobs Creation Act of 2004 expanded income averaging to
    include commercial fisherman.  It also coordinated income averaging with the
    individual alternative minimum tax so that the use of income averaging would
    not cause farmers or fishermen to incur alternative minimum tax liability.

     It appears, however, that the current income averaging provisions fall short
    of the economic ideal on several fronts.  For instance,  from an economic
    perspective the source of income fluctuations should not matter when
    deciding whether or not income averaging is needed.  Hence, limiting
    averaging to farm income or commercial fishing income may appear unfair to
    other taxpayers such as artists and writers who also may have significant
    fluctuations in their annual incomes.

    A more significant theoretical problem is that these provisions only allow
    for upward income averaging.  Under a theoretically correct income tax,
    income averaging would be available for downward fluctuations in income as
    well as upward fluctuations.  Downward income averaging would mean that
    taxpayers who experienced major reductions in their annual incomes would
    also qualify for income averaging.  This would allow them to mitigate sharp
    reductions in their current year incomes by reducing their current year taxes to
    reflect taxes that had already been prepaid in previous years when their
    incomes were higher.

    	Selected Bibliography

    U.S. Congress, House of Representatives.  American Jobs Creation Act of
    2004.  Conference Report to Accompany H.R. 4520.  H. Rept. 108-755.
    October 2004.
    -,Joint Committee on Taxation.  Overview of Present Law and Selected
    Proposals Regarding the Federal Income Taxation of Small Business and
    Agriculture.  JCX-45-02, May 2002, pp. 44-45.
    -, Joint Committee on Taxation.  Technical Explanation of S.3152,
    "Community Renewal and New Markets Act of 2000."  JCX-105-00, October
    2000, p. 54.
    -, Joint Committee on Taxation.  Conference Report on Tax and Trade
    Provisions of the Omnibus Consolidated and Emergency Supplemental
    Appropriations Act.  (H.R. 4328).  October 1998.

    -, Joint Committee on Taxation.  Taxpayer Relief Act of 1998.  September
    1998.
     	-, Joint Committee on Taxation.  Taxpayer Relief Act of 1997.  July 1997.
    -, Joint Committee on Taxation.  General Explanation of the Tax Reform
    Act of 1986.  May 1987.
    U.S. Department of the Treasury.  Internal Revenue Service.  IRS Final
    Regulations (T.D. 8972) on Averaging of Farm Income.  January 8, 2002.
    -, Internal Revenue Service.  Farmer's Tax Guide.  Publication 225.  2005.

    Agriculture

    FIVE-YEAR CARRYBACK PERIOD FOR
    NET OPERATING LOSSES ATTRIBUTABLE TO FARMING

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    (1)

    (1)

    (1)

    2007

    (1)

    (1)

    (1)

    2008

    (1)

    (1)

    (1)

    2009

    (1)

    (1)

    (1)

    2010

    (1)

    (1)

    (1)

    (1)Less than $50 million.

    Authorization

    Section 172.

    	Description

    A net operating loss, the amount by which business and certain other
    expenses exceed income for the year, may be carried forward and deducted
    from other income for 20 years following the loss year.  It may, at the
    taxpayer's election, instead be carried back to earlier years in which there was
    positive income.  For most taxpayers, the carryback period is limited to the
    previous 2 years, although small businesses in federally declared disaster
    areas may carry losses back 3 years.  (The Job Creation and Workers
    Assistance Act of 2002 temporarily extended the net operating loss carryback
    period to 5 years for losses arising in taxable years ending in 2001 and 2002
    for businesses that normally have a 2 or 3 year loss carryback.)  Current law
    permits losses attributed to a farming business (as defined in section
    263A(e)(4)) to be carried back 5 years.  The Gulf Opportunity Zone Act of
    2005 broadened the definition of farm income to include losses on qualified
    timber property located in the Gulf or Rita Opportunity Zones.

    	Impact

    For businesses that have paid taxes within the allowed carryback period,
    making use of the carryback rather than the carryforward option for operating
    losses means receiving an immediate refund rather than waiting for a future
    tax reduction.  Although the special 5-year carryback applies only to losses
    incurred in a farming business, the losses may be used to offset taxes paid on
    any type of income.  Thus the beneficiaries of this provision are farmers who
    have either been profitable in the past or who have had non-farm income on
    which they paid taxes.

    	Rationale

    Some provision for deducting net operation losses from income in other
    years has been an integral part of the income tax system from its inception.
    The current general rules (20-year carryforwards and 2-year carrybacks) date
    from the "Taxpayer Relief Act of 1997," P.L. 105-34, which shortened the
    carryback period from 3 to 2 years (except for farmers and small businessmen
    in federally declared disaster areas, which remained at 3 years).

    The 5-year carryback for farm losses was enacted as a part of the "Omnibus
    Consolidated and Emergency Supplemental Appropriations Act," P.L. 105-
    277.  The committee reports state that a special provision for farmers was
    considered appropriate because of the exceptional volatility of farm income.

    The Gulf Opportunity Zone Act of 2005 broadened the definition of farm
    income to include losses on qualified timber property located in the Gulf or
    Rita Opportunity Zones.  This change is effective for losses incurred on or
    after August 28, 2005 (in the Gulf Opportunity Zone), on or after September
    23, 2005 (in the Rita Zone), on or after October 23, 2005 (in the Wilma Zone)
    and before January 1, 2007.

    Assessment

    In an ideal income tax system, the government would refund taxes in loss
    years with the same alacrity that it collects them in profit years, and a
    carryback of losses would not be considered a deviation from the normal tax
    structure.  Since the current system is less than ideal in many ways, however,
    it is difficult to say whether the loss carryover rules bring it closer to or move
    it further away from the ideal.

    The special rule for farmers is intended to compensate for the excessive
    fluctuations in income farmers are said to experience.  This justification is
    offered for many of the tax benefits farmers are allowed, but it is not actually
    based on evidence that farmers experience annual income fluctuations greater
    than other small businessmen.  The farm losses may offset taxes on non-farm
    income, so some of the benefit will accrue to persons whose income is not
    primarily from farming.

    	Selected Bibliography

    U.S. Treasury Department.  Internal Revenue Service.  Net Operating
    Losses (NOLs) for Individuals, Estates, and Trusts.  Publication 536.  2005.
    U.S. Congress, Joint Committee on Taxation.  General Explanation of Tax
    Legislation Enacted in 1998, pp. 276-277.
    -, Joint Committee on Taxation.  Summary of P. L. 107-147, The "Job
    Creation and Worker Assistance Act of 2002", JCX-22-02, March 2002,  p. 2.
    -, Joint Committee on Taxation.  Technical Explanation of the Revenue
    Provisions of H.R. 4440, "The Gulf Opportunity Zone Act of 2005" As
    Passed By The House of Representatives and the Senate.  JCX-88-05,
    December 16, 2005, p. 22.
    U.S. House, Committee on Ways and Means.  Taxpayer Relief Act of 1998.
     105th Congress, 2nd session, September 23, 1998, pp. 57-59.

    Commerce and Housing:
    	Financial Institutions

    EXEMPTION OF CREDIT UNION INCOME

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    -

    1.7

    1.7

    2007

    -

    1.8

    1.8

    2008

    -

    1.9

    1.9

    2009

    -

    2.0

    2.0

    2010

    -

    2.1

    2.1

    	Authorization

    Section 501(c)(14) of the Internal Revenue Code of 1986 and section 122
    of the Federal Credit Union Act, as amended (12 U.S.C. sec. 1768).

    	Description

    Credit unions without capital stock and organized and operated for mutual
    purposes and without profit are not subject to Federal income tax.

    	Impact

    Credit unions are the only depository institutions exempt from Federal
    income taxes.  If this exemption were repealed, both federally chartered and
    State chartered credit unions would become liable for payment of Federal
    corporate income taxes on their retained earnings but not on earnings
    distributed to depositors.

    For a given addition to retained earnings, this tax exemption permits credit
    unions to pay members higher dividends and charge members lower interest
    rates on loans.  Over the past 20 years, this tax exemption may have
    contributed to the more rapid growth of credit unions compared to other
    depository institutions.

    Opponents of credit union taxation emphasize that credit unions provide
    many services free or below cost in order to assist low-income members.
    These services include small loans, financial counseling, and low-balance
    share drafts.  They argue that the taxation of credit unions would create
    pressure to eliminate these subsidized services.  But whether or not consumer
    access to basic depository services is a significant problem is disputed.

    	Rationale

    Credit unions have never been subject to the Federal income tax.  Initially,
    they were included in the provision that exempted domestic building and loan
    associations - whose business was at one time confined to lending to
    members - and nonprofit cooperative banks operated for mutual purposes.
    The exemption for mutual banks and savings and loan institutions was
    removed in 1951, but credit unions retained their exemption.  No specific
    reason was given for continuing the exemption of credit unions.

    In 1978, the Carter Administration proposed that the taxation of credit
    unions be phased in over a five-year period.  In 1984, a report of the
    Department of the Treasury to the President proposed that the tax exemption
    of credit unions be repealed.  In 1985, the Reagan Administration proposed
    the taxation of credit unions with over $5 million in gross assets.  In the
    budget for fiscal year 1993, the Bush Administration proposed that the tax
    exemption for credit unions with assets in excess of $50 million be repealed.
    On March 16, 2004, Donald E. Powell, Chairman of the Federal Deposit
    Insurance Corporation, stated that "credit unions ought to pay taxes."

    	Assessment

    Supporters of the credit union exemption emphasize the uniqueness of
    credit unions compared to other depository institutions.  Credit unions are
    nonprofit financial cooperatives organized by people with a common bond
    which is a unifying characteristic among members that distinguishes them
    from the general public.

    Credit unions are directed by volunteers for the purpose of serving their
    members.  Consequently, the exemption's supporters maintain that credit
    unions are member-driven while other depository institutions are profit-
    driven.  Furthermore, supporters argue that credit unions are subject to certain
    regulatory constraints not required of other depository institutions and that
    these constraints reduce the competitiveness of credit unions.  For example,
    credit unions may lend only to members.

    Proponents of taxation argue that deregulation has caused extensive
    competition among all depository institutions, including credit unions, and
    that the tax exemption gives credit unions an unwarranted advantage.
    Proponents of taxation argue that depository institutions should have a level
    playing field in order for market forces to allocate resources efficiently.

    	Selected Bibliography

    Bickley, James M.  Should Credit Unions be Taxed?  Library of Congress,
    Congressional Research Service Report 97-548 E.  Washington, DC: Updated
    March 28, 2006.
    Jolly, Robert W., Gary D. Koppenhaver, and Joshua D. Roe.  Growth of
    Large-Scale Credit Union in Iowa: Implications for Public Policy.  Ames,
    Iowa: Department of Economics, Iowa State University, Working Paper
    #04031, November 2004.
    U.S. Congress, Congressional Budget Office.  Budget Options.
    Washington, DC: U.S. Government Printing Office, February 2005, p. 301.
    U.S. Government Accountability Office, Issues Regarding the Tax-Exempt
    Status of Credit Unions, Testimony before the House Committee on Ways
    and Means, November 3, 2005.
    Tatom, John.  Competitive Advantage: A Study of the Federal Tax
    Exemption for Credit Unions.  Washington, DC: Tax Foundation, 2005.

    	 Commerce and Housing:
    	Insurance Companies

    	EXCLUSION OF INVESTMENT INCOME
    	ON LIFE INSURANCE AND ANNUITY CONTRACTS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    25.5

    2.5

    28.0

    2007

    26.1

    2.5

    28.6

    2008

    26.8

    2.6

    29.4

    2009

    27.5

    2.7

    30.2

    2010

    28.2

    2.7

    30.9

    	Authorization

    Sections 72, 101, 7702, 7702A.

    	Description

    Life insurance companies invest premiums they collect, and returns on
    those investments help pay benefits.  Amounts not paid as benefits may be
    paid as policy dividends or given back to policyholders as cash surrender
    values or loan values.

    Policyholders are not generally taxed on this investment income,
    commonly called "inside build-up," as it accumulates.  Insurance companies
    also usually pay no taxes on this investment income.  Death benefits for most
    policies are not taxed at all, and amounts paid as dividends or withdrawn as
    cash values are taxed only when they exceed total premiums paid for the
    policy, allowing tax-free investment income to pay part of the cost of the
    insurance protection.  Investment income that accumulates within annuity
    policies is also free from tax, but annuities are taxed on their investment
    component when paid.

    Life insurance policies must meet tests designed to limit the tax-free
    accumulation of income.  If investment income accumulates very much faster
    than is needed to fund the promised benefits, that income will be attributed to
    the owner of the policy and taxed currently.  If a corporation owns a life
    insurance policy, investment income is included in alternative minimum
    taxable income.

    	Impact

    The interest exclusion on life insurance savings allows policyholders to
    pay for a portion of their personal insurance with tax-free interest income.
    Although the interest earned is not currently paid to the policyholder, it is
    used to cover at least part of the cost of the insurance coverage, and it may be
    received in cash if the policy is terminated.  In spite of recent limitations on
    the amount of income that can accumulate tax-free in a contract, the tax-free
    interest income benefit can be substantial.

    The tax deferral for interest credited to annuity contracts allows taxpayers
    to save for retirement in a tax-deferred environment without restriction on the
    amount that can be invested for these purposes.  Although the amounts
    invested in an annuity are not deductible by the taxpayer, as are contributions
    to qualified pension plans or some IRAs, the tax deferral on the income
    credited to such investments represents a significant tax benefit to the
    taxpayer.

    These provisions thus offer preferential treatment for the purchase of life
    insurance coverage and for savings held in life insurance policies and annuity
    contracts.   Middle-income taxpayers, who make up the bulk of the life
    insurance market, reap most of this provision's benefits.  Higher-income
    taxpayers, once their life insurance requirements are satisfied, generally
    obtain better after-tax yields from tax-exempt State and local obligations or
    tax-deferred capital gains.

    	Rationale

    The exclusion of death benefits paid on life insurance dates back to the
    1913 tax law.  While no specific reason was given for exempting such
    benefits, insurance proceeds may have been excluded because they were
    believed to be comparable to bequests, which also were excluded from the tax
    base.

    The nontaxable status of the life insurance inside build-up and the tax
    deferral on annuity investment income also dates from 1913.  Floor
    discussions of the bill made it clear that inside build-up was not taxable, and
    that amounts received during the life of the insured would be taxed only when
    they exceeded the investment in the contract (premiums paid), although these
    provisions were not explicitly included in the law.

    These rules were to some extent based on the general tax principle of
    constructive receipt.  The interest income was not viewed as actually
    belonging to the policyholders because they would have to give up the
    insurance protection or the annuity guarantees to obtain the interest.

    The inside build-up in several kinds of insurance products was made
    taxable to the policy owners in recent years.  (Corporate-owned policies were
    included under the minimum tax in the Tax Reform Act of 1986.  The Deficit
    Reduction Act of 1984 and the Technical and Miscellaneous Revenue Act of
    1988 imposed taxes on inside build-up and distributions for policies with an
    overly large  investment component.)  This change suggests that the Congress
    finds the exclusion rationale based on the constructive receipt doctrine
    unpersuasive in some cases.  The President's Advisory Panel on Federal Tax
    Reform, which issued its final report in November 2005, recommended
    elimination of the exemption on life insurance investment earnings.  Instead
    the Advisory Panel favored savings incentives which would treat various
    investment vehicles in a more neutral manner.  Congress has enacted no
    legislation which would implement recommendations of the Advisory Panel.

    	Assessment

    The tax treatment of policy income combined with the tax treatment of life
    insurance company reserves (see "Special Treatment of Life Insurance
    Company Reserves," below) makes investments in life insurance policies
    virtually tax-free.   Cash value life insurance can operate as an investment
    vehicle that combines life insurance protection with a financial instrument
    that operates similarly to bank certificates of deposit and mutual fund
    investments.  This exemption of  inside build-up distorts investors' decisions
    by encouraging them to choose life insurance over competing savings
    vehicles such as bank accounts, mutual funds, or bonds.  The result could be
    overinvestment in life insurance and excessive levels of life insurance
    protection relative to what would occur if life insurance products competed on
    a level playing field with other investment opportunities.

    There is some evidence, however, that people underestimate the financial
    loss their deaths could cause and so tend to be underinsured.  If this is the
    case, some encouragement of the purchase of life insurance might be
    warranted.  There is no evidence of the degree of encouragement required or
    of the efficacy of providing that encouragement through tax exemption.

    The practical difficulties of taxing inside build-up to the policy owners and
    the desire not to add to the distress of heirs by taxing death benefits have
    discouraged many tax reform proposals covering life insurance.  Taxing at the
    company level as a proxy for individual income taxation has been a suggested
    alternative.

    Inside build-up exclusion contributed to the surge in the number of
    corporate-owned life insurance (COLI) policies in the 1980s.  Many firms,
    which had previously bought policies only for key personnel, began to buy
    life insurance on large numbers of lower level employees.  Several newspaper
    articles focused COLI policies bought without employees' knowledge or
    consent, which have been termed "dead peasant insurance" or "janitor
    insurance."  The IRS, arguing that such COLI policies serve as a tax shelter,
    sued several major corporations, and these cases limited some of the tax
    benefits of COLI policies. (See the 2006 Joint Tax Committee summary for
    citations.)  The Pension Protection Act of 2006 (P. L. 109-280) limited tax
    benefits of COLI policies to key personnel and to benefits paid to survivors,
    and requires firms to obtain employee's written consent.  The Joint Tax
    Committee estimated that these limits will have a negligible effect on
    revenues.

    	Selected Bibliography

    Brumbaugh, David L.  Taxes and the "Inside Build-Up" of Life
    Insurance: Recent Issues.   Library of Congress, Congressional Research
    Service Report RS20923, August 2, 2006.
    Christensen, Burke A.  "Life Insurance: the Under-Appreciated Tax
    Shelter." Trusts and Estates  135 (November 1996), pp. 57-60.
    Esperti, Robert A., et al.  "Post-EGTRRA Life Insurance Planning: the
    Economic Growth and Tax Relief Reconciliation Act of 2001 Promises
    Repeal of the Estate Tax in 2010, But Will it Ever Come to Pass?"  The Tax
    Adviser 33 (August 2002), pp. 532-537.
    Gallagher, Gregory W. and Charles L. Ratner, eds.  Federal Income
    Taxation of Life Insurance, 2nd edition.  Chicago: American Bar Association,
    1999.
    Goode, Richard.  "Policyholders' Interest Income from Life Insurance
    Under the Income Tax," Vanderbilt Law Review 15 (December 1962), pp.
    33-55.
    Harman, William B., Jr.  "Two Decades of Insurance Tax Reform." Tax
    Notes 57 (November 12, 1992), pp. 901-914.
    Kotlikoff, Lawrence J.  The Impact of Annuity Insurance on Savings and
    Inequality, Cambridge, Mass.: National Bureau of Economic Research, 1984.
    McClure, Charles E.  "The Income Tax Treatment of Interest Earned on
    Savings in Life Insurance."  In The Economics of Federal Subsidy Programs.
      Part 3: Tax Subsidies.  (U.S. Congress, Joint Economic Committee.)
    Washington, DC: U.S. Government Printing Office, July 15, 1972.

    Pike, Andrew D. Taxation of Life Insurance Products: Background and
    Issues.  Library of Congress, Congressional Research Service Report
    RL32000, July 18, 2003.
    President's Advisory Panel on Federal Tax Reform. Simple, Fair, and
    Pro-Growth: Proposals to Fix America's Tax System: Report of the
    President's Advisory Panel on Federal Tax Reform.  Washington, DC:
    November 2005.
    Schultz Ellen E. and Theo Francis, "Companies Profit on Workers' Deaths
    Through 'Dead Peasants' Insurance", Wall Street Journal, April 19, 2002
    U.S. Congress, Committee on Ways and Means.  Technical and
    Miscellaneous Revenue Act of  1988.  Report to accompany H.R. 4333. 100th
    Congress, 2nd session.  House Report 100-1104.  Washington, DC:
    Government Printing Office, October 21, 1988, pp. 96-108.
    U.S. Congress, Joint Committee on Taxation.  "Life Insurance Tax
    Provisions." In General  Explanation of the Revenue Provisions of the Deficit
    Reduction Act of 1984.  Joint  Committee Print, 98th Congress, 2nd session.
    Washington, DC: Government Printing Office, December 31, 1984.
    -. Tax Reform Proposals: Taxation of Insurance Products and
    Companies.  Joint Committee Print, 99th Congress, 1st session.  Washington:
    Government Printing Office,  September 20, 1985.
    -. Present-Law Federal Tax Treatment, Proposals, and Issues Relating to
    Company-Owned Life Insurance, Joint Committee Print JCX-91-03, 108th
    Congress, 1st session.  Washington: Government Printing Office, October 15,
    2003
    -. 'Technical Explanation of H.R. 4, The "Pension Protection Act
    of 2006," As Passed by the House on July 28, 2006, and As
    Considered by the Senate on August 3, 2006." Joint Committee Print
    JCX-38-06, 109th Congress, 2nd session.  Washington, DC: Government
    Printing Office, August 3, 2006, pp.208-222.
    -. 'Estimated Budget Effects of H.R. 4, The "Pension Protection
    Act of 2006," As Introduced in The House of Representatives on July
    28, 2006.'  Joint Committee Print JCX-36-06 , 109th Congress, 2nd
    session.  Washington, DC: Government Printing Office, July 28, 2006,
    p.4.
    U.S. Congressional Budget Office.  "Options to Increase Revenues:
    Include Investment Income from Life Insurance and Annuities in Taxable
    Income."  In Budget Options.  Washington, DC: 2005.
    U.S. Department of the Treasury.  Report to the Congress on the Taxation
    of Life Insurance Company Products.  Washington, DC: March 30, 1990.
    Vickrey, William S.  Agenda for Progressive Taxation.  New York:
    Ronald Press, 1947.  Reprint, Clifton, NJ: Kelley, 1970.
    -.  "Insurance Under the Federal Income Tax," Yale Law Journal 52 (June
    1943), pp. 554-585.
    Webel, Baird. Corporate Owned Life Insurance (COLI): Insurance and
    Tax Issues, Library of Congress, Congressional Research Service Report
    RL33414, May 10, 2006.

    	 Commerce and Housing:
    	Insurance Companies

    	SMALL LIFE INSURANCE COMPANY
    	TAXABLE INCOME ADJUSTMENT

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    -

    0.1

    0.1

    2007

    -

    0.1

    0.1

    2008

    -

    0.1

    0.1

    2009

    -

    0.1

    0.1

    2010

    -

    0.1

    0.1

    	Authorization

    Section 806.

    	Description

    Life insurance companies with gross assets of less than $500 million are
    allowed a special "small life insurance company deduction."  Generally,
    consolidated group tests are used in applying the taxable income and gross
    asset standards.  The amount of the deduction is 60 percent of so much of
    otherwise taxable income from insurance operations for a taxable year that
    does not exceed $3 million, reduced by 15 percent of the excess of otherwise
    taxable income over $3 million.

    Thus, the deduction phases out as a company's taxable insurance income
    increases from $3 million to $15 million, computed without this deduction.  A
    company with taxable insurance income over $15 million, computed without
    this deduction, is not entitled to a small life insurance company deduction.

    	Impact

    The small life insurance company deduction reduces the tax rate for
    "small" life insurance companies.  An insurer with assets of up to $500
    million and taxable incomes of up to $15 million can still be considered small
    relative to very large companies that comprise most of the industry.  A
    company eligible for the maximum small company deduction of $1.8 million
    is, in effect, taxed at a rate of 13.6 percent instead of the regular 34 percent
    corporate rate.

    Because these companies may be either investor-owned stock companies
    or policyholder-owned mutual companies, determining the distribution of
    benefits is difficult.  Competitive pressures may force companies to pass some
    of these benefits on to life insurance policyholders.

    	Rationale

    This provision was added in the massive revision of life insurance
    company taxation included in the Deficit Reduction Act of 1984 (P.L. 98-
    369).  The justification given is that, although "the Congress believed that,
    without this provision, the Act provided for the proper reflection of taxable
    income," the Congress was also concerned about a sudden sharp increase in
    the companies' taxes.  A companion provision, reducing taxes by an arbitrary
    amount for all life insurance companies, was repealed in the Tax Reform Act
    of 1986, but the deduction for small companies was retained.

    	Assessment

    The principle of basing taxes on the ability to pay, often put forth as a
    requisite of an equitable and fair tax system, does not justify reducing taxes
    on business income for firms below a certain size.  Tax burdens are ultimately
    borne by persons, such as business owners, customers, employees, or other
    individuals, not by firms.  The burden that a business's taxes places on a
    person is not determined by the size of the business.

    Imposing lower tax rates on smaller firms distorts the efficient allocation of
    resources, since it offers a cost advantage based on size and not economic
    performance.  This tax reduction serves no simplification purpose, since it
    requires an additional set of computations and some complex rules to prevent
    abuses.  It may serve to help newer companies to become established and
    build up the reserves State laws require of insurance companies.

    	Selected Bibliography

    U.S. Congress, Joint Committee on Taxation.  "Tax Treatment of Life
    Insurance Companies."  In General  Explanation of the Revenue Provisions
    of the Deficit Reduction Act of 1984.  Joint Committee Print, 98th Congress,
    2d session.  Washington, DC: Government Printing Office, December 31,
    1984, pp. 582-593.
    -.  Tax Reform Proposals: Taxation of Insurance Products and
    Companies.  Joint Committee Print, 99th Congress, 1st session.  Washington,
    DC: Government Printing Office,  September 20, 1985.

    	 Commerce and Housing:
    	Insurance Companies

    	SPECIAL TREATMENT
    	OF LIFE INSURANCE COMPANY RESERVES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    -

    1.9

    1.9

    2007

    -

    2.0

    2.0

    2008

    -

    2.0

    2.0

    2009

    -

    2.1

    2.1

    2010

    -

    2.2

    2.2

    	Authorization

    Sections 803(a)(2), 805(a)(2), 807.

    	Description

    Most businesses calculate taxable income by deducting expenses when the
    business becomes liable for paying them.  Life insurance companies,
    however, are allowed to deduct additions to reserves for future liabilities
    under insurance policies, offsetting current income with future expenses.

    	Impact

    Reserves are accounts recorded in the liabilities section of balance sheets
    to indicate a claim against assets for future expenses.  When additions to the
    reserve accounts are allowed as deductions in computing taxable income, it
    allows an amount of tax-free (or tax-deferred) income to be used to purchase
    assets.  Amounts are added to reserves from both premium income and the
    investment income earned by the invested assets, so reserve accounting
    shelters both premium and investment income from tax.

    A large part of the reserves of life insurance companies is credited to
    individual policyholders, to whom the investment income is not taxed either
    (see "Exclusion of Investment Income on Life Insurance and Annuity
    Contracts," above).

    The nature of the life insurance industry suggests that a reduction in its
    corporate taxes would go primarily to policyholders.  Thus the beneficiaries
    of this tax expenditure are probably not the owners of capital in general (see
    Introduction) but rather those who invest in life insurance products in
    particular.

    	Rationale

    The first modern corporate income tax enacted in 1909 provided that
    insurance companies could deduct additions to reserves required by law, and
    some form of reserve deduction has been allowed ever since.

    Originally, the accounting rules of most regulated industries were adopted
    for tax purposes, and reserve accounting was required by all State insurance
    regulations.  The many different methods of taxing insurance companies tried
    since 1909 all allowed some form of reserve accounting.

    Before the Deficit Reduction Act of 1984, which set the current rules for
    taxing life insurance companies, reserves were those required by State law
    and generally computed by State regulatory rules.  The Congress, concluding
    that the conservative regulatory rules allowed a significant overstatement of
    deductions, set rules for tax reserves that specified what types of reserves
    would be allowed and what discount rates would be used.

    	Assessment

    Reserve accounting allows the deduction from current income of expenses
    relating to the future.  This is the standard method of accounting for insurance
    regulatory purposes, where the primary goal is to assure that a company will
    be able to pay its promised benefits and the understatement of current income
    is regarded as simply being conservative.

    Under the income tax, however, the understatement of current income
    gives a tax advantage.  Combined with virtual tax exemption of life insurance
    product income at the individual level, this tax advantage makes life
    insurance a far more attractive investment vehicle than it would otherwise be
    and leads to the overpurchase of insurance and overinvestment in insurance
    products.

    One often-proposed solution would retain reserve accounting but limit the
    deduction to amounts actually credited to the accounts of specific
    policyholders, who would then be taxable on the additions to their accounts.
    This would assure that all premium and investment income not used to pay
    current expenses was taxed at either the company or individual level, more in
    line with the tax treatment of banks, mutual funds, and other competitors of
    the life insurance industry.

    	Selected Bibliography

    Aaron, Henry J.  The Peculiar Problem of Taxing Life Insurance
    Companies.  Washington, DC: The Brookings Institution, 1983.
    Harman, William B., Jr.  "Two Decades of Insurance Tax Reform."  Tax
    Notes 57 (November 12, 1992), pp. 901-914.
    Kopcke, Richard W.  "The Federal Income Taxation of Life Insurance
    Companies." New England Economic Review.  (March/April 1985), pp. 5-19.
    Taylor, Jack.  "Federal Taxation of the Insurance Industry."  In The
    Encyclopedia of Taxation and Tax Policy (2nd ed.), eds. Joseph J. Cordes,
    Robert O. Ebel, and Jane G. Gravelle.  Washington DC: Urban Institute
    Press, 2005.
    U.S. Congress, Joint Committee on Taxation.  "Life Insurance Tax
    Provisions." In General  Explanation of the Revenue Provisions of the Deficit
    Reduction Act of 1984.  Joint  Committee Print, 98th Congress, 2d session.
    Washington, DC: Government Printing Office, December 31, 1984.
    -.  Tax Reform Proposals: Taxation of Insurance Products and
    Companies.  Joint Committee Print, 99th Congress, 1st session.  Washington,
    DC: Government Printing Office,  September 20, 1985.
    -.  Taxation of Life Insurance Companies.  Joint Committee Print, 101st
    Congress, 1st session.  Washington, DC: Government Printing Office, October
    16, 1989, pp. 8-11.
    U.S. Department of the Treasury.  Final Report to the Congress on Life
    Insurance Company Taxation.  Washington, DC, 1989.
    -.  Tax Reform for Fairness, Simplicity, and Economic Growth, Volume 2,
    General Explanation of the Treasury Department Proposals.  Washington,
    DC, November 1984, pp. 268-269.

    	 Commerce and Housing:
    	Insurance Companies

    	DEDUCTION OF UNPAID PROPERTY LOSS RESERVES
    FOR PROPERTY AND CASUALTY INSURANCE COMPANIES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    -

    3.4

    3.4

    2007

    -

    3.4

    3.4

    2008

    -

    3.5

    3.5

    2009

    -

    3.6

    3.6

    2010

    -

    3.6

    3.6

    	Authorization

    Sections 832(b)(5), 846.

    	Description

    Most businesses calculate taxable income by deducting expenses when the
    business becomes liable for paying them.  Property and casualty insurance
    companies, however, are allowed to deduct the discounted value of estimated
    losses they will be required to pay in the future under insurance policies
    currently in force, including claims in dispute.  This allows them to deduct
    future expenses from current income and thereby defer tax liability.

    	Impact

    The allowance of a deduction for unpaid losses of a property or casualty
    insurer differs from the treatment of other taxpayers in two important
    respects.  First, insurers may estimate not only the amount of liabilities they
    have incurred but also the existence of the liability itself.  Second, the
    company may deduct an unpaid loss even though it is contesting the liability.
    An ordinary accrual-method taxpayer generally may not deduct the amount of
    a contested liability.

    The net effect of these differences is to permit insurers to accelerate the
    deduction of losses claimed relative to the timing of those deductions under
    the generally applicable rules.

    Competition in the property and casualty insurance industry would cause
    most of this reduction in corporate taxes to go to the benefit of the purchasers
    of insurance, including other businesses, homeowners, and private property
    owners.

    	Rationale

    The first modern corporate income tax enacted in 1909 provided that
    insurance companies could deduct additions to reserves required by law, and
    some form of loss-reserve deduction has been allowed ever since.  Originally,
    the accounting rules of most regulated industries were adopted for tax
    purposes, and reserve accounting was required by all State insurance
    regulations.

    Before the Tax Reform Act of 1986, property and casualty insurance
    company reserves for unpaid losses were simply the undiscounted amount
    expected to be paid eventually, as generally required or allowed by State law.
     The Congress, concluding that the conservative regulatory rules allowed an
    overstatement of loss reserve deductions, required that loss reserves be
    discounted for tax purposes.

    	Assessment

    Reserve accounting allows the deduction from current income of expenses
    relating to the future.  This is the standard method of accounting for insurance
    regulatory purposes, where the primary goal is assuring that a company will
    be able to pay its policyholders and the possible understatement of current
    income is not regarded as a problem.

    But the understatement of current income gives an income tax advantage,
    which is the basis for calling this item a tax expenditure.

    An argument can be made, however, that deducting additions to a properly
    discounted reserve for losses that have already occurred and that can be
    estimated with reasonable certainty does not distort economic income.  Since
    the insurance industry is based on being able to estimate its future payments
    from current policies, measuring current income could appropriately take into
    account the known future payments.  From this perspective, only those
    additions to reserves that exceed expected losses (as perhaps those for
    contested liabilities) would properly be considered a tax expenditure.

    	Selected Bibliography

    Harman, William B., Jr.  "Two Decades of Insurance Tax Reform."  Tax
    Notes 57 (November 12, 1992), pp. 901-914.
    Shepard, Lee A.  "Normal Tax Accounting for Property and Casualty
    Insurance." Tax Notes 71 (April 15, 1996), pp. 395-398.
    Taylor, Jack.  "Federal Taxation of the Insurance Industry."  In The
    Encyclopedia of Taxation and Tax Policy (2nd ed.), eds. Joseph J. Cordes,
    Robert O. Ebel, and Jane G. Gravelle.  Washington DC: Urban Institute
    Press, 2005.
    U.S. Congress, Joint Committee on Taxation.  "Loss Reserves."  In
    General Explanation of the Tax Reform Act of 1986.  Joint Committee Print,
    100th Congress, 1st session.  Washington, DC: Government Printing Office,
    May 4, 1987, pp. 600-618.
    -..  Tax Reform Proposals: Taxation of Insurance Products and
    Companies.  Joint Committee Print, 99th Congress, 1st session.  Washington,
    DC: Government Printing Office,  September 20, 1985, pp. 32-49.
    U.S. Department of the Treasury.  "Limit Property and Casualty Insurance
    Company Reserve Deduction."  In Tax Reform for Fairness, Simplicity, and
    Economic Growth.  General Explanation of the Treasury Department
    Proposals.  Washington, DC:  November 1984, pp. 273-277.
    U.S. General Accounting Office.  Congress Should Consider Changing
    Federal Income Taxation of the Property/Casualty Insurance Industry.
    GAO/GGD-85-10.  Washington, DC, March 25, 1985.

    	 Commerce and Housing:
    	Insurance Companies

    	SPECIAL DEDUCTION FOR
    	BLUE CROSS AND BLUE SHIELD COMPANIES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    -

    0.9

    0.9

    2007

    -

    1.0

    1.0

    2008

    -

    1.0

    1.0

    2009

    -

    1.0

    1.0

    2010

    -

    1.0

    1.0

    	Authorization

    Section 833.

    	Description

    Blue Cross and Blue Shield and a number of smaller health insurance
    providers in existence on August 16, 1986, and other nonprofit health insurers
    that meet strict community-service standards, are subject to tax as property
    and casualty insurance companies, but are allowed a special deduction (for
    regular tax purposes only) of up to 25 percent of the excess of the year's
    health-related claims and expenses over their accumulated surplus at the
    beginning of the year.  The deduction is limited to net taxable income for the
    year and is not allowed in computing the alternative minimum tax.  These
    organizations are also allowed a full deduction for unearned premiums, unlike
    other property and casualty insurance companies.

    	Impact

    The special deduction exempts from the regular corporate tax of up to 35
    percent enough taxable income each year to maintain reserves equal to 25
    percent of the year's health-related payouts (three months' worth).  Since the
    deduction is not allowed for the alternative minimum tax, however, the
    income is subject to tax at the minimum tax rate of 20 percent.  The Blue
    Cross/Blue Shield organizations are not investor owned, so the reduced taxes
    benefit either their subscribers or all health insurance purchasers (in reduced
    premiums), their managers and employees (in increased wages and/or
    discretionary funds), or affiliated hospitals and physicians (in increased fees).

    	Rationale

    The Blue Cross/Blue Shield plans were first subjected to tax in the Tax
    Reform Act of 1986, which also provided for the special deduction described
    above.  The "Blues" had been ruled tax-exempt by Internal Revenue
    regulations since their inception in the 1930s, apparently because they were
    regarded as community service organizations.  The special tax deduction was
    given them in 1986 partly in recognition of their continuing (but much more
    limited) role in providing community-rated health insurance.

    	Assessment

    Most of the health insurance written by Blue Cross and Blue Shield plans
    is in the form of group policies indistinguishable in price and coverage from
    those offered by commercial insurers.  Some of the plans have accumulated
    enough surplus to purchase unrelated businesses, many receive a substantial
    part of their income from administering Medicare or self-insurance plans of
    other companies, and some have argued that their tax preferences have
    benefitted their managers and their affiliated hospitals and physicians more
    than their communities.

    They do, however, retain in their charters a commitment to offer individual
    policies not available elsewhere.  Some continue to offer policies with
    premiums based on community payout experience ("community rated").
    Their former tax exemption and their current reduced tax rates presumably
    serve to subsidize these community activities.

    	Selected Bibliography

    Embry-Thompson, Leah D. and Robert K. Kolbe.  "Federal Tax
    Exemption of Prepaid Health Care Plans after IRC 501(m)." Exempt
    Organizations 1992 Continuing Professional Education Text.  Available at
    [www.irs.gov/pub/irs-tege/eotopicl92.pdf].
    Law, Sylvia A.  Blue Cross: What Went Wrong?  New Haven: Yale
    University Press, 1974.
    McGovern, James J.  "Federal Tax Exemption of Prepaid Health Care
    Plans." The Tax Adviser 7  (February 1976), pp. 76-81.
    McNurty, Walter.  "Big Questions for the Blues: Where to from Here?"
    Inquiry 33 (Summer 1996), pp. 110-117.
    Starr, Paul.  The Social Transformation of American Medicine.  New
    York: Basic Books, 1983, pp.290-310.
    Taylor, Jack.  Blue Cross/Blue Shield and Tax Reform. Library of
    Congress, Congressional Research Service Report 86-651 E.  Washington,
    DC: April 9, 1986.
    -.  Income Tax Treatment of Health Care Insurers.  Library of Congress,
    Congressional Research Service Report 94-772 E.  Washington, DC: October
    5, 1994.
    U.S. Congress, Joint Committee on Taxation.  "Tax Exempt Organizations
    Engaged in Insurance Activities."  In General Explanation of the Tax Reform
    Act of 1986. Joint Committee Print, 100th Congress, 1st session.  Washington,
    DC: Government Printing Office,  May 4, 1987, pp.  583-592.
    -.  Description and Analysis of Title VII of H.R. 3600, S. 1757, and S.
    1775 ("Health Security Act"), Joint Committee Print, 103rd Congress, 1st
    session.  Washington, DC: Government Printing Office, December 20, 1993,
    pp. 82-96.
    Wasley, Terree P.  "Health Care in the Twentieth Century: A History of
    Government Interference and Protection." Business Economics 28 (April
    1993), pp. 11-17.
    Weiner, Janet Ochs.  "The Rebirth of the Blues."  Medicine and Health
    Supplement (February 18, 1991).

    	Commerce and Housing:
    	Housing

    	DEDUCTION FOR MORTGAGE INTEREST
    	ON OWNER-OCCUPIED RESIDENCES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    69.4

    -

    69.4

    2007

    75.6

    -

    75.6

    2008

    80.7

    -

    80.7

    2009

    85.9

    -

    85.9

    2010

    91.1

    -

    91.1

    H.R. 6111 (December 2006) increased the cost by $0.1 billion in FY2008.

    	Authorization

    Section 163(h).

    	Description

    A taxpayer may claim an itemized deduction for "qualified residence
    interest," which includes interest paid on a mortgage secured by a principal
    residence and a second residence.  The underlying mortgage loans can
    represent acquisition indebtedness of up to $1 million, plus home equity
    indebtedness of up to $100,000.  In 2007, premiums for mortgage insurance
    are deductible as interest, but are phased out as 10 percent for each $1,000
    over $100,000.

    Impact

    The deduction is considered a tax expenditure because homeowners are
    allowed to deduct their mortgage interest even though the implicit rental
    income from the home (comparable to the income they could earn if the home
    were rented to someone else) is not subject to tax.

    Renters and the owners of rental property do not receive a comparable
    benefit.  Renters may not deduct any portion of their rent under the Federal
    income tax.  Landlords may deduct mortgage interest paid for rental property,
    but they are subject to tax on the rental income.

    For taxpayers who can itemize, the home mortgage interest deduction
    encourages home ownership by reducing the cost of owning compared with
    renting.  It also encourages them to spend more on housing (measured before
    the income tax offset), and to borrow more than they would in the absence of
    the deduction.

    The mortgage interest deduction primarily benefits middle- and upper-
    income households.  Higher-income taxpayers are more likely to itemize
    deductions.  As with any deduction, a dollar of mortgage interest deduction is
    worth more the higher the taxpayer's marginal tax rate.

    Higher-income households also tend to have larger mortgage interest
    deductions because they can afford to spend more on housing and can qualify
    to borrow more.  The home equity loan provision favors taxpayers who have
    been able to pay down their acquisition indebtedness and whose homes have
    appreciated in value.

    Distribution by Income Class of the Tax
    Expenditure for Mortgage Interest, 2005

    Income Class
    (in thousands of $)

    Percentage
    Distribution

    Below $10

    0.0%

    $10 to $20

    0.1%

    $20 to $30

    0.7%

    $30 to $40

    1.6%

    $40 to $50

    3.1%

    $50 to $75

     12.2%

    $75 to $100

    13.8%

    $100 to $200

    40.4%

    $200 and over

    28.1%

    	Rationale

    The income tax code instituted in 1913 contained a deduction for all
    interest paid, with no distinction between interest payments made for
    business, personal, living, or family expenses.  There is no evidence in the
    legislative history that the interest deduction was intended to encourage home
    ownership or to stimulate the housing industry at that time.  In 1913 most
    interest payments represented business expenses.  Home mortgages and other
    consumer borrowing were much less prevalent than in later years.

    Before the Tax Reform Act of 1986 (TRA86), there were no restrictions
    on either the dollar amount of mortgage interest deduction or the number of
    homes on which the deduction could be claimed.  The limits placed on the
    mortgage interest deduction in 1986 and 1987 were part of the effort to limit
    the deduction for personal interest.

    Under the provisions of TRA86, for home mortgage loans settled on or
    after August 16, 1986, mortgage interest could be deducted only on a loan
    amount up to the purchase price of the home, plus any improvements, and on
    debt secured by the home but used for qualified medical and educational
    expense.  This was an effort to restrict tax-deductible borrowing of home
    equity in excess of the original purchase price of the home.  The interest
    deduction was also restricted to mortgage debt on a first and second home.

    The Omnibus Budget Reconciliation Act of 1987 placed new dollar limits
    on mortgage debt incurred after October 13, 1987, upon which interest
    payments could be deducted.  An upper limit of $1 million ($500,000 for
    married filing separately) was placed on the combined "acquisition
    indebtedness" for a principal and second residence.  Acquisition indebtedness
    includes any debt incurred to buy, build, or substantially improve the
    residence(s).  The ceiling on acquisition indebtedness for any residence is
    reduced down to zero as the mortgage balance is paid down, and can only be
    increased if the amount borrowed is used for improvements.

    The TRA86 exception for qualified medical and educational expenses was
    replaced by the explicit provision for home equity indebtedness: in addition to
    interest on acquisition indebtedness, interest can be deducted on loan amounts
    up to $100,000 ($50,000 for married filing separately) for other debt secured
    by a principal or second residence, such as a home equity loan, line of credit,
    or second mortgage.  The sum of the acquisition indebtedness and home
    equity debt cannot exceed the fair market value of the home(s).  There is no
    restriction on the purposes for which home equity indebtedness can be used.

    Mortgage interest is one of several deductions subject to the phaseout on
    itemized deductions for taxpayers whose AGI exceeds the applicable
    threshold amount--$150,500 for single taxpayers in 2006, indexed for
    inflation.  (This phaseout was instituted for tax years 1991 through 1995 by
    the Omnibus Budget Reconciliation Act of 1990 and made permanent by the
    Omnibus Budget Reconciliation Act of 1993.)

    The temporary deductibility of mortgage insurance was added by H.R.
    6111 (December 2006).

    Assessment

    Major justifications for the mortgage interest deduction have been the
    desire to encourage homeownership and to stimulate residential construction.
     Homeownership is alleged to encourage neighborhood stability, promote
    civic responsibility, and improve the maintenance of residential buildings.
    Homeownership is also viewed as a mechanism to encourage families to save
    and invest in what for many will be their major financial asset.

    A major criticism of the mortgage interest deduction has been its
    distribution of tax benefits in favor of higher-income taxpayers.  It is unlikely
    that a housing subsidy program that gave far larger amounts to high income
    compared with low income households would be enacted if it were proposed
    as a direct expenditure program.

    The preferential tax treatment of owner-occupied housing relative to other
    assets is also criticized for encouraging households to invest more in housing
    and less in other assets that might contribute more to increasing the Nation's
    productivity and output.

    Efforts to limit the deduction of some forms of interest more than others
    must address the ability of taxpayers to substitute one form of borrowing for
    another.  For those who can make use of it, the home equity interest deduction
    can substitute for the deductions phased out by TRA86 for consumer interest
    and investment interest in excess of investment income.  This alternative is
    not available to renters or to homeowners with little equity buildup.

    Analysts have pointed out that the rate of homeownership in the United
    States is not significantly higher than in countries such as Canada that do not
    provide a mortgage interest deduction under their income tax.  The value of
    the U.S. deduction may be at least partly capitalized into higher prices at the
    middle and upper end of the housing market.

    Selected Bibliography

    Bourassa, Steven C. and Grigsby,  William G. "Income Tax Concessions
    for Owner-Occupied Housing," Housing Policy Debate, vol. 11, iss. 3, 2000,
    pp. 521-546.
    Brady, Peter, Cronin, Julie-Anne, and Houser, Scott.  "Regional
    Differences in the Utilization of the Mortgage Interest Deduction," Public
    Finance Review, vol. 31, (July 2003), pp. 327-366.

    Capozza, Dennis R., Richard K. Green, and Patric H. Hendershott.
    "Taxes, Mortgage Borrowing and Residential Land Prices," in  Economic
    Effects of Fundamental Tax Reform, eds. Henry H. Aaron and William G.
    Gale.  Washington, DC: Brookings Institution Press, 1996, pp. 171-210.
    Cecchetti, Stephen G. and Peter Rupert. "Mortgage Interest Deductibility
    and Housing Prices," Economic Commentary. Federal Reserve Bank of
    Cleveland, February 1, 1996.
    Chatterjee, Satyjit.  "Taxes, Homeownership, and the Allocation of
    Residential Real Estate Risk," Business Review, Federal Reserve Bank of
    Philadelphia, September-October 1996, pp. 3-10.
    Engen, Eric M. and William G. Gale.  "Tax-Preferred Assets and Debt,
    and the Tax Reform Act of 1986: Some Implications for Fundamental Tax
    Reform," National Tax Journal, vol. 49, (September 1996), pp. 331-339.
    Follain, James R., and David C. Ling.  "The Federal Tax Subsidy to
    Housing and the Reduced Value of the Mortgage Interest Deduction,"
    National Tax Journal, vol. 44, (June 1991), pp. 147-168.
    Follain, James R., and Robert M. Dunsley.  "The Demand for Mortgage
    Debt and the Income Tax," Journal of Housing Research, vol. 8, no. 2, 1997,
    pp. 155-191.
    Glaeser, Edward L. and Jesse M. Shapiro.  "The Benefits of the Home
    Mortgage Interest Deduction," NBER Working Paper Series 9284, National
    Bureau of Economic Research, October 2002.
    Green, Richard K. and Kerry D. Vandell.  "Giving Households Credit:
    How Changes in the U.S. Tax Code Could Promote Homeownership,"
    Regional Science and Urban Economics, vol. 29, no. 4, July 1999, pp.
    419-444.
    Gyourko, Joseph  and Sinai, Todd.  "The Spatial Distribution of
    Housing-Related Ordinary Income Tax Benefits," Real Estate Economics,
    vol. 31, (Winter 2003),  pp. 529-531.
    Howard, Christopher.  The Hidden Welfare State: Tax Expenditures and
    Social Policy in the United States.  Princeton: Princeton Univ. Press, 1997.
    Jackson, Pamela J. Fundamental Tax Reform: Options for the Mortgage
    Interest Deduction, Library of Congress, Congressional Research Service
    Report RL33025, April 26, 2006.
    Maki, Dean M.  "Portfolio Shuffling and Tax Reform," National Tax
    Journal , vol. 49, ( September 1996), pp. 317-329.
    Nakagami, Yasuhiro and Alfred M. Pereira.  "Budgetary and Efficiency
    Effects of Housing Taxation in the United States," Journal of Urban
    Economics, vol. 39, (January 1996), pp. 68-86.
    Rose, Clarence C.  "The Investment Value of Home Ownership," Journal
    of Financial Service Professionals, vol. 60, (January 2006), pp. 57-66.
    Rosen, Harvey S.  "Housing Subsidies: Effects on Housing Decisions,
    Efficiency, and Equity," Handbook of Public Economics, vol. I, eds. Alan J.
    Auerbach and Martin Feldstein.  The Netherlands, Elsevier Science
    Publishers B.V. (North-Holland), 1985, pp. 375-420.
    Reschovsky, Andrew and Richard K. Green.  Tax Credits and Tenure
    Choice, Proceedings, 91st Annual Conference on Taxation, 1998.
    Washington, DC:  National Tax Association, 1999, pp. 401-410.

    Sinai, Todd, and Joseph Gyourko.  "The (Un)Changing Geographical
    Distribution of Housing Tax Benefits: 1980 to 2000," in Tax Policy and the
    Economy, 2003 Conference Report, ed. James Poterba. National Bureau of
    Economic Research, November 4, 2003.
    U.S. Department of Treasury, Internal Revenue Service, Publication 936,
    Home Mortgage Interest Deduction.

    	Commerce and Housing:
    	Housing

    	DEDUCTION FOR PROPERTY TAXES
    	ON OWNER-OCCUPIED RESIDENCES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    19.9

    -

    19.9

    2007

    13.8

    -

    13.8

    2008

    13.5

    -

    13.5

    2009

    13.4

    -

    13.4

    2010

    13.2

    -

    13.2

    Authorization

    Section 164.

    	Description

    Taxpayers may claim an itemized deduction for property taxes paid on
    owner-occupied residences.

    	Impact

    The deductibility of property taxes on owner-occupied residences provides
    a subsidy both to home ownership and to the financing of State and local
    governments.  Like the deduction for home mortgage interest, the Federal de-
    duction for real property (real estate) taxes reduces the cost of home
    ownership relative to renting.

    Renters may not deduct any portion of their rent under the Federal income
    tax.  Landlords may deduct the property tax they pay on a rental property but
    are taxed on the rental income.

    Homeowners may deduct the property taxes but are not subject to income
    tax on the imputed rental value of the dwelling.  For itemizing homeowners,
    the deduction lowers the net price of State and local public services financed
    by the property tax and raises their after-Federal-tax income.

    Like all personal deductions, the property tax deduction provides uneven
    tax savings per dollar of deduction.  The tax savings are higher for those with
    higher marginal tax rates, and those homeowners who do not itemize
    deductions receive no direct tax savings.

    Higher-income groups are more likely to itemize property taxes and to
    receive larger average benefits per itemizing return.  Consequently, the tax
    expenditure benefits of the property tax deduction are concentrated in the
    upper-income groups.

    Distribution by Income Class of the Tax Expenditure
    for Property Taxes, 2005

    Income Class
    (in thousands of $)

    Percentage
    Distribution

    Below $10

    0.0

    $10 to $20

    2.1

    $20 to $30

    4.0

    $30 to $40

    5.9

    $40 to $50

    8.2

    $50 to $75

    20.9

    $75 to $100

    18.8

    $100 to $200

    30.2

    $200 and over

    9.0

    	Rationale

    Under the original 1913 Federal income tax law all Federal, State, and
    local taxes were deductible, except those assessed against local benefits (for
    improvements which tend to increase the value of the property), for
    individuals as well as businesses.

    A major rationale was that tax payments reduce disposable income in a
    mandatory way and thus should be deducted when determining a taxpayer's
    ability to pay the Federal income tax.

    Over the years, the Congress has gradually eliminated the deductibility of
    certain taxes under the individual income tax, unless they are business-
    related.  Deductions were eliminated for Federal income taxes in 1917, for
    estate and gift taxes in 1934, for excise and import taxes in 1943, for State
    and local excise taxes on cigarettes and alcohol and fees such as drivers' and
    motor vehicle licenses in 1964, for excise taxes on gasoline and other motor
    fuels in 1978, and for sales taxes in 1986.

    In 2004, sales tax deductibility was reinstated for the 2004 and 2005 tax
    years by the "American Jobs Creation Act of 2004," (P.L. 108-357).  In
    contrast to pre-1986 law, State sales and use taxes can only be deducted in
    lieu of State income taxes, not in addition to.  Taxpayers who itemize and live
    in States without a personal income tax benefitted the most from the new law.
     As of October 2006, the sales tax deductibility option had not been extended.

    State and local taxes are among several deductions subject to the phaseout
    on itemized deductions for taxpayers whose AGI exceeds the applicable
    threshold amount--$150,500 for 2006, indexed for inflation.  (The phaseout is
    scheduled to gradually phase-out beginning in the 2006 tax year and be
    completely eliminated beginning with the 2010 tax year.)

    Assessment

    Proponents argue that the deduction for State and local taxes is a way of
    promoting fiscal federalism by helping State and local governments to raise
    revenues from their own taxpayers.   Itemizers receive an offset for their
    deductible State and local taxes in the form of lower Federal income taxes.
    Deductibility thus helps to equalize total Federal-State-local tax burdens
    across the country: itemizers in high-tax States and local jurisdictions pay
    somewhat lower Federal taxes as a result of their higher deductions, and vice
    versa.

    By allowing property taxes to be deducted in the same way as State and
    local income, sales, and personal property taxes, the Federal Government
    avoids interfering in State and local decisions about which of these taxes to
    rely on.  The property tax is particularly important as a source of revenue for
    local governments and school districts.

    Nevertheless, the property tax deduction is not an economically efficient
    way to provide Federal aid to State and local governments in general, or to
    target aid on particular needs, compared with direct aid.  The deduction works
    indirectly to increase taxpayers' willingness to support higher State and local
    taxes by reducing the net price of those taxes and increasing their income
    after Federal taxes.

    The same tax expenditure subsidy is available to property taxpayers,
    regardless of whether the money is spent on quasi-private benefits enjoyed by
    the taxpayers or redistributive public services, or whether they live in
    exclusive high-income jurisdictions or heterogeneous cities encompassing a
    low-income population.  The property-tax-limitation movements of the 1970s
    and 1980s, and State and local governments' increased reliance on non-
    deductible sales and excise taxes and user fees during the 1980s and 1990s,
    suggest that other forces can outweigh the advantage of the property tax
    deduction.

    Two separate lines of argument are offered by critics to support the case
    that the deduction for real property taxes should be restricted.  One is that a
    large portion of local property taxes may be paying for services and facilities
    that are essentially private benefits being provided through the public sector.
    Similar services often are financed by non-deductible fees and user charges
    paid to local government authorities or to private community associations
    (e.g., for water and sewer services or trash removal).

    Another argument is that if imputed income from owner-occupied housing
    is not subject to tax, then associated expenses, such as mortgage interest and
    property taxes, should not be deductible.

    Like the mortgage interest deduction, the value of the property tax
    deduction may be capitalized to some degree into higher prices for the type of
    housing bought by taxpayers who can itemize.  Consequently, restricting the
    deduction for property taxes could lower the price of housing purchased by
    middle- and upper-income taxpayers, at least in the short run.

    	Selected Bibliography

    Aaron, Henry.  Who Pays the Property Tax?  Washington, DC: The
    Brookings Institution, 1975.
    Birch, John W., Mark A. Sunderman, and Brent C. Smith.  "Vertical
    Inequity in Property Taxation: A Neighborhood Based Analysis," Journal of
    Real Estate Finance and Economics, v. 29, n. 1, July 2004, pp. 71-78.
    Carroll, Robert J., and John Yinger.  "Is the Property Tax a Benefit Tax?
    The Case of Rental Housing," National Tax Journal, v. 47, no. 2,  June 1994,
    pp. 295-316.
    Kenyon, Daphne A.  "Federal Income Tax Deductibility of State and Local
    Taxes," Intergovernmental Perspective, Fall 1984, v. 10, no. 4, pp. 19-22.
    Maguire, Steven.  Federal Deductibility of State and Local Taxes.  Library
    of Congress, Congressional Research Service Report RL32781.  Washington,
    D.C.:  September 28, 2006.

    Netzer, Dick.  "Local Government Finance and the Economics of Property
    Tax Exemption," State Tax Notes, June 23, 2003, pp. 1053-1069.
    Rosen, Harvey S. "Housing Decisions and the U.S. Income Tax: An
    Economic Analysis," Journal of Public Economics, v. 11, no. 1.  February
    1979, pp. 1-23.
    Tannenwald, Robert.  "The Subsidy from State and Local Tax
    Deductibility: Trends, Methodological Issues and its Value After Federal Tax
    Reform," Federal Reserve Bank of Boston, Working Paper 97/08, December
    1997.
    U.S. Congress, Senate Committee on Governmental Affairs,
    Subcommittee on Intergovernmental Relations.  Limiting State-Local Tax
    Deductibility in Exchange for Increased General Revenue Sharing: An
    Analysis of the Economic Effects, 98th Congress, 1st session, Committee
    Print S. Prt. 98-77,   August 1983.  A condensed version was published in
    Nonna A. Noto and Dennis Zimmerman, "Limiting State-Local Tax
    Deductibility: Effects Among the States," National Tax Journal, v. 37, no. 4,
    December 1984, pp. 539-549.
    U.S. Department of the Treasury, Office of State and Local Finance.
    Federal-State-Local Fiscal Relations, Report to the President and the
    Congress.  Washington, DC: U.S. Government Printing Office, September
    1985, pp. 251-283.  Also Technical Papers, September 1986, v. 1, pp. 349-
    552.

    Commerce and Housing:
    Housing

    EXCLUSION OF CAPITAL GAINS
    ON SALES OF  PRINCIPAL RESIDENCES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    24.1

    -

    24.1

    2007

    25.2

    -

    25.2

    2008

    25.7

    -

    25.7

    2009

    26.3

    -

    26.3

    2010

    27.1

    -

    27.1

    Authorization

    Section 121.

    	Description

    A taxpayer may exclude from federal income tax up to $250,000 of capital
    gain ($500,000 in the case of married taxpayers filing joint returns) from the
    sale or exchange of their principal residence.  To qualify the taxpayer must
    have owned and occupied the residence for at least two of the previous five
    years.  The exclusion is limited to one sale every two years.  Special rules
    apply in the case of sales necessitated by changes in employment, health, and
    other circumstances.

    	Impact

    Excluding the capital gains on the sale of principal residences from tax
    primarily benefits middle- and upper-income taxpayers.  At the same time,
    however, this provision avoids putting an additional tax burden on taxpayers,
    regardless of their income levels, who have to sell their homes because of
    changes in family status, employment, or health.  It also provides tax benefits
    to elderly taxpayers who sell their homes and move to less expensive housing
    during their retirement years.  This provision simplifies income tax
    administration and record keeping.

    	Rationale

    Capital gains arising from the sale of a taxpayer's principal residence have
    long received preferential tax treatment.  The Revenue Act of 1951
    introduced the concept of deferring the tax on the capital gain from the sale of
    a principal residence if the proceeds of the sale were used to buy another
    residence of equal or greater value.  This deferral principal was supplemented
    in 1964 by the introduction of the tax provision that allowed elderly taxpayers
    a one-time exclusion from tax for some of the capital gain derived from the
    sale of their principal residence. Over time, the one-time exclusion provision
    was modified such that all taxpayers aged 55 and older were allowed a one-
    time exclusion for up to $125,000 gain from the sale of their principal
    residence.

    By 1997, Congress had concluded that these two provisions, tax free
    rollovers and the one-time exclusion of $125,000 in gain for elderly
    taxpayers, had created significant complexities for the average taxpayer with
    regard to the sale of their principal residence.  To comply with tax
    regulations, taxpayers had to keep detailed records of the financial
    expenditures  associated with their home ownership.  Taxpayers had to
    differentiate between those expenditures that affected the basis of the property
    and those that were merely for maintenance or repairs.  In many instances
    these records had to be kept for decades.

    In addition to record keeping problems, Congress believed that the prior
    law rules promoted an inefficient use of taxpayers' resources.  Because
    deferral of tax required the purchase of a new residence of equal or greater
    value, prior law may have encouraged taxpayers to purchase more expensive
    homes than they otherwise would have.

    Finally, Congress believed that prior law may have discouraged some
    elderly taxpayers from selling their homes to avoid possible tax consequences.
     Elderly taxpayers who had already used their one-time exclusion and those
    who might have realized a gain in excess of $125,000, may have held on to
    their homes longer than they otherwise would have.

    As a result of these concerns, Congress repealed the rollover provisions
    and the one-time exclusion of $125,000 of gain in the Taxpayer Relief Act of
    1997.  In their place, Congress enacted the current tax rules which allow a
    taxpayer to exclude from federal income tax up to $250,000 of capital gain
    ($500,000 in the case of married taxpayers filing joint returns) from the sale
    or exchange of their principal residence.

    Assessment

    This exclusion from income taxation gives homeownership a competitive
    advantage over other types of investments, since the capital gains from
    investments in other assets are generally taxed when the assets are sold.
    Moreover, when combined with other provisions in the tax code such as the
    deductibility of home mortgage interest, homeownership is an especially
    attractive investment.  As a result, savings are diverted out of other forms of
    investment and into housing.

    Viewed from another perspective, many see the exclusion on the sale of a
    principal residence as justifiable because the tax law does not allow the
    deduction of personal capital losses, because much of the profit from the sale
    of a personal residence can represent only inflationary gains, and because the
    purchase of a principal residence is less of a profit-motivated decision than
    other types of investments.  Taxing the gain on the sale of a principal
    residence might also interfere with labor mobility.

    	Selected Bibliography

    Gravelle, Jane and Jackson, Pamela J.  The Exclusion of Capital Gains for
    Owner Occupied Housing.  Library of Congress, Congressional Research
    Service Report RL32978.  Washington DC: 2006.
    Esenwein, Gregg A.  Individual Capital Gains Income: Legislative
    History.  Library of Congress, Congressional Research Service Report 98-
    473E.  Washington DC: 2006.
    Fox, John O., If Americans Really Understood the Income Tax.  Boulder,
    Colorado: Westview Press, 2001, pp. 177- 200.
    Burman, Leonard E., Sally Wallace, and David Weiner, "How Capital
    Gains Taxes Distort Homeowners' Decisions," Proceedings of the 89th
    Annual Conference, 1996, Washington, DC: National Tax Association, 1997.
    U.S. Department of the Treasury, Internal Revenue Service, Selling Your
    Home, Publication 523, 2005.
    U.S. Congress, Joint Committee on Taxation.  Description of Revenue
    Provisions Contained in the President's Fiscal Year 2001 Budget Proposal.
    March 6, 2000.
    -.  General Explanation of Tax Legislation Enacted in 1997.  December
    17, 1997.
    U.S. Congress, Congressional Budget Office.  Perspectives on the
    Ownership of Capital Assets and the Realization of Capital Gains.  May
    1997.

    Commerce and Housing:
    Housing

    EXCLUSION OF INTEREST ON STATE AND LOCAL
    GOVERNMENT BONDS FOR OWNER-OCCUPIED HOUSING

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.9

    0.3

    1.2

    2007

    1.0

    0.4

    1.4

    2008

    1.0

    0.4

    1.4

    2009

    1.1

    0.4

    1.5

    2010

    1.1

    0.4

    1.5

    Authorization

    Sections 103, 141, 143, and 146 of the Internal Revenue Code of 1986.

    	Description

    Interest income on State and local bonds issued to provide mortgages at
    below-market interest rates on owner-occupied principal residences of first-
    time homebuyers is tax exempt.  The issuer of mortgage bonds typically uses
    bond proceeds to purchase mortgages made by a private lender.  The
    homeowners make their monthly payments to the private lender, which passes
    them through as payments to the bondholders.  The first time homebuyer's
    requirement is waived on a one time basis for veterans from the enactment of
    H.R. 6111 (December 2006) through 2008.

    These mortgage revenue bonds (MRBs) are classified as private-activity
    bonds rather than governmental bonds because a substantial portion of their
    benefits accrues to individuals or business rather than to the general public.
    For more discussion of the distinction between governmental bonds and
    private-activity bonds, see the entry under General Purpose Public
    Assistance: Exclusion of Interest on Public Purpose State and Local Debt.

    Numerous limitations have been imposed on State and local MRB
    programs, among them restrictions on the purchase prices of the houses that
    can be financed, on the income of the homebuyers, and on the portion of the
    bond proceeds that must be expended for mortgages in targeted (lower
    income) areas.

    A portion of capital gains on an MRB-financed home sold within ten years
    must be rebated to the Treasury.  Housing agencies may trade in bond
    authority for authority to issue equivalent amounts of mortgage credit
    certificates (MCCs).  MCCs take the form of nonrefundable tax credits for
    interest paid on qualifying home mortgages.

    MRBs are subject to the private-activity bond annual volume cap that is
    equal to the greater of $80 per State resident or $246.6 million in 2006.  The
    cap has been adjusted for inflation since 2003.  Housing agencies must
    compete for cap allocations with bond proposals for all other private-activities
    subject to the volume cap.

    	Impact

    Since interest on the bonds is tax exempt, purchasers are willing to accept
    lower before-tax rates of interest than on taxable securities.  These low
    interest rates enable issuers to offer mortgages on owner-occupied housing at
    reduced mortgage interest rates.

    Some of the benefits of the tax exemption also flow to bondholders.  For a
    discussion of the factors that determine the shares of benefits going to
    bondholders and homeowners, and estimates of the distribution of tax-exempt
    interest income by income class, see the "Impact" discussion under General
    Purpose Public Assistance: Exclusion of Interest on Public Purpose State
    and Local Debt.

    	Rationale

    The first MRBs were issued without any Federal restrictions during the
    high-interest-rate period of the late 1970s.  State and local officials expected
    reduced mortgage interest rates to increase the incidence of homeownership.
    The Mortgage Subsidy Bond Tax Act of 1980 imposed several targeting
    requirements, most importantly restricting the use of MRBs to lower-income
    first-time purchasers.  The annual volume of bonds issued by governmental
    units within a State was capped, and the amount of arbitrage profits (the
    difference between the interest rate on the bonds and the higher mortgage rate
    charged to the home purchaser) was limited to one percentage point.

    Depending upon the state of the housing market, targeting restrictions have
    been relaxed and tightened over the decade of the 1980s.  MRBs were
    included under the unified volume cap on private-activity bonds by the Tax
    Reform Act of 1986.

    MRBs had long been an "expiring tax provision" with a sunset date.
    MRBs first were scheduled to sunset on December 31, 1983, by the Mortgage
    Subsidy Bond Tax Act of 1980.  Additional sunset dates have been adopted
    five times when Congress has decided to extend MRB eligibility for a
    temporary period.  The Omnibus Budget Reconciliation Act of 1993 made
    MRBs a permanent provision.

    The most recent change to the program was enacted by  the Tax Increase
    Prevention and Reconciliation Act (TIPRA; P.L. 109-222), which required
    that payors of state and municipal bond tax-exempt interest begin to report
    those payments to the Internal Revenue Service after December 31, 2005.
    The manner of reporting is similar to reporting requirements for interest paid
    on taxable obligations.  Additionally in the 109th Congress, the program was
    expanded temporarily to assist in the rebuilding efforts after the Gulf Region
    hurricanes of the Fall of 2005.

    	Assessment

    Income, tenure status, and house-price-targeting provisions imposed on
    MRBs make them more likely to achieve the goal of increased
    homeownership than many other housing tax subsidies that make no targeting
    effort, such as is the case for the mortgage-interest deduction.  Nonetheless, it
    has been suggested that most of the mortgage revenue bond subsidy goes to
    families that would have been homeowners even if the subsidy were not
    available.

    Even if a case can be made for this federal subsidy for homeownership, it
    is important to recognize the potential costs.  As one of many categories of
    tax-exempt private-activity bonds, MRBs increase the financing cost of bonds
    issued for other public capital.  With a greater supply of public bonds, the
    interest rate on the bonds necessarily increases to lure investors.  In addition,
    expanding the availability of tax-exempt bonds increases the assets available
    to individuals and corporations to shelter their income from taxation.

    Selected Bibliography

    Cooperstein, Richard L.  "Economic Policy Analysis of Mortgage Revenue
    Bonds."  In Mortgage Revenue Bonds: Housing Markets, Home Buyers and
    Public Policy, edited by Danny W. Durning, Boston, MA: Kluwer Academic
    Publishers, 1992.

    -.  "The Economics of Mortgage Revenue Bonds: A Still Small Voice."
    In Mortgage Revenue Bonds: Housing Markets, Home Buyers and Public
    Policy, edited by Danny W. Durning, Boston, MA: Kluwer Academic
    Publishers, 1992.
    MacRae, Duncan, David Rosenbaum, and John Tuccillo.  Mortgage
    Revenue Bonds and Metropolitan Housing Markets.  Washington, DC: The
    Urban Institute, May 1980.
    Maguire, Steven.  Private Activity Bonds: An Introduction.  Library of
    Congress, Congressional Research Service Report RL31457.  June 90, 2006.
    -.  Tax-Exempt Bonds: A Description of State and Local Government
    Debt.  Library of Congress, Congressional Research Service Report
    RL30638.  March 10, 2006.
    Temple, Judy.  "Limitations on State and Local Government Borrowing for
    Private Purposes," National Tax Journal, v. 46, March 1993, pp. 41-52.
    U.S. General Accounting Office.  Home Ownership: Mortgage Bonds Are
    Costly and Provide Little Assistance to Those in Need.  GAO/RCED-88-111.
     1988.
    Wrightson, Margaret T.  Who Benefits from Single-Family Housing
    Bonds? History, Development and Current Experience of State-Administered
    Mortgage Revenue Bond Programs.  Washington, DC:  Georgetown
    University, Public Policy Program, April 1988.
    Zimmerman, Dennis.  The Private Use of Tax-Exempt Bonds: Controlling
    Public Subsidy of Private Activity.  Washington, DC: The Urban Institute
    Press, 1991.

    Commerce and Housing:
    Housing

    EXCLUSION OF INTEREST ON STATE AND LOCAL
    GOVERNMENT BONDS FOR RENTAL HOUSING

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.5

    0.2

    0.7

    2007

    0.5

    0.2

    0.7

    2008

    0.5

    0.2

    0.7

    2009

    0.6

    0.2

    0.8

    2010

    0.6

    0.2

    0.8

    Authorization

    Sections 103, 141, 142, and 146 of the Internal Revenue Code of 1986.

    	Description

    Interest income on State and local bonds used to finance the construction
    of multifamily residential rental housing units for low- and moderate-income
    families is tax exempt.  These rental housing bonds are classified as private-
    activity bonds rather than as governmental bonds because a substantial
    portion of their benefits accrues to individuals or business, rather than to the
    general public.  For more discussion of the distinction between governmental
    bonds and private-activity bonds, see the entry under General Purpose Public
    Assistance: Exclusion of Interest on Public Purpose State and Local Debt.

    These residential rental housing bonds are subject to the State private-
    activity bond annual volume cap that is equal to the greater of $80 per State
    resident or $246.6 million in 2006.  The cap has been adjusted for inflation
    since 2003.  Several additional requirements have been imposed on these
    projects, primarily on the share of the rental units that must be occupied by
    low-income families and the length of time over which the income restriction
    must be satisfied.

    	Impact

    Since interest on the bonds is tax exempt, purchasers are willing to accept
    lower before-tax rates of interest than on taxable securities.  These low
    interest rates enable issuers to offer residential rental housing units at reduced
    rates.  Some of the benefits of the tax exemption also flow to bondholders.
    For a discussion of the factors that determine the shares of benefits going to
    bondholders and renters, and for estimates of the distribution of tax-exempt
    interest income by income class, see the "Impact" discussion under General
    Purpose Public Assistance: Exclusion of Interest on Public Purpose State
    and Local Debt.

    	Rationale

    Before 1968, State and local governments were allowed to issue tax-
    exempt bonds to finance multifamily rental housing without restriction.  The
    Revenue and Expenditure Control Act of 1968 (RECA 1968) imposed tests
    that restricted the issuance of these bonds.  However, the Act also provided a
    specific exception which allowed unrestricted issuance for multifamily rental
    housing.

    Most States issue these bonds in conjunction with the Leased Housing
    Program under Section 8 of the United States Housing Act of 1937.  The Tax
    Reform Act of 1986 restricted eligibility for tax-exempt financing to projects
    satisfying one of two income-targeting requirements: 40 percent or more of
    the units must be occupied by tenants whose incomes are 60 percent or less of
    the area median gross income, or 20 percent or more of the units are occupied
    by tenants whose incomes are 50 percent or less of the area median gross
    income.  The Tax Reform Act of 1986 subjected these bonds to the State
    volume cap on private-activity bonds.

    The most recent change to the program was enacted by  the Tax Increase
    Prevention and Reconciliation Act (TIPRA; P.L. 109-222), which required
    that payors of state and municipal bond tax-exempt interest begin to report
    those payments to the Internal Revenue Service after December 31, 2005.
    The manner of reporting is similar to reporting requirements for interest paid
    on taxable obligations.  Additionally in the 109th Congress, the program was
    expanded temporarily to assist in the rebuilding efforts after the Gulf Region
    hurricanes of the Fall of 2005.

    	Assessment

    This exception was provided because it was believed that subsidized
    housing for low- and moderate-income families provided benefits to the
    Nation, and provided equitable treatment for families unable to take
    advantage of the substantial tax incentives available to those able to invest in
    owner-occupied housing.

    Even if a case can be made for a federal subsidy for multifamily rental
    housing due to underinvestment at the State and local level, it is important to
    recognize the potential costs.  As one of many categories of tax-exempt
    private-activity bonds, those issued for multifamily rental housing increase the
    financing cost of bonds issued for other public capital.  With a greater supply
    of public bonds, the interest rate on the bonds necessarily increases to lure
    investors.  In addition, expanding the availability of tax-exempt bonds
    increases the assets available to individuals and corporations to shelter their
    income from taxation.

    	Selected Bibliography

    Maguire, Steven.  Private Activity Bonds: An Introduction.  Library of
    Congress, Congressional Research Service Report RL31457.  June 9, 2006.
    -.  Tax-Exempt Bonds: A Description of State and Local Government
    Debt.  Library of Congress, Congressional Research Service Report
    RL30638.  March 10, 2006.
    U.S. General Accounting Office.  Information on Selected Capital
    Facilities Related to the Essential Governmental Function Test.  GAO-06-
    1082.  2006.
    U.S. Congress, Congressional Budget Office.  Tax-Exempt Bonds for
    Multi-Family Residential Rental Property, 99th Congress, 1st session. June
    21, 1985.
    -, Joint Committee on Taxation.  General Explanation of the Revenue
    Provisions of the Tax Reform Act of 1986.  May 4, 1987:  1171-1175.
    Zimmerman, Dennis.  The Private Use of Tax-Exempt Bonds:  Controlling
    Public Subsidy of Private Activity.  Washington, DC: The Urban Institute
    Press, 1991.

    	Commerce and Housing:
    	Housing

    	TAX CREDIT FOR FIRST-TIME HOMEBUYERS
    	IN THE DISTRICT OF COLUMBIA

    Estimated Revenue Loss*

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    (1)

    -

    (1)

    2007

    (1)

    -

    (1)

    2008

    (1)

    -

    (1)

    2009

    (1)

    -

    (1)

    2010

    (1)

    -

    (1)

    *This provision expired on December 31st, 2005.  H. R. 6111
    	(December 2006) extended it through 2007 but there is no separate
    revenue estimate.
    (1)Less than $50 million.

    	Authorization

    Section 1400C.

    	Description

    The Tax Credit for First-Time District of Columbia Homebuyers (TCDCH)
    allows a non-refundable credit against federal taxes of up to $5,000 for the
    first-time purchase of a principal residence in the District of Columbia.  The
    credit applies to both individuals and married couples filing jointly.  The
    credit is phased out for individuals earning from $70,000 to $90,000 and for
    joint filers earning from $110,000 to $130,000.  The credit is available only
    once for homebuyers who acquired title to a qualifying principal residence
    after August 4, 1997 and before December 31, 2005.

    Impact

    The TCDCH transfers federal revenue to qualified first-time homebuyers in
    the District of Columbia (DC) and indirectly to those selling homes to  tax
    credit recipients. Assuming individuals who receive the tax credit are
    relatively well-off - they have the resources to purchase a home in a relatively
    expensive market - the primary beneficiaries of this credit are most likely
    better off financially than the average federal taxpayer.

    	Rationale

    Some analysts suggest that a high rate of owner-occupied housing creates
    significant positive spillovers or externalities for a community or city and
    should be encouraged.  Owners, it is argued, maintain their homes and
    property better than do renters, and thus, the value of their property as well as
    neighboring properties increases.  Created by the Taxpayer Relief Act of 1997
    (P.L. 105-34), the TCDCH provides an incentive to purchase a home in DC
    which should then increase the rate of home ownership.  Compared to
    neighboring Maryland (71.2%) and Virginia (71.2%), the homeownership
    rate was significantly lower in the District of Columbia (45.8%).

    	Assessment

    The TCDCH is intended to encourage the first-time purchase of a home in
    DC.  In effect, the federal government is offering individuals and married
    couples up to $5,000 to do something they may or may not do otherwise: buy
    their first home in the District of Columbia.  The effectiveness of the tax
    credit thus depends upon how many marginal or additional homebuyers are
    induced into buying homes in DC.  There are actually two choices that may
    be influenced by the tax credit: 1) whether or not to buy a first home, and 2)
    whether or not to buy the home in DC.

    As an investment, the decision to buy a home is very similar to the decision
    to buy any long-term asset.  From a financial perspective, the decision
    depends on the rate of return of the asset over the holding period.  The one-
    time tax credit will not increase the long-term rate of return appreciably and
    thus is unlikely to attract many more first-time homebuyers.  Some of the
    advantage offered by the credit is counterbalanced by the fact that the
    existence of the credit may induce sellers to raise their selling price.
    However, the one-time tax credit may not increase demand (and thus price)
    enough to lure many existing property owners in DC to convert their property
    into owner-occupied housing.

    The tax credit is may or may not be very effective in influencing the
    location of a first-time home purchase in the Washington, D.C. metropolitan
    area.  DC is distinctly different from the two alternative home locations,
    Maryland and Virginia.  In theory, the lack of comparable substitute locations
    implies that homebuyers are not going to switch preferences based upon the
    small tax credit (relative to the 2005 median home price in the DC
    metropolitan area of $404,900).  For example, a first-time home-buyer will
    most likely choose a location based on the array of public (and private)
    services to be consumed in the jurisdiction rather than the one-time tax credit.

    Currently, little significant empirical evidence exists concerning the use of
    the TCDCH or its effectiveness in promoting home-ownership in DC.
    However, a 2005 study suggests that the credit has been successful because of
    several factors occurring after implementation of the credit, including an
    increase in the rate of  first-time homebuyers, an increase in the rate of
    growth in homeownership in the District of Columbia (as compared to
    neighboring regions in Maryland and Virginia), and an increase in the rate of
    house price appreciation in the District of Columbia (relative to its
    neighbors).  According to Bureau of the Census data, from 1996 (the year
    before the program was implemented) to 2005 the rate of home-ownership in
    DC has increased slightly faster (from 40.4% to 45.8%) than the rate in the
    greater Washington Metropolitan area (from 63.4% to 68.4%).  Of course the
    growth in DC home-ownership rates may have been the same without the
    TCDCH.

    	Selected Bibliography

    The data on home-ownership rates are available on the internet from the
    United States Bureau of Census,  Housing Vacancy and Homeownership
    Annual Statistics: 2005, Table 13: Homeownership Rates by State: 1984 to
    2005,
    http://www.census.gov/hhes/www/housing/hvs/annual05/ ann05t13. html
    Poterba, James M. "Tax Subsidies to Owner-Occupied Housing: An Asset-
    Market Approach," Quarterly Journal of Economics, v. 99 (November 1984),
    p. 729.
    Strauss, Robert P.  "The Income of Central City Suburban Migrants: A
    Case Study of the Washington, D.C. Metropolitan Area," National Tax
    Journal, v. 51, no. 3 (September 1998).
    Tong, Zhong Yi, "Washington DC's First-Time Home-Buyer Tax Credit:
    An Assessment of the Program," Fannie Mae Foundation Special Report,
    2005;
    http://www.fanniemaefoundation.org/programs/pdf/dctaxcredit_rpt.pdf.
    U.S Congress, Joint Committee on Taxation. General Explanation of Tax
    Legislation Enacted in 1997, committee print, 105th cong., 1st session
    Washington,DC: Government Printing Office, 1997, p. 104.

    	Commerce and Housing:
    	Housing

    	ADDITIONAL EXEMPTION FOR HOUSING PROVIDED
    	TO INDIVIDUALS DISPLACED BY HURRICANE KATRINA

    	Estimated Revenue Loss

    	[in billions of dollars]

    Fiscal Year

    Individuals

    Corporations

    Total

    2006

    0.1

    -

    0.1

    2007

    (1)

    -

    (1)

    2008

    -

    -

    -

    2009

    -

    -

    -

    2010

    -

    -

    -

    (1) Less than $50 million in revenue loss.

    	Authorization

    Section 151.

    	Description

    Taxable income is reduced by $500 for each Hurricane Katrina displaced
    individual to whom a taxpayer provides housing.  The total for each taxpayer
    is capped at $2,000 and is reduced by any exemptions claimed under the
    provision for prior years.  The exemption is available in 2005 and 2006,
    although a taxpayer may claim a person only once.  No deduction is allowed
    if the taxpayer receives any rent or other amount (from any source) in
    connection with the provision of housing.

    The taxpayer must include on his or her return the displaced person's
    taxpayer identification number.  The displaced individual may not be the
    spouse or dependent of the taxpayer.

    In order to qualify, the displaced person must have had a principal place of
    abode on August 28, 2005, in the Hurricane Katrina disaster area. If the home
    was not in the core disaster area, then either the home had to have been
    damaged by the Hurricane or the person was evacuated due to it.

    Impact

    The additional exemption generally results in additional tax savings for
    taxpayers who chose to provide free housing to displaced persons.  The
    additional exemption is not subject to the income-based phaseouts applicable
    to personal exemptions and is allowed as a deduction in computing alternative
    minimum taxable income.

    	Rationale

    The exemption was enacted by the Katrina Emergency Tax Relief Act of
    2005 (KETRA; P.L. 109-73) in September 2005, after the extensive damage
    caused by hurricanes in the Gulf Region.  The law contained temporary tax
    relief intended to directly and indirectly assist individuals in recovering from
    Hurricane Katrina.  The exemption, which was included among several other
    charitable giving incentives, is itself a charitable giving incentive that
    subsidizes the provision of housing assistance by one individual on behalf of
    another.

    Assessment

    The provision provides relief to taxpayers who have assisted individuals
    adversely affected by Hurricane Katrina by reducing the amount of income
    subject to tax.

    While the provision was aimed at taxpayers who assisted individuals
    suffering losses, some questions might be raised as to why relief provisions
    were allowed for a major disaster, such as a large scale hurricane, but not for
    smaller scale disasters (e.g., tornadoes) or losses proceeding from other
    sources.

    	Selected Bibliography

    Gravelle, Jane, Tax Policy Options After Hurricane Katrina, Library of
    Congress, Congressional Research Service Report RL33088, October 23,
    2006.
    Internal Revenue Service, Information for Taxpayers Affected by
    Hurricanes Katrina, Wilma and Rita, Publication 4492, January 1, 2006.
    Lunder, Erika.. The Gulf Opportunity Zone Act of 2005, Library of
    Congress, Congressional Research Service Report RS22344, February 14,
    2006.
    U.S. Congress, Joint Committee on Taxation, Technical Explanation of the
    Revenue Provisions of H.R. 3768, The Katrina Emergency Relief Act of
    2005, As Passed by the House of Representatives and the Senate, JCX-69-05,
    Washington, DC, September 21, 2005.

    	Commerce and Housing:
    	Housing

    	EMPLOYER HOUSING FOR INDIVIDUALS AFFECTED
    	BY HURRICANE KATRINA

    	EXCLUSION OF EMPLOYER PROVIDED HOUSING;
    	EMPLOYER CREDIT FOR HOUSING EMPLOYEES

    	Estimated Revenue Loss

    	[in billions of dollars]

    Fiscal Year

    Individuals

    Corporations

    Total

    2006

    -

    0.1

    0.1

    2007

    -

    (1)

    (1)

    2008

    -

    -

    -

    2009

    -

    -

    -

    2010

    -

    -

    -

    (1) Less than $50 million in revenue loss.

    	Authorization

    Section 1400P.

    	Description

    A temporary income exclusion is available for the value of in-kind lodging
    provided  to a qualified employee (and the employee's spouse or dependents)
    by, or on behalf of, a qualified employer.  The amount of the exclusion for
    any month for which lodging is furnished cannot exceed $600.  The exclusion
    does not apply for purposes of Social Security and Medicare taxes or
    unemployment tax.  Qualified employers providing in-kind lodging to
    qualified employees may claim a credit equal to 30 percent of the amount of
    the expense. The remainder of the cost may be deducted.

    In order to be eligible, the employee must have had a principal residence in
    the Gulf Opportunity (GO) Zone on August 28, 2005, and must perform
    substantially all employment services for the qualified employer in the GO
    Zone. The employer must have a trade or business in the GO Zone, and the
    lodging must have been provided during the first six months after the act's
    enactment.  The GO Zone is the core disaster area designated by the Federal
    Emergency Management Agency (FEMA) as eligible for individual assistance
    and includes the southern parts of Louisiana and Mississippi, and
    southwestern counties in Alabama.

    Impact

    Prior to the enactment of the temporary provisions for Katrina victims,
    employer-provided housing was included in income as compensation (and
    deducted by the employer) and was considered wages for purposes of social
    security and Medicare taxes and unemployment tax.  For employees, the
    exclusion reduces income subject to tax.  For employers, the credit is
    equivalent to a direct cost reduction.  For example, for a firm in the 35
    percent tax bracket, the credit reduces the cost of providing housing by 19.5
    percent, the difference between a credit and a deduction (100 -35 or 65
    percent ) on 30 percent of the cost.

     	As a result of the special exclusion, taxpayers receiving  housing assistance
    pay less tax than other taxpayers with the same or smaller economic incomes.
      At the same time, however, they may be willing to accept lower wages so
    that part of the benefit is passed back to the employer as a reduction in
    employment costs.   The individual exclusion also provides a reduction in the
    cost of hiring workers in that case: if the worker is in the 15 percent tax
    bracket, the employer could provide compensation only 85 percent as large as
    needed compared to the case where such compensation is taxable.

    The benefit of the credit is larger for smaller firms with lower tax rates,
    while the benefit of the housing exclusion is greater for higher paid
    employees who have higher marginal tax rates.  As a fraction of wages,
    however, the benefit for higher income individuals is limited because of the
    dollar ceiling.

    	Rationale

    The provisions were enacted by the Gulf Opportunity Zone Act of 2005
    (GOZone; P.L. 109-135) in December 2005 as part of the congressional
    response to the hurricane that struck the Gulf Region.  This legislation,
    adopted within a few months of Hurricane Katrina, was largely directed at
    creating incentives for rebuilding and recovery, and one objective of the
    provision may be to encourage employers to hire workers in an area where
    substantial amounts of housing were destroyed.

    Assessment

    There is relatively little evidence to determine the effectiveness of the
    housing exclusion and credit in increasing employment and business activity
    in the GO Zone. The evidence based on previous studies of enterprise zone
    provisions targeted at poor areas does not indicate that tax incentives are very
    successful.  However, experience in a low income area, usually of a city, may
    not provide sufficient evidence to gauge the effects on a much larger
    geographic area composed of both higher and lower income affected by a
    major disaster.

    To the extent that employers would have provided lodging in the absence
    of the incentive, the tax provision provides a benefit to either the employee or
    the employer, resulting in some inequity in the tax system.

    	Selected Bibliography

    Gravelle, Jane G. "Tax Incentives in the Aftermath of Hurricane Katrina,"
    Municipal Finance Journal, v. 26, Fall 2005, pp. 1-13.
    Gravelle, Jane, Tax Policy Options After Hurricane Katrina, Library of
    Congress, Congressional Research Service Report RL33088, October 23,
    2006.
    Lunder, Erika. The Gulf Opportunity Zone Act of 2005, Library of
    Congress, Congressional Research Service, Report RS22344, February 14,
    2006.
    Stoker, Robert P. And Michael J. Rich.  "Lessons and Limits: Tax
    Incentives and Rebuilding the Gulf Coast After Katrina," The Brookings
    Institution, Survey Series, August 2006.
    U.S. Congress, Joint Committee on Taxation, Technical Explanation of the
    Revenue Provisions of H.R. 4440, The "Gulf Opportunity Zone Act of 2005,"
    as Passed by The House Of Representatives And The Senate,  JCX-88-05,
    December 16, 2005.

    Commerce and Housing:
    Housing

    DEPRECIATION OF RENTAL HOUSING IN EXCESS
    OF ALTERNATIVE DEPRECIATION SYSTEM

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    4.0

    0.4

    4.4

    2007

    4.6

    0.5

    5.1

    2008

    5.3

    0.6

    5.9

    2009

    6.1

    0.7

    6.8

    2010

    7.0

    0.8

    7.8

    Authorization

    Sections 167 and 168.

    	Description

    Taxpayers are allowed to deduct the costs of acquiring depreciable assets
    (assets that wear out or become obsolete over a period of years) as
    depreciation deductions. The tax code currently allows new rental housing to
    be written off over 27.5 years, using a "straight line" method where equal
    amounts are deducted in each period.  This rule was adopted in 1986.  There
    is also a prescribed 40-year write-off period for rental housing under the
    alternative minimum tax (also based on a straight-line method).

    The tax expenditure measures the revenue loss from current depreciation
    deductions in excess of the deductions that would have been allowed under
    this longer 40-year period.  The current revenue effects also reflect different
    write-off methods and lives prior to the 1986 revisions, since many buildings
    pre-dating that time are still being depreciated.

    Prior to 1981, taxpayers were generally offered the choice of using the
    straight-line method or accelerated methods of depreciation, such as double-
    declining balance and sum-of-years digits, in which greater amounts are
    deducted in the early years.  (Used buildings with a life of twenty years or
    more were restricted to 125-percent declining balance methods.)  The period
    of time over which deductions were taken varied with the taxpayer's
    circumstances.

    Beginning in 1981, the tax law prescribed specific write-offs which
    amounted to accelerated depreciation over periods varying from 15 to 19
    years.  Since 1986, all depreciation on residential buildings has been on a
    straight-line basis over 27.5 years.

    Example: Suppose a building with a basis of $10,000 was subject to
    depreciation over 27.5 years.  Depreciation allowances would be constant at
    1/27.5 x $10,000 = $364.  For a 40-year life the write-off would be $250 per
    year.  The tax expenditure in the first year would be measured as the
    difference between the tax savings of deducting $364 or $250, or $114.

    Impact

    Because depreciation methods faster than straight-line allow for larger
    deductions in the early years of the asset's life and smaller depreciation deduc-
    tions in the later years, and because shorter useful lives allow quicker
    recovery, accelerated depreciation results in a deferral of tax liability.

    It is a tax expenditure to the extent it is faster than economic (i.e., actual)
    depreciation, and evidence indicates that the economic decline rate for
    residential buildings is much slower than that reflected in tax depreciation
    methods.

    The direct benefits of accelerated depreciation accrue to owners of rental
    housing.  Benefits to capital income tend to concentrate in the higher-income
    classes (see discussion in the Introduction).

    	Rationale

    Prior to 1954, depreciation policy had developed through administrative
    practices and rulings.  The straight-line method was favored by IRS and
    generally used.  Tax lives were recommended for assets through "Bulletin F,"
    but taxpayers were also able to use a facts-and-circumstances justification.

    A ruling issued in 1946 authorized the use of the 150-percent declining
    balance method.  Authorization for it and other accelerated depreciation
    methods first appeared in legislation in 1954 when the double declining
    balance and other methods were enacted.  The discussion at that time focused
    primarily on whether the value of machinery and equipment declined faster in
    their earlier years.  However, when the accelerated methods were adopted,
    real property was included as well.

    By the 1960s, most commentators agreed that accelerated depreciation
    resulted in excessive allowances for buildings.  The first restriction on
    depreciation was to curtail the benefits that arose from combining accelerated
    depreciation with lower capital gains taxes when the building was sold.  That
    is, while taking large deductions reduced the basis of the asset for measuring
    capital gains, these gains were taxed at the lower capital gains rate rather than
    the ordinary tax rate.

    In 1964, 1969, and 1976 various provisions to "recapture" accelerated
    depreciation as ordinary income in varying amounts when a building was sold
    were enacted.

    In 1969, depreciation on used rental housing was restricted to 125 percent
    declining balance depreciation.  Low-income housing was exempt from these
    restrictions.

    In the Economic Recovery Tax Act of 1981, residential buildings were
    assigned specific write-off periods that were roughly equivalent to 175-
    percent declining balance methods (200 percent for low-income housing) over
    a 15-year period under the Accelerated Cost Recovery System (ACRS).

    These changes were intended as a general stimulus to investment.
    Taxpayers could elect to use the straight-line method over 15 years, 35 years,
    or 45 years. (The Deficit Reduction Act of 1984 increased the 15-year life to
    18 years; in 1985, it was increased to 19 years.)  The recapture provisions
    would not apply if straight-line methods were originally chosen.  The
    acceleration of depreciation that results from using the shorter recovery period
    under ACRS was not subject to recapture as accelerated depreciation.

    The current treatment was adopted as part of the Tax Reform Act of 1986,
    which lowered tax rates and broadened the base of the income tax.

    Assessment

    Evidence suggests that the rate of economic decline of residential structures
    is much slower than the rates allowed under current law, and this provision
    causes a lower effective tax rate on such investments than would otherwise be
    the case.  This treatment in turn tends to increase investment in rental housing
    relative to other assets, although there is considerable debate about how
    responsive these investments are to tax subsidies.

    At the same time, the more rapid depreciation roughly offsets the
    understatement of depreciation due to the use of historical cost-basis
    depreciation, assuming inflation is at a rate of two percent or so. Moreover,
    many other assets are eligible for accelerated depreciation as well, and the
    allocation of capital depends on relative treatment.

    Much of the previous concern about the role of accelerated depreciation in
    encouraging tax shelters in rental housing has faded because the current
    depreciation provisions are less rapid than those previously in place, and
    because there is a restriction on the deduction of passive losses.  (However,
    the restrictions were eased somewhat in 1993.)

    	Selected Bibliography

    Auerbach, Alan, and Kevin Hassett. "Investment, Tax Policy, and the Tax
    Reform Act of 1986," Do Taxes Matter: The Impact of the Tax Reform Act of
    1986, ed. Joel Slemrod.  Cambridge, Mass.: MIT Press, 1990, pp. 13-49.
    Board of Governors of the Federal Reserve System.  Public Policy and
    Capital Formation.  April 1981.
    Brannon, Gerard M.  "The Effects of Tax Incentives for Business
    Investment: A Survey of the Economic Evidence," The Economics of Federal
    Subsidy Programs, Part 3: Tax Subsidies, U.S. Congress, Joint Economic
    Committee, July 15, 1972, pp. 245-268.
    Brazell, David W. and James B. Mackie III.  "Depreciation Lives and
    Methods: Current Issues in the U.S. Capital Cost Recovery System," National
    Tax Journal, v. 53 (September 2000), pp. 531-562.
    Break, George F. "The Incidence and Economic Effects of Taxation," The
    Economics of Public Finance.  Washington, DC: The Brookings Institution,
    1974.
    Bruesseman, William B., Jeffrey D.  Fisher and Jerrold J. Stern.  "Rental
    Housing and the Economic Recovery Tax Act of 1981," Public Finance
    Quarterly, v. 10.  April 1982, pp. 222-241.
    Burman, Leonard E., Thomas S. Neubig, and D. Gordon Wilson. "The Use
    and Abuse of Rental Project Models," Compendium of Tax Research 1987,
    Office of Tax Analysis, Department of The Treasury. Washington, DC: U.S.
    Government Printing Office, 1987, pp. 307-349.
    DeLeeuw, Frank, and Larry Ozanne.  "Housing," In How Taxes Affect
    Economic Behavior, eds. Henry J. Aaron and Joseph A. Pechman.
    Washington, DC: The Brookings Institution, 1981, pp. 283-326.
    Deloitte and Touche.  Analysis of the Economic Depreciation of Structure,
    Washington, DC: June 2000.
    Feldstein, Martin.  "Adjusting Depreciation in an Inflationary Economy:
    Indexing Versus Acceleration." National Tax Journal, v. 34. March 1981, pp.
    29-43.
    Follain, James R., Patric H. Hendershott, and David C. Ling. "Real Estate
    Markets Since 1980: What Role Have Tax Changes Played?", National Tax
    Journal, v. 45, September 1992, pp. 253-266.

    Fromm, Gary, ed.  Tax Incentives and Capital Spending.  Washington, DC:
    The Brookings Institution, 1971.
    Fullerton, Don, Robert Gillette, and James Mackie. "Investment Incentives
    Under the Tax Reform Act of 1986," Compendium of Tax Research 1987,
    Office of Tax Analysis, Department of The Treasury.  Washington, DC: U.S.
    Government Printing Office, 1987, pp. 131-172.
    Fullerton, Don, Yolanda K. Henderson, and James Mackie. "Investment
    Allocation and Growth Under the Tax Reform Act of 1986," Compendium of
    Tax Research 1987, Office of Tax Analysis, Department of The Treasury.
    Washington, DC: U.S. Government Printing Office, 1987, pp. 173-202.
    Gravelle, Jane G.  "Differential Taxation of Capital Income: Another Look
    at the Tax Reform Act of 1986,"  National Tax Journal, v. 63.  December
    1989, pp. 441-464.
    -. Depreciation and the Tax Treatment of Real Estate. Library of
    Congress, Congressional Research Service Report RL30163.  Washington,
    DC: October 25, 2000.
    -.  Economic Effects of Taxing Capital Income, Chapters 3 and 5.
    Cambridge, MA: MIT Press, 1994.
    -.  "Whither Tax Depreciation?"  National Tax Journal, vol. 54,
    September, 2001, pp. 513-526.
    Harberger, Arnold.  "Tax Neutrality in Investment Incentives," The
    Economics of Taxation, eds. Henry J. Aaron and Michael J. Boskin.
    Washington, DC: The Brookings Institution, 1980, pp. 299-313.
    Hulten, Charles, ed.  Depreciation, Inflation, and the Taxation of Income
    From Capital.  Washington, DC: The Urban Institute, 1981.
    Hulten, Charles R., and Frank C. Wykoff.  "Issues in Depreciation
    Measurement." Economic Inquiry, v. 34, January 1996, pp. 10-23.
    Jorgenson, Dale W.  "Empirical Studies of Depreciaton." Economic
    Inquiry, v. 34, January 1996, pp. 24-42.
    Mackie, James.  "Capital Cost Recovery," in The Encyclopedia of Taxation
    and Tax Policy, eds. Joseph J. Cordes, Robert O. Ebel, and Jane G. Gravelle.
     Washington, DC: Urban Institute Press, 2005.
    Nadiri, M. Ishaq, and Ingmar R. Prucha.  "Depreciation Rate Estimation of
    Physical and R&D Capital." Economic Inquiry, v. 34, January 1996, pp. 43-
    56.
    Poterba, James M.  "Taxation and Housing Markets: Preliminary Evidence
    on the Effects of Recent Tax Reforms," Do Taxes Matter: The Impact of the
    Tax Reform Act of 1986, ed. Joel Slemrod.  Cambridge, Mass: The MIT
    Press, 1990, pp. 13-49.
    Surrey, Stanley S.  Pathways to Tax Reform.  Chapter VII: "Three Special
    Tax Expenditure Items: Support to State and Local Governments, to
    Philanthropy, and to Housing."  Cambridge, Mass: Harvard University Press,
    1973.
    Taubman, Paul and Robert Rasche.  "Subsidies, Tax Law, and Real Estate
    Investment," The Economics of Federal Subsidy Programs, Part 3: "Tax
    Subsidies."  U.S. Congress, Joint Economic Committee, July 15, 1972, pp.
    343-369.

    U.S. Congress, Congressional Budget Office.  Real Estate Tax Shelter
    Subsidies and Direct Subsidy Alternatives.  May 1977.
    -, Joint Committee on Taxation.  General Explanation of the Tax Reform
    Act of 1986.  May 4, 1987, pp. 89-110.
    U.S. Department of Treasury.  Report to the Congress on Depreciation
    Recovery Periods and Methods.  Washington, DC: June 2000.

    Commerce and Housing:
      Housing

    	TAX CREDIT FOR LOW-INCOME HOUSING

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    1.4

    3.4

    4.8

    2007

    1.5

    3.6

    5.1

    2008

    1.6

    3.8

    5.4

    2009

    1.7

    4.1

    5.8

    2010

    1.9

    4.4

    6.3

    	Authorization

    Section 42.

    	Description

    The Low Income Housing Tax Credit (LIHTC) was created by the Tax
    Reform Act of 1986 (P.L. 99-514), providing a tax credit for a portion of the
    costs of low-income rental housing.  The credit is claimed over a period of 10
    years.  The credit rate is set so that the present value of the tax credit is equal
    to 70 percent for new construction and 30 percent for projects receiving other
    Federal benefits (such as tax exempt bond financing), or for substantially
    rehabilitated existing housing.

    The credit is allowed only for the fraction of units serving low-income
    tenants, which are subject to a maximum rent.  To qualify, at least 40 percent
    of the units in a rental project must be occupied by families with  incomes less
    than 60 percent of the area median or at least 20 percent of the units in a
    rental project must be occupied by families with  incomes less than 50 percent
    of the area median .  (In practice, data show the vast majority of tax credit
    projects are composed almost entirely of low-income units).  Rents in low-
    income units are restricted to 30 percent of the 60 percent (or 50 percent) of
    area median income.  An owner's required commitment to keep units
    available for low-income use was originally 15 years, but the Omnibus
    Budget Reconciliation Act of 1989 extended this period to 30 years for
    projects begun after 1989.

    The credits are allocated in a competitive process by State housing
    agencies to developers, most of whom then sell their 10-year stream of tax
    credits to investors to raise capital for the project. The original law established
    an annual per-resident limit of $1.25 for the State's total credit authority.
    Under the Community Renewal Tax Relief Act of 2000 (P.L 106-554), this
    limit was increased to $1.50 in 2001, $1.75 in 2002, and thereafter, adjusted
    for inflation ($1.90 for 2006).  There is a minimum annual credit amount for
    small States, also indexed for inflation, currently about $2.1 million for States
    where the $1.90 per capita formula would yield less. The housing authority
    must require an enforceable 30-year low-income use (through restrictive
    covenants), although after the initial 15-year period, an owner may sell the
    project (at a controlled price) or convert it to market-rate housing if the
    housing authority is unable to find a buyer, often a nonprofit group, willing to
    maintain the project as low-income use for the remainder of the 30 year
    period.

    The amount of the credit that can be offset against unrelated income is
    limited to the equivalent of $25,000 in deductions, under the passive loss
    restriction rules.

    	Impact

    This provision substantially reduces the cost of investing in qualified units.
     The competitive sale of tax credits by developers to investors and the
    oversight requirements by housing agencies should prevent excess profits
    from occurring, and direct much of the benefit to qualified tenants of the
    housing units.

    Most tax credits are now purchased by corporations, including banks who
    are satisfying their requirements under the Community Reinvestment Act, and
    by the government-sponsored enterprises, Fannie Mae and Freddie Mac, also
    satisfying their affordable housing lending goals.  Freddie Mac reported that
    its low-income housing tax credit portfolio now exceeds $3 billion (200,000
    units in more than 2,800 projects).

    	Rationale

    The tax credit for low-income housing was adopted in the Tax Reform Act
    of 1986 to provide a subsidy directly linked to the addition of rental housing
    with limited rents for low-income households.  It replaced less targeted
    subsidies in the law, including accelerated depreciation, five-year
    amortization of rehabilitation expenditures, expensing of construction-period
    interest and taxes, and general availability of tax-exempt bond financing.  The
    credit was scheduled to expire at the end of 1989, but was temporarily
    extended a number of times until made permanent by the Omnibus Budget
    Reconciliation Act of 1993 (P.L. 103-66).

    The Omnibus Budget Reconciliation Act of 1989 (P.L. 101-239) required
    States to regulate tax-credit projects more carefully to insure that investors
    were not earning excessive rates of return and  introduced the requirement
    that new projects have a long-term plan for providing low-income housing.
    Legislation in 1988, (the Technical and Miscellaneous Revenue Act of  1988,
    P.L. 100-647), in 1989 (noted above), and in 1990 (the Omnibus Budget
    Reconciliation Act of 1990, P.L. 101-508) made technical and substantive
    changes to the provision. As noted above, the Community Renewal Tax
    Relief Act of 2000 increased the annual tax credit allocation limit, indexed it
    to inflation, and made minor amendments to the program.

    Assessment

    The low-income housing credit, now giving States the equivalent of nearly
    $5.5 billion of annual budget authority, is more targeted to benefitting lower-
    income individuals than the more general tax provisions it replaced.
    Moreover, by allowing State authorities to direct its use, the credit can be
    used as part of a general neighborhood revitalization program.  The most
    comprehensive data base of tax credit units, compiled by the Department of
    Housing and Urban Development (HUD), revised as of March 31, 2006,
    shows nearly 24,500 projects and nearly 1,257,000 housing units placed in
    service between 1987 and 2003.  With about 100,000 units now being added
    each year, the current total is likely in excess of 1.5 million units.  The HUD
    data base of units built from 1995 through 2003 shows nearly two-thirds were
    newly constructed (although only one-third in the Northeast were new
    construction), about one-third of the projects had a nonprofit sponsor, nearly
    one-half of units are located in central cities and about 40 percent are in metro
    area suburbs. It is estimated that about 35 percent of LIHTC properties have
    tenant-based rental assistance (HUD's Section 8 program, now called the
    Housing Choice Voucher program). Data also show that LIHTC units are
    more likely to be located in largely minority- or renter-occupied census tracts
    or tracts with large proportions of female-headed households, compared to
    households in general or rental units in general.

    Much less is known about the financial aspects of tax credit projects and
    how much it actually costs to provide an affordable rental unit under this
    program when all things are considered.  Many tax credit projects receive
    other Federal subsidies, and as noted, more than one-third of tax credit renters
    receive additional Federal rental assistance.  HUD's Federal Housing
    Administration (FHA) program is insuring an increasing number of tax credit
    projects.  There are reports that some neighborhoods are saturated with tax
    credit projects and projects targeted to households with 60 percent of area
    median income frequently have as high a vacancy rate as the surrounding
    unsubsidized market.

    There are a number of  criticisms that can be made of the credit (see the
    Congressional Budget Office study in the bibliography below for a more
    detailed discussion).  The credit is unlikely to have a substantial effect on the
    total supply of low-income housing, based on both micro-economic analysis
    and some empirical evidence.  There are significant overhead and
    administrative costs, especially if there are attempts to insure that investors do
    not earn excess profits.  Direct funding by the Federal government to State
    housing agencies would avoid the cost of the syndication process (the sale of
    tax credits to investors as "tax shelters.") And, in general, many economists
    would argue that housing vouchers, or direct-income supplements to the low-
    income, are more direct and fairer methods of providing assistance to lower-
    income individuals.  However, others argue that because of landlord
    discrimination against low income people, minorities, and those with young
    children (and sometimes an unwillingness to get involved in a government
    program, particularly in tight rental markets), a mix of vouchers and project-
    based assistance like the tax credit might be necessary.

     A study by the Chicago Rehab Network of 1998 audits of Chicago tax
    credit projects containing 8,704 units found that 73 percent had no operating
    reserves and 44 percent had no replacement reserves, with a significant
    number of projects likely to face "a future of deferred maintenance, rising
    vacancies and ever deepening budget shortfalls."  A HUD-commissioned
    study (report dated August 2000) of 39 projects found that 50 percent of tax
    credit renters pay more than 30 percent of their income for rent, 13 percent
    paying more than 50 percent of income.

    A looming issue has to do with the projects completed from 1987
    through1989 that have 15-year affordability restrictions that began expiring in
    2002.  There may be as many as 70,000 of these units whose owners could
    decide to opt out of the low-income rental operations with relative ease.
    There has been almost no information yet reported on this potential.  A report
    by the Joint Center for Housing Studies at Harvard University and the
    Neighborhood Reinvestment Corporation on the expiring affordability issue
    concluded that : "Lack of monitoring or insufficient funds for property repair
    or purchase will place even properties for which there is an interest in
    preserving affordability at risk of market conversion, reduced income-
    targeting, or disinvestment and decline."  An increasing amount of tax credits
    have been and are likely to be used for the preservation of existing affordable
    housing in the future rather than for new units that add to the overall supply
    of affordable units.

    	Selected Bibliography

    Burman, Leonard. "Low Income Housing Credit," in The Encyclopedia of
    Taxation and Tax Policy, eds. Joseph J. Cordes, Robert O. Ebel, and Jane G.
    Gravelle.  Washington, DC: Urban Institute Press, 2005.
    Collignon, Kate.  Expiring Affordability of Low-Income Housing Tax
    Credit Properties: The Next Era in Preservation.  Cambridge, MA:
    Neighborhood Reinvestment Corporation and Joint Center for Housing
    Studies of Harvard University, October 1999.
    Cummings, Jean L, and Denise DiPasquale.  "The Low-Income Housing
    Tax Credit: An Analysis of the First Ten Years," Housing Policy Debate, v.
    10, no. 2, 1999.  pp. 251-307.
    Freeman, Lance.  Siting Affordable Housing: Location and Neighborhood
    Trends of Low Income Housing Tax Credit Developments in the 1990s.  The
    Brookings Institution.  March 2004.
    Green, Richard K., Stephen Malpezzi, and Kiat-Ying Seah.  Low Income
    Housing Tax Credit Housing Developments And Property Values.  The
    Center for Urban Land Economics Research.  June 12, 2002.
    Herman, Kim, Walter Clare, Susan Herd, Dana Jones, Erica Stewart, and
    Barbara Burnham. "Tax Credits and Rural Housing," Voices from the
    Housing Assistance Council , Winter 2003-2004.
    Jackson, Pamela J. An Introduction to the Design of the Low-Income
    Housing Tax Credit, Library of Congress, Congressional Research Service
    Report RS22389, March 21, 2006.
    Khadduri, Jill, Larry Buron, and Carissa Climaco. "Are States Using the
    Low Income Housing Tax Credit to Enable Families with Children to Live in
    Low poverty and Racially Integrated Neighborhoods?" a report prepared for
    the Poverty and Race Research Action Council and the National Fair
    Housing Alliance, July 2006.
    Olsen, Edgar O. "The Low-Income Housing Tax Credit: An Assessment,"
    working paper from the University of Virginia, December 2004.
    Olsen, Edgar O. "Fundamental Housing Policy Reform," working paper
    from the University of Virginia, January 2006.
    Present Realities, Future Prospects: Chicago's Low Income Housing Tax
    Credit Portfolio.  Summary Report 2002.  Chicago Rehab Network.
    Understanding the Dynamics: A Comprehensive Look at Affordable
    Housing Tax Credit Properties.  Ernst & Young's Affordable Housing
    Services, July, 2002.
    United States General Accounting Office. Costs and Characteristics of
    Federal Housing Assistance.  GAO-01-901R. July 2001.
    House Committee on Ways and Means. Tax Provisions Related to
    Housing. 2004 Green Book. 108th Congress, 2nd session, March 2004, pp. 13-
    56 to 13-58.
     	Joint Committee on Taxation.  General Explanation of the Tax Reform Act
    of 1986.  May 4, 1987, pp. 152-177.
    U.S. Department of Housing and Urban Development.  Making the Best
    Use of Your LIHTC Dollars: A Planning Paper for State Policy Makers.
    Washington, D. C.  July 2004.

    -, Assessment of the Economic and Social Characteristics of LIHTC
    Residents and Neighborhoods.  Washington, D. C.  August 2000.
    -, Updating the Low Income Housing Tax Credit  Database: Projects
    Placed in Service Through 2003.  Washington, D.C. March 2006.

    Commerce and Housing:
    Housing

    TAX CREDIT FOR REHABILITATION OF
    HISTORIC STRUCTURES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.1

    0.3

    0.4

    2007

    0.1

    0.3

    0.4

    2008

    0.1

    0.3

    0.4

    2009

    0.1

    0.3

    0.4

    2010

    0.1

    0.3

    0.4

    Authorization

    Section 47.

    	Description

    Expenditures on certified structures qualify for a 20 percent tax credit if
    used to substantially rehabilitate historic structures for use as residential rental
    or commercial property.  The basis (cost for purposes of depreciation) of the
    building is reduced by the amount of the rehabilitation credit.  The costs of
    acquiring a building or an interest in such a building, such as a leasehold
    interest, are not considered as qualifying expenditures.  The costs of facilities
    related to an existing building, such as a parking lot, also are not considered
    as qualifying expenditures.  Expenditures incurred by a lessee do not qualify
    for the credit unless the remaining lease term on the date the rehabilitation is
    completed is at least as long as the applicable recovery period under the
    general depreciation rules (generally, 27.5 years for residential property and
    39 years for nonresidential property).  Straight-line depreciation must be used
    to qualify for the rehabilitation credit.

    The amount of the credit that can be offset against unrelated income is
    limited to the equivalent of $25,000 in deductions under the passive loss
    restriction rules.  The ordering rules for the phaseout are provided in Section
    469 of the Internal Revenue Code.

    Certified historic structures are either individually registered in the
    National Register of Historic Places or are structures certified by the Secretary
    of the Interior as having historic significance and located in a registered
    historic district.  The State Historic Preservation Office reviews applications
    and forwards recommendations for designation to the U.S. Department of
    Interior.

    Impact

    The credit reduces the taxpayer's cost of preservation projects.  Prior to the
    Tax Reform Act of 1986 (P.L. 99-514), historic preservation projects had
    become a popular tax shelter with rapid growth.  The limits on credits under
    the passive loss restrictions limit the use of this investment as a tax shelter.

    	Rationale

    Rapid depreciation (amortized over a 60-month period) for capital
    expenditures incurred in rehabilitation of certified historic structures was
    adopted as part of the Tax Reform Act of 1976 (P.L. 94-455).  In addition, the
    act provided that in case of a substantially altered or demolished certified
    historic structure, the amount expended for demolition or any loss sustained
    on account of the demolition is to be charged to the capital account with
    respect to the land and not includible in the depreciable basis of a replacement
    structure.  Further, accelerated depreciation methods are prohibited for the
    replacement structure.  These actions were taken because Congress believed
    the preservation of historic structures and neighborhoods is an important
    national goal dependent upon the enlistment of private funds in the
    preservation movement.  It was argued that prior law encouraged the
    demolition and replacement of old buildings instead of their rehabilitation.

    Partly in a move toward simplification and partly to add counterbalance to
    new provisions for accelerated cost recovery, the tax incentives were changed
    to a tax credit in 1981 and made part of a set of credits for rehabilitating older
    buildings (varying by type or age).

    The credit amount was reduced in 1986 because the rate was deemed too
    high when compared with the new lower tax rates, and a reduction from a
    three- to a two-tiered rehabilitation rate credit was adopted.  A higher credit
    rate was allowed for preservation of historic structures than for rehabilitations
    of older qualified buildings first placed in service prior to 1936.

    In response to tax simplification proposals which noted the numerous
    limitations and qualifications of the loss limitation rules, ordering rules in the
    Internal Revenue Code (Section 469) were clarified with the passage of the
    Job Creation and Worker Assistance Act of 2002 (P.L. 107-147).

    Temporary expansion of the tax credit amount was enacted with the Gulf
    Opportunity Zone Act (GO Zone; P.L. 109-135).  The expansion, which
    became effective for expenditures made after August 28, 2005 and before
    January 1, 2009, applies to certified historic structures located in specific
    areas of the Gulf Region that were adversely affected by hurricanes in the fall
    of 2005.

    Assessment

    Owners of historic buildings are encouraged to renovate them through the
    use of the 20 percent tax credit available for substantial rehabilitation
    expenditures approved by the Department of the Interior.  Opponents of the
    credit note that investments are allocated to historic buildings that would not
    be profitable projects without the credit, resulting in economic inefficiency.
    Proponents argue that investors fail to consider external benefits (preservation
    of social and aesthetic values) which are desirable for society at large.

    	Selected Bibliography

    Alperin, Kenneth A.  "What You Should Know About The Historic
    Rehabilitation Tax Credit," The Practical Tax Lawyer, vol. 19, iss. 2, pp. 31-
    39.
    Escherich, Susan M., Stephen J. Farneth, and Bruce D. Judd; with a
    preface by Katherine H. Stevenson.  "Affordable Housing Through Historic
    Preservation: Tax Credits and the Secretary of the Interior's Standards for
    Historic Rehabilitation."  Washington, DC: U.S. Dept. of the Interior,
    National Park Service, Cultural Resources, Preservation Assistance. For sale
    by the U.S. Government Printing Office,  Superintendent of Documents
    [1995].
    Fogleman, Valerie M.  "A Capital Tax System to Preserve America's
    Heritage: A Proposal Based on the British National Heritage Capital Tax
    System," Vanderbilt Journal of Transnational Law, vol. 23, 1990,  pp. 1-63.
    Foong, Keat.  "Historic Tax Credit Use Continues to Rise: Use of Federal
    Program Can Be Extremely Lucrative, Although Requirements Can Deter
    Developers," Multi-Housing News, vol. 37 (July 2002), pp. 1-4.
    Kamerick, Megan. "Framers get a History Lesson: Historic Tax Credits
    Can Help Framers Secure the Shops of Their Dreams," Art Business News,
    vol. 31, April 2003, p. S1.
    Linn, Charles. "PSFS Adaptive Reuse Illustrates Preservation Tax Credits
    at Work," Architectural Record, vol. 188, October 2000, p. 63.

    Listokin, David, Barbara Listokin, and Micahel Lahr.  "The Contributions
    of Historic Preservation to Housing and Economic Development," Housing
    Policy Debate, vol. 9, Issue 3, 1998, pp. 431-478.
    Mann, Roberta F. "Tax Incentives for Historic Preservation: An Antidote
    for Sprawl?" Widner Law Symposium Journal, vol. 8, 2002, pp. 207-236.
    National Park Service.  Federal Historic Preservation Tax Incentives.
    World Wide Web http://www2.cr.nps.gov/tps/tax/.
    Novogradac, Michael J. and Eric J. Fortenbach. "Financing Rehab Projects
    with the Rehabilitation Tax Credit," Journal of Property Management, vol.
    54, September-October 1989, pp. 72-73.
    Preservation Tax Incentives for Historic Buildings.  Washington, DC: U.S.
    National Park Service, 1990.
    Oliver-Remshefski, Rebecca N. "Washington Slept Here: Protection and
    Preservation of Our Architectural Heritage," Rutgers Law Review, vol. 55,
    Winter 2003, pp. 611-640.
    Smith, Neil.  "Comment on David Listokin, Barbara Listokin, and Michael
    Lahr's The Contributions of Historic Preservation to Housing and Economic
    Development: Historic Preservation in a Neoliberal Age," Housing Policy
    Debate, vol. 9,  1998, pp. 479-485.
    Swaim, Richard. "Politics and Policymaking: Tax Credits and Historic
    Preservation," Journal of Arts Management, Law, and Society, vol. 33, Issue
    1, Spring 2003, pp. 32-40.
    U.S. Congress, Congressional Budget Office.  Budget Options.  "Reduce
    Tax Credits for Rehabilitating Buildings and Repeal the Credit for
    Nonhistoric Structures."  Washington, DC: February 2001, p. 427.
    U.S. General Accounting Office.  Historic Preservation Tax Incentives.
    August 1, 1986.  Washington, DC: GAO, August 1, 1986.
    U.S. Congress, Joint Committee on Taxation.  General Explanation of the
    Revenue Act of 1978 (H.R. 13511, 95th Congress; Public Law 95-600).
    Washington, DC: U.S. Government Printing Office, March 12, 197, pp. 155-
    158.
    -.  General Explanation of the Economic Recovery Tax Act of 1981 (H.R.
    4242, 97th Congress; Public Law 97-34).  Washington, DC: U.S.
    Government Printing Office, December 31, 1981, pp. 111-116.
    -.  General Explanation of the Tax Reform Act of 1986 (H.R. 3838, 99th
    Congress; Public Law 99-514).  Washington, DC: U.S. Government Printing
    Office, May 4, 1987, pp.

    	Commerce and Housing:
    	Housing

    	INVESTMENT CREDIT FOR REHABILITATION
    	OF STRUCTURES, OTHER THAN HISTORIC STRUCTURES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.1

    (1)

    0.1

    2007

    0.1

    (1)

    0.1

    2008

    0.1

    (1)

    0.1

    2009

    0.1

    (1)

    0.1

    2010

    0.1

    (1)

    0.1

    (1)Less than $50 million.

    	Authorization

    Section 47.

    	Description

    Qualified expenditures made to substantially rehabilitate a nonresidential
    building receive a 10-percent tax credit.  Only expenditures on buildings
    placed in service before 1936 are eligible.  Expenditures made during any 24-
    month period must exceed the greater of $5,000 or the adjusted basis (cost
    less depreciation taken) of the building.  The basis must be reduced by the full
    amount of the rehabilitation credit.

    For buildings to be eligible, at least 50 percent of the external walls must
    be retained as external walls, at least 75 percent of the exterior walls must be
    retained as internal or external walls, and at least 75 percent of the internal
    structural framework of the building must be retained.  The building must not
    have been moved since 1936.

    Impact

    This provision encourages business firms to renovate property rather than
    relocate.  The credit reduces the cost of rehabilitation and thereby can turn
    unprofitable rehabilitation projects into profitable rehabilitation projects, and
    can make rehabilitation of a building more profitable than new construction.

    	Rationale

    The Revenue Act of 1978 (P.L. 95-600) provided an investment tax credit
    for rehabilitation expenditures made for nonresidential buildings in use for at
    least 20 years, in response to concerns over the declining usefulness of older
    buildings (especially those in older neighborhoods and central cities).  The
    purpose was to promote stability and restore economic vitality to deteriorating
    areas.

    Larger rehabilitation tax credits were enacted in the Economic Recovery
    Tax Act of 1981(P.L. 97-34); the purpose was to counteract any tendency to
    encourage firms to relocate and build new plants in response to significantly
    shortened recovery periods.  Concerns were expressed that investment in new
    structures in new locations does not promote economic recovery if it displaces
    older structures, and that relocation can cause hardship to workers and their
    families.

    The credit was retained in the Tax Reform Act of 1986 (P.L. 99-514),
    because investors were viewed as failing to consider social and aesthetic
    values of restoring older structures.  The credit amount was reduced, because
    the rate would have been too high when compared with the new lower tax
    rates, also changed by the 1986 act.

    Temporary expansion of the tax credit amount was enacted with the Gulf
    Opportunity Zone Act (GO Zone; P.L. 109-135).  The expansion, which
    became effective for expenditures made after August 28, 2005 and before
    January 1, 2009, applies to qualified structures located in specific areas of the
    Gulf Region that were adversely affected by hurricanes in the fall of 2005.

    Assessment

    The main criticism of the tax credit is that it allocates investments to
    restoring older buildings that would not otherwise be profitable, causing
    economic inefficiency.  This allocation may be desirable if there are external
    benefits to society (e.g., aesthetic benefits or the promotion of using the
    existing building stock rather than the promotion of destruction and
    rebuilding at a greater cost) that the firm would not take into account.
    Proponents of the credit note that if buildings at least 50 years old are worth
    saving, then a rolling qualification period should be provided rather than the
    fixed 1936 date, which was set in 1976 for buildings of that age.  More
    recently, the Joint Committee on Taxation recommended the elimination of
    the 10 percent credit based on simplification arguments.

    	Selected Bibliography

    Everett, John O.  "Rehabilitation Tax Credit Not Always Advantageous,"
    Journal of Taxation.  August 1989, pp. 96-102.
    Kamerick, Megan. "Framers get a History Lesson: Historic Tax Credits
    Can Help Framers Secure the Shops of Their Dreams," Art Business News, v.
    31, April 2003, p. S1.
    Mann, Roberta F. "Tax Incentives for Historic Preservation: An Antidote
    for Sprawl?" Widner Law Symposium Journal, v. 8, 2002, pp. 207-236.
    National Park Service.   Federal Historic Preservation Tax Incentives.
    World Wide Web page http://www2.cr.nps.gov/tps/tax/.
    Oliver-Remshefski, Rebecca N. "Washington Slept Here: Protection and
    Preservation of Our Architectural Heritage," Rutgers Law Review, v. 55,
    Winter 2003, pp. 611-640.
    Taylor, Jack.  Income Tax Treatment of Rental Housing and Real Estate
    Investment After the Tax Reform Act of 1986, Library of Congress,
    Congressional Research Service Report 87-603 E.  Washington, DC: July 2,
    1987.
    U.S. Congress, Congressional Budget Office.  Budget Options.  "Reduce
    Tax Credits for Rehabilitating Buildings and Repeal the Credit for
    Nonhistoric Structures."  Washington, DC: February 2001, p. 427.
    U.S. Congress, Joint Committee on Taxation.  General Explanation of the
    Revenue Act of 1978, H.R. 13511, 95th Congress, Public Law 95-600.
    Washington, DC: U.S. Government Printing Office, March 12, 1979, pp.
    155-158.
    -.  General Explanation of the Economic Recovery Tax Act of 1981, H.R.
    4242, 97th Congress, Public Law 97-34.  Washington, DC:  U.S.
    Government Printing Office, December 31, 1981, pp. 111-116.
    -.  General Explanation of the Tax Reform Act of 1986, H.R. 3838, 99th
    Congress, Public Law 99-514.  Washington, DC: U.S. Government Printing
    Office, May 4, 1987, pp. 148-152.
    U.S. General Accounting Office.  Historic Preservation Tax Incentives.
    Washington, DC: August 1, 1986.

    Commerce and Housing:
    	Other Business and Commerce

    	REDUCED RATES OF TAX*
    	ON DIVIDENDS AND LONG-TERM CAPITAL GAINS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    92.2

    -

    92.2

    2007

    94.5

    -

    94.5

    2008

    101.7

    -

    101.7

    2009

    99.6

    -

    99.6

    2010

    50.2

    -

    50.2

    * The Tax Increase Prevention and Reconciliation Act of 2006 extended
    the reduced rates, with a projected additional revenue cost of $5.3 billion in
    FY2008, $12.8 billion in FY2009 and $5.3 billion in FY2010.

    Authorization

    Sections 1(h), 631, 1201-1256.

    Description

    Dividends on corporate stock and gains on the sale of capital assets held for
    more than a year are subject to lower tax rates under the individual income
    tax.  Individuals subject to the 10- or 15-percent rate pay a 5-percent rate and
    individuals in higher rates pay a 15-percent rate.  The 5-percent rate will be
    zero in 2008.  After 2010 the rates will revert to their levels prior to changes
    in 2003 (see rationale). Gain arising from prior depreciation deductions is
    taxed at ordinary rates but with a maximum of 28 percent.  Also, gain on the
    sale of property used in a trade or business is treated as a long-term capital
    gain if all gains for the year on such property exceed all losses for the year on
    such property.  Qualifying property used in a trade or business generally is
    depreciable property or real estate that is held more than a year, but not
    inventory.

    The tax expenditure is the difference between taxing gains and dividends at
    the lower rates and taxing them at the rates that apply to other income.

    Several special categories of income that are treated as capital gains have
    been listed separately in previous tax expenditure compendiums: energy
    (capital gains treatment of coal royalties), natural resources (capital gains
    treatment of iron ore royalties and timber), and agriculture (gains on farm
    property including livestock).  These items have become smaller, with only a
    small subsidy, limited to individuals.

      To be eligible for the lower dividend rate, stock must be held for 60 days
    out of 120 days that begin 60 days before the ex dividend day.   Only stock
    paid by domestic corporations is eligible.  For passthrough entities RICs
    (regulated investment companies, commonly known as mutual funds) and real
    estate investment trusts (REITs), payments to shareholders are eligible only to
    the extent they were qualified dividends to the passthrough entities.

    Impact

    Since higher-income individuals receive most capital gains, benefits accrue
    to high-income taxpayers.  Dividends are also concentrated among higher
    income individuals, although not to as great a degree as capital gains.
    Estimates of the benefit in the table below are based on data provided by the
    Joint Committee on Taxation.

    Estimated Distribution of Tax Expenditure, 2005

    [In billions of dollars]

    Income Class

    Capital Gains

    Dividends

    Less than $50,000

    1.5

    5.8

    $50,000-$100,000

    3.9

    13.6

    $100,000-$200,000

    7.1

    17.5

    $200,000-$1,000,000

    21.9

    31.1

    Over $1,000,000

    65.6

    32.0

    The primary assets that typically yield capital gains are corporate stock, and
    business and rental real estate.  Corporate stock accounts for 20 percent to 50
    percent of total realized gains, depending on the state of the economy and the
    stock market.  There are also gains from assets such as bonds, partnership
    interests, owner-occupied housing, timber, and collectibles, but all of these
    are relatively small as a share of total capital gains.

    	Rationale

    Although the original 1913 Act taxed capital gains at ordinary rates, the
    1921 law provided for an alternative flat-rate tax for individuals of 12.5
    percent for gain on property acquired for profit or investment.  This treatment
    was to minimize the influence of the high progressive rates on market
    transactions. The Committee Report noted that these gains are earned over a
    period of years, but are nevertheless taxed as a lump sum.

    Over the years, many revisions in this treatment have been made.  In 1934,
    a sliding scale treatment was adopted (where lower rates applied the longer
    the asset was held).  This system was revised in 1938.

    In 1942, the sliding scale approach was replaced by a 50-percent exclusion
    for all but short-term gains (held for less than six months), with an elective
    alternative tax rate of 25 percent.  The alternative tax affected only
    individuals in tax brackets above 50 percent.

    The 1942 act also extended special capital gains treatment to property used
    in the trade or business, and introduced the alternative tax for corporations at
    a 25-percent rate, the alternative tax rate then in effect for individuals.  This
    tax relief was premised on the belief that many wartime sales were
    involuntary conversions which could not be replaced during wartime, and that
    resulting gains should not be taxed at the greatly escalated wartime rates.

    Treatment of gain from cutting timber was adopted in 1943, in part to
    equalize the treatment of those who sold timber as a stand (where income
    would automatically be considered a capital gain) and those who cut timber.
    Capital gains treatment for coal royalties was added in 1951 to make the
    treatment of coal lessors the same as that of timber lessors and to encourage
    coal production.  Similar treatment of iron ore was enacted in 1964 to make
    the treatment consistent with coal and to encourage production.  The 1951 act
    also specified that livestock was eligible for capital gains, an issue that had
    been in dispute since 1942.

    The alternative tax  for individuals was repealed in 1969, and the
    alternative rate for corporations was reduced to 30 percent. The minimum tax
    on preference income and the maximum tax offset, enacted in 1969, raised
    the capital gains rate for some taxpayers.

    In 1976 the minimum tax was strengthened, and the holding period
    lengthened to one year.  The effect of these provisions was largely eliminated
    in 1978, which also saw introduced a 60-percent exclusion for individuals and
    a lowering of the alternative rate for corporations to 28 percent.  The
    alternative corporate tax rate was chosen to apply the same maximum
    marginal rate to capital gains of corporations as applied to individuals (since
    the top rate was 70 percent, and the capital gains tax was 40 percent of that
    rate due to the exclusion).

    The Tax Reform Act of 1986, which lowered overall tax rates and provided
    for only two rate brackets (15 percent and 28 percent), provided that capital
    gains would be taxed at the same rates as ordinary income.  This rate structure
    included a "bubble" due to phase-out provisions that caused effective
    marginal tax rates to go from 28 percent to 33 percent and back to 28 percent.

    In 1990, this bubble was eliminated, and a 31-percent rate was added to the
    rate structure.  There had, however, been considerable debate over proposals
    to reduce capital gains taxes.  Since the new rate structure would have
    increased capital gains tax rates for many taxpayers from 28 percent to 31
    percent, the separate capital gains rate cap was introduced.  The 28- percent
    rate cap was retained when the 1993 Omnibus Budget Reconciliation Act
    added a top rate of 36 percent and a 10-percent surcharge on very high
    incomes, producing a maximum rate of 39.6 percent.

    The Taxpayer Relief Act of 1997 provided the lower rates; its objective
    was to increase saving and risk-taking, and to reduce lock-in.  Individuals
    subject to the 15-percent rate paid a 10-percent rate and individuals in the 28-,
    31-, 36-, and 39.6-percent rate brackets paid a 20-percent rate.  Gain arising
    from prior depreciation deductions was taxed at ordinary rates but with a
    maximum of 28 percent.  Eventually, property held for five years or more
    would be taxed at 8 percent and 18 percent, rather than 10 percent and 20
    percent.  The 8-percent rate applied to sales after 2000; the 18-percent rate
    applied to property acquired after 2000 (and, thus, to such property sold after
    2005). The holding period was increased to 18 months, but cut back to one
    year in 1998.

    The Jobs and Growth Tax Relief Reconciliation Act of 2003 provided for
    the current lower rates, with a sunset after 2008 (extended to 2010 by the Tax
    Increase Prevention and Reconciliation Act of 2006).  The stated rationale
    was to encourage investment and growth, and to reduce the distortions due to
    higher taxes on dividends, which also encouraged use of debt finance and
    retention of earnings.

    Assessment

    The original rationale for allowing a capital gains exclusion or alternative
    tax benefit-the problem of bunching of income under a progressive tax-is
    relatively unimportant under the current flatter rate structure.

    A primary rationale for reducing the tax on capital gains is to mitigate the
    lock-in effect.  Since the tax is paid only on a realization basis, an individual
    is discouraged from selling an asset.  This effect causes individuals to hold a
    less desirable mix of assets, causing an efficiency loss.  This loss could be
    quite large relative to revenue raised if the realizations response is large.

    Some have argued, based on certain statistical studies, that the lock-in
    effect is, in fact, so large that a tax cut could actually raise revenue.  Others
    have argued that the historical record and other statistical studies do not
    support this view and that capital gains tax cuts will cause considerable
    revenue loss.  This debate about the realizations response has been a highly
    controversial issue.

    Although there are efficiency gains from reducing lock-in, capital gains
    taxes can also affect efficiency through other means, primarily through the
    reallocation of resources between types of investments.  Lower capital gains
    taxes may disproportionately benefit real estate investments, and may cause
    corporations to retain more earnings than would otherwise be the case,
    causing efficiency losses.  At the same time lower capital gains taxes reduce
    the distortion that favors corporate debt over equity, which produces an
    efficiency gain.

    Another argument in favor of capital gains relief is that much of gain
    realized is due to inflation.  On the other hand, capital gains benefit from
    deferral of tax in general, and this deferral can become an exclusion if gains
    are held until death.  Moreover, many other types of capital income (e.g.,
    interest income) are not corrected for inflation.

    The particular form of this capital gains tax relief also results in more of a
    concentration towards higher-income individuals than would be the case with
    an overall exclusion.

    The extension of lower rates to dividends in 2003 significantly reduced the
    pre-existing incentives to corporations to retain earnings and finance with
    debt, and reduced the distortion that favors corporate over non-corporate
    investment.  It is not at all clear, however, that the lower tax rates will induce
    increased saving, another stated objective of the 2003 dividend relief, if the
    tax cuts are financed with deficits.

    	Selected Bibliography

    Amromin, Gene, Paul Harrison, Nellie Liang, and Steven Sharpe, How Did
    the 2003 Dividend Tax Cut Affect Stock Prices and Corporate Payout Policy?
     Board of Governors of the Federal Reserve System, Finance and Economic
    Discussion Series 2005-57, 2005.
    Amromin, Gene, Paul Harrison, and Steven Sharpe, How Did the 2003
    Dividend Tax Cut Affect Stock Prices?  Board of Governors of the Federal
    Reserve System, Finance and Economic Discussion Series 2005-61, 2005.
    Auerbach, Alan J.  "Capital Gains Taxation and Tax Reform,"  National
    Tax Journal, v. 42.  September 1989, pp. 391-401.
    Auerbach, Alan J., Leonard E. Burman, and Jonathan Siegel. "Capital
    Gains Taxation and Tax Avoidance," in Does Atlas Shrug? The Economic
    Consequences of Taxing the Rich, ed. Joel B. Slemrod.  New York: Russell
    Sage, 2000.
    Auten, Gerald.  "Capital Gains Taxation," in The Encyclopedia of Taxation
    and Tax Policy, eds. Joseph J. Cordes, Robert O. Ebel, and Jane G. Gravelle.
     Washington, DC: Urban Institute Press, 2005.
    Auten, Gerald E., Leonard E. Burman, and William C. Randolph.
    "Estimation and Interpretation of Capital Gains Realization Behavior:
    Evidence from Panel Data," National Tax Journal, v. 42.  September 1989,
    pp. 353-374.
    Auten, Gerald E., and Joseph J. Cordes. "Cutting Capital Gains Taxes,"
    Journal of Economic Perspectives, v. 5.  Winter 1991, pp. 181-192.
    Bailey, Martin J.  "Capital Gains and Income Taxation," Taxation of
    Income From Capital, ed. Arnold C. Harberger. Washington, DC: The
    Brookings Institution, 1969, pp. 11-49.
    Blouin, Jennifer L. ; Raedy, Jana Smith ; Shackelford, Douglas A.  "Did
    Dividends Increase Immediately After the 2003 Reduction in Tax Rates?"
    NBER Working Paper 10301, Cambridge, MA: National Bureau of
    Economic Research, February, 2004.
    Bogart, W.T. and W.M. Gentry.  "Capital Gains Taxes and Realizations:
    Evidence from Interstate Comparisons," Review of Economics and Statistics,
    v. 71, May 1995, pp. 267-282.
    Burman, Leonard E.  The Labyrinth of Capital Gains Tax Policy.
    Washington, DC: The Brookings Institution, 1999.
    -.  "Why Capital Gains Tax Cuts (Probably) Don't Pay for Themselves,"
    Tax Notes.  April 2, 1990, pp. 109-110.
    -, and Peter D. Ricoy. "Capital Gains and the People Who Realize Them,"
    National Tax Journal, v. 50, September 1997, pp.427-451.
    -, and William C. Randolph. "Measuring Permanent Responses to Capital
    Gains Tax Changes In Panel Data," American Economic Review, v. 84,
    September, 1994.
    -.   "Theoretical Determinants of Aggregate Capital Gains Realizations."
    Manuscript, 1992.
    -, Kimberly Clark and John O'Hare.  "Tax Reform and Realization of
    Capital Gains in 1986," National Tax Journal, v. 41, March 1994, pp. 63-87.

    Carroll, Robert; Hassett, Kevin A.; Mackie, James B., III.  "The Effect of
    Dividend Tax Relief on Investment Incentives," National Tax Journal v56,
    September 2003: 629-51
    Cook. Eric W., and John F. O'Hare, "Capital Gains Redux:  Why Holding
    Periods Matter," National Tax Journal, v. 45. March 1992, pp. 53-76.
    Chetty, Raj and Emmanuel Saez, Dividend Taxes and Corporate Behavior:
    Evidence from the 2003 Dividend Tax Cut, National Bureau of Economic
    Research Working Paper 10841, Cambridge, MA, 2004.
    David, Martin.  Alternative Approaches to Capital Gains Taxation.
    Washington DC: The Brookings Institution, 1968.
    Davis, Albert J., "Measuring the Distributional Effects of Tax Changes for
    the Congress," National Tax Journal, v. 44. September, 1991, pp. 257-268.
    Desai, Mihir, "Taxing Corporation Capital Gains," Tax Notes, March 6,
    2006, pp. 1079-1092.
    Esenwein, Gregg, and Jane G. Gravelle, The Taxation of Dividend Income:
    An Overview and Economic Analysis of the Issues, Library of Congress,
    Congressional Research Service, Report RL31597, Washington, DC: June 2,
    2006.
    Fox, John O., "The Great Capital Gains Debate," Chapter 12, If Americans
    Really Understood the Income Tax, Boulder, Colorado: Westview Press,
    2001.
    Gillingham, Robert, and John S. Greenlees, "The Effect of Marginal Tax
    Rates on Capital Gains Revenue: Another Look at the Evidence," National
    Tax Journal, v. 45.  June 1992, pp. 167-178.
    Gordon, Roger, and Martin Dietz,  Dividends and Taxes,  National Bureau
    of Economic Research Working Paper 12292, Cambridge, MA, 2005.
    Gravelle, Jane G.  Can a Capital Gains Tax Cut Pay for Itself?  Library of
    Congress, Congressional Research Service Report 90-161 RCO.  Washington,
    DC: March 23, 1990.
    -. Capital Gains Taxes: An Overview.  Library of Congress, Congressional
    Research Service Report 96-769 E. Washington, DC: Updated July 15, 2003.
    -.  Capital Gains Taxes, Innovation and Growth.  Library of Congress,
    Congressional Research Service Report RL30040, July 14, 1999.
    -.  Economic Effects of Taxing Capital Income, Chapters 4 and 6.
    Cambridge, MA: MIT Press, 1994.
    -. "Effects of Dividend Relief on Economic Growth, The Stock Market,
    and Corporate Tax Preferences," National Tax Journal, v. 56, September
    2003, 653-668.
    -.  Limits to Capital Gains Feedback Effects.  Library of Congress,
    Congressional Research Service Report 91-250. Washington, DC: March 15,
    1991.
    Hoerner, J. Andrew, ed.  The Capital Gains Controversy: A Tax Analyst's
    Reader.  Arlington, VA: Tax Analysts, 1992.
    Holt, Charles C., and John P. Shelton, "The Lock-In Effect of the Capital
    Gains Tax," National Tax Journal, v. 15.  December 1962, pp. 357-352.

    Kiefer, Donald W.  "Lock-In Effect Within a Simple Model of Corporate
    Stock Trading," National Tax Journal, v. 43.  March 1990, pp. 75-95.
    Lang, Mark H. and Douglas A. Shackleford.  "Capitalization of Capital
    Gains Taxes: Evidence from Stock Price Reactions to the 1997 Rate
    Reduction." Journal of Public Economics, v. 76 (April 2000), pp. 69-85.
    Minarik, Joseph.  "Capital Gains," How Taxes Affect Economic Behavior,
    eds. Henry J. Aaron and Joseph A. Pechman.  Washington, DC: The
    Brookings Institution, 1983, pp. 241-277.
    Plancich, Stephanie.  "Mutual Fund Capital Gain Distributions and the Tax
    Reform Act of 1997," National Tax Journal v.56,March 2003 (Part 2), pp.
    271-96.
    Poterba, James, "Venture Capital and Capital Gains Taxation,"  Tax Policy
    and the Economy, v. 3, ed. Lawrence H. Summers, National Bureau of
    Economic Research.  Cambridge, Mass.: MIT Press, 1989, pp. 47-67.
    Slemrod, Joel, and William Shobe.  "The Tax Elasticity of Capital Gains
    Realizations: Evidence from a Panel of Taxpayers," National Bureau of
    Economic Research Working Paper 3737.  January 1990.
    U.S. Congress, Congressional Budget Office.  How Capital Gains Tax
    Rates Affect Revenues: The Historical Evidence.  Washington, DC:  U.S.
    Government Printing Office, March 1988.
    -.  An Analysis of the Potential Macroeconomic Effects of the Economic
    Growth Act of 1998.  Prepared by John Sturrock.  Washington, DC: August 1,
    1998.
    -.  Indexing Capital Gains, prepared by Leonard Burman and Larry
    Ozanne.  Washington, DC: U.S. Government Printing Office, August 1990.
    -.  Perspectives on the Ownership of Capital Assets and the Realization of
    Gains.	Prepared by Leonard Burman and Peter Ricoy.  Washington, DC:
    May 1997.
    U.S. Congress, Joint Committee on Taxation.  General Explanation of Tax
    Legislation Enacted in 1997.  105th Congress, 1st Session.  Washington, DC:
    U.S. Government Printing Office, December 17,1997, pp. 48-56.
    U.S. Department of the Treasury, Office of Tax Analysis.  Report to the
    Congress on the Capital Gains Tax Reductions of 1978.  Washington, DC:
    U.S. Government Printing Office, September 1985.
    Wetzler, James W.  "Capital Gains and Losses," Comprehensive Income
    Taxation, ed. Joseph Pechman.  Washington, DC: The Brookings Institution,
    1977, pp. 115-162.
    Zodrow, George R.  "Economic Analysis of Capital Gains Taxation:
    Realizations, Revenues, Efficiency and Equity," Tax Law Review, v. 48, no.
    3, pp. 419-527.

    Commerce and Housing:
    Other Business and Commerce

    EXCLUSION OF CAPITAL GAINS AT DEATH
    CARRYOVER BASIS OF CAPITAL GAINS ON GIFTS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    56.3

    -

    56.3

    2007

    57.4

    -

    57.4

    2008

    58.9

    -

    58.9

    2009

    77.3

    -

    77.3

    2010

    121.5

    -

    121.5

    Authorization

    Sections 1001, 1002, 1014, 1015, 1023, 1040, 1221, and 1222.

    Description

    A capital gains tax generally is imposed on the increased value of a capital
    asset (the difference between sales price and original cost of the asset) when
    the asset is sold or exchanged.  This tax is not, however, imposed on the
    appreciation in value when ownership of the property is transferred as a result
    of the death of the owner or as a gift during the lifetime of the owner.

    In the case of assets transferred at death, the heir's cost basis in the asset
    (the amount that he subtracts from sales price to determine gain if the asset is
    sold in the future) generally is the fair market value as of the date of
    decedent's death.  Thus no income tax is imposed on appreciation occurring
    before the decedent's death, since the cost basis is increased by the amount of
    appreciation that has already occurred.  In the case of gift transfers, the
    donee's basis in the property is the same as the donor's (usually the original
    cost of the asset).  Thus, if the donee disposes of the property in a sale or
    exchange, the capital gains tax will apply to the pre-transfer appreciation.
    Tax on the gain is deferred, however, and may be forgiven entirely if the
    donee in turn passes on the property at death.

    Assets transferred at death or by inter vivos gifts (gifts between living
    persons) may be subject to the Federal estate and gift taxes, respectively,
    based upon their value at the time of transfer.  In 2010, when the estate tax is
    scheduled to expire, some gain will be taxed at death, but this provision will
    sunset after 2010.

    	Impact

    The exclusion of capital gains at death is most advantageous to individuals
    who need not dispose of their assets to achieve financial liquidity.  Generally
    speaking, these individuals tend to be wealthier.  The deferral of tax on the
    appreciation involved combined with the exemption for the appreciation
    before death is a significant benefit for these investors and their heirs.

    Failure to tax capital gains at death encourages lock-in of assets, which in
    turn means less current turnover of funds available for investment.  In
    deciding whether to change his portfolio, an investor, in theory, takes into
    account the higher pre-tax rate of return he might obtain from the new
    investment, the capital gains tax he might have to pay if he changes his
    portfolio, and the capital gains tax his heirs might have to pay if he decides
    not to change his portfolio.

    Often an investor in this position decides that, since his heirs will incur no
    capital gains tax on appreciationprior to the investor's death, he should
    transfer his portfolio unchanged to the next generation.  The failure to tax
    capital gains at death and the deferral of tax tend to benefit high-income
    individuals (and their heirs) who have assets that yield  capital gains.

    Some insight into the distributional effects of this tax expenditure may be
    found by considering the distribution of current payments of capital gains tax,
    based on data provided by the Joint Committee on Taxation.   These taxes are
    heavily concentrated among high-income individuals.  Of course, the
    distribution of capital gains taxes could be different from the distribution of
    taxes not paid because they are passed on at death, but the provision would
    always accrue largely to higher-income individuals who tend to hold most of
    the wealth in the country.

    Estimated Distribution of Capital Gains Taxes, 2005

    Income Class

    Percentage

    Less than $50,000

    1.2

    $50,000-$100,000

    3.7

    $100,000-$1,000,000

    30.7

    Over $1,000,000

    64.4

    The primary assets that typically yield capital gains are corporate stock, real
    estate, and owner-occupied housing.

    	Rationale

    The original rationale for nonrecognition of capital gains on inter vivos
    gifts or transfers at death is not indicated in the legislative history of any of
    the several interrelated applicable provisions.  However, one current
    justification given for the treatment is that death and inter vivos gifts are
    considered as inappropriate events to result in the recognition of income.

    The Tax Reform Act of 1976 provided that the heir's basis in property
    transferred at death would be determined by reference to the decedent's basis.
     This carryover basis provision was not permitted to take effect and was
    repealed in 1980.  The primary stated rationale for repeal was the concern that
    carryover basis created substantial administrative burdens for estates, heirs,
    and the Treasury Department.

    Assessment

    Failure to tax gains transferred at death is probably a primary cause of lock-
    in and its attendant efficiency costs; indeed, without the possibility of passing
    on gains at death without taxation, the lock-in effect would be greatly
    reduced.

    The lower capital gains taxes that occur because of failure to tax capital
    gains at death can also affect efficiency through other means, primarily
    through the reallocation of resources between types of investments.  Lower
    capital gains taxes may disproportionally benefit real estate investments and
    may cause corporations to retain more earnings than would otherwise be the
    case, causing efficiency losses. At the same time, lower capital gains taxes
    reduce the distortion that favors corporate debt over equity, which produces
    an efficiency gain.

    There are several problems with taxing capital gains at death. There are
    administrative problems, particularly for assets held for a very long time when
    heirs do not know the basis.  In addition, taxation of capital gains at death
    would cause liquidity problems for some taxpayers, such as owners of small
    farms and businesses.  Therefore most proposals for taxing capital gains at
    death would combine substantial averaging provisions, deferred tax payment
    schedules, and a substantial deductible floor in determining the amount of
    gain to be taxed.

    	Selected Bibliography

    Auerbach, Alan J.  "Capital Gains Taxation and Tax Reform,"  National
    Tax Journal, v. 42.  September, 1989, pp. 391-401.
    Auerbach, Alan J., Leonard E. Burman, and Jonathan Siegel. "Capital
    Gains Taxation and Tax Avoidance," in Does Atlas Shrug? The Economic
    Consequences of Taxing the Rich, ed. Joel B. Slemrod.  New York: Russell
    Sage, 2000.
    Auten, Gerald.  "Capital Gains Taxation," in The Encyclopedia of Taxation
    and Tax Policy, eds. Joseph J. Cordes, Robert O. Ebel, and Jane G. Gravelle.
     Washington, DC: Urban Institute Press, 2005.
    Bailey, Martin J.  "Capital Gains and Income Taxation," Taxation of
    Income From Capital, ed. Arnold C. Harberger.  Washington, DC: The
    Brookings Institution, 1969, pp. 11-49.
    Bogart, W.T. and W.M. Gentry.  "Capital Gains Taxes and Realizations:
    Evidence from Interstate Comparisons," Review of Economics and Statistics,
    v. 71, May 1995, pp. 267-282.
    Burman, Leonard E.  The Labyrinth of Capital Gains Tax Policy.
    Washington, DC: The Brookings Institution, 1999.
    Burman, Leonard E., and Peter D. Ricoy. "Capital Gains and the People
    Who Realize Them," National Tax Journal, v. 50, September 1997, pp.427-
    451.
    Burman, Leonard E., and William C. Randolph.  "Measuring Permanent
    Responses to Capital Gains Tax Changes In Panel Data,"  American
    Economic Review, v. 84, September, 1994.
    -.  "Theoretical Determinants of Aggregate Capital Gains Realizations,"
    Manuscript, 1992.
    David, Martin.  Alternative Approaches to Capital Gains Taxation.
    Washington, DC: The Brookings Institution, 1968.
    Fox, John O., "The Great Capital Gains Debate," Chapter 12, If Americans
    Really Understood the Income Tax, Boulder, Colorado: Westview Press,
    2001.
    Gravelle, Jane G.  Can a Capital Gains Tax Cut Pay for Itself?  Library of
    Congress, Congressional Research Service Report 90-161 RCO, March 23,
    1990.

    -.  Capital Gains Tax Issues and Proposals: An Overview.  Library of
    Congress, Congressional Research Service Report 96-769 E. Washington,
    DC: Updated August 30, 1999.
    -.  Capital Gains Taxes, Innovation and Growth.  Library of Congress,
    Congressional Research Service Report RL30040, July 14, 1999.
    -.  Economic Effects of Taxing Capital Income, Chapter 6. Cambridge,
    MA: MIT Press, 1994.
    -.  Limits to Capital Gains Feedback Effects.  Library of Congress,
    Congressional Research Service Report 91-250, March 15, 1991.
    Hoerner, J. Andrew, ed.  The Capital Gains Controversy: A Tax Analyst's
    Reader.  Arlington, VA: Tax Analysts, 1992.
    Holt, Charles C., and John P. Shelton.  "The Lock-In Effect of the Capital
    Gains Tax," National Tax Journal, v. 15.  December 1962, pp. 357-352.
    Kiefer, Donald W.  "Lock-In Effect Within a Simple Model of Corporate
    Stock Trading,"  National Tax Journal, v. 43.  March, 1990, pp. 75-95.
    Minarik, Joseph.  "Capital Gains." How Taxes Affect Economic Behavior,
    eds. Henry J. Aaron and Joseph A. Pechman.  Washington, DC: The
    Brookings Institution, 1983, pp. 241-277.
    Surrey, Stanley S., et al., eds.  "Taxing Capital Gains at the Time of a
    Transfer at Death or by Gift," Federal Tax Reform for 1976.  Washington,
    DC: Fund for Public Policy Research, 1976, pp. 107-114.
    U.S. Congress, Congressional Budget Office.  Perspectives on the
    Ownership of Capital Assets and the Realization of Gains.  Prepared by
    Leonard Burman and Peter Ricoy.  Washington, DC: May 1997.
    -.  An Analysis of the Potential Macroeconomic Effects of the Economic
    Growth Act of 1998.  Prepared by John Sturrock.  Washington, DC: August 1,
    1998.
    U.S. Congress, Senate Committee on Finance hearing.  Estate and Gift
    Taxes: Problems Arising from the Tax Reform Act of 1976.  95th Congress,
    1st session, July 25, 1977.
    U.S. Department of the Treasury, Office of Tax Analysis.  Report to the
    Congress on the Capital Gains Tax Reductions of 1978.  Washington, DC:
    U.S. Government Printing Office, September, 1985.
    Wagner, Richard E.  Inheritance and the State.  Washington, DC:
    American Enterprise Institute for Public Policy Research, 1977.
    Wetzler, James W.  "Capital Gains and Losses," Comprehensive Income
    Taxation, ed. Joseph Pechman.  Washington, DC: The Brookings Institution,
    1977, pp. 115-162.
    Zodrow, George R.  "Economic Analysis of Capital Gains Taxation:
    Realizations, Revenues, Efficiency and Equity," Tax Law Review, v. 48, no.
    3, pp. 419-527.

    Commerce and Housing:
    Other Business and Commerce

    DEFERRAL OF GAIN ON NON-DEALER
    INSTALLMENT SALES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.5

    0.6

    1.1

    2007

    0.5

    0.7

    1.2

    2008

    0.5

    0.7

    1.2

    2009

    0.6

    0.7

    1.3

    2010

    0.6

    0.8

    1.4

    Authorization

    Sections 453 and 453A(b).

    	Description

    An installment sale is a sale of property in which at least one payment will
    be received in a tax year later than the year in which the sale took place.
    Some taxpayers are allowed to report some sales of this kind for tax purposes
    under a special method of accounting, called the installment method, in which
    the gross profit from the sale is prorated over the years during which the
    payments are received.

    This conveys a tax advantage compared to being taxed in full in the year of
    the sale, because the taxes that are deferred to future years have a time value
    (the amount of interest they could earn).

    Use of the installment method was once widespread, but it has been
    severely curtailed in recent years.  Under current law, it can be used only by
    persons who do not regularly deal in the property being sold (except for the
    sellers of farm property, timeshares, and residential building lots who may use
    the installment method but must pay interest on the deferred taxes).  The
    latest legislative change in 2004 was a provision of the American Jobs
    Creation Act denying the installment sale treatment to readily tradeable debt.

    For sales by non-dealers, interest must be paid to the government on the
    deferred taxes attributable to the portion of the installment sales that arise
    during and remain outstanding at the end of the tax year of more than
    $5,000,000.  Transactions where the sales price is less than $150,000 do not
    count towards the $5,000,000 limit.  Interest payments offset the value of tax
    deferral, so this tax expenditure represents only the revenue loss from those
    transactions that give rise to interest-free deferrals.

    	Impact

    Installment sale treatment constitutes a departure from the normal rule that
    gain is recognized when the sale of property occurs.  The deferral of taxation
    permitted under the installment sale rules essentially furnishes the taxpayer an
    interest-free loan equal to the amount of tax on the gain that is deferred.

    The benefits of deferral are currently restricted to those transactions by
    non-dealers in which the sales price is no more than $150,000 and to the first
    $5,000,000 of installment sales arising during the year, to sales of personal-
    use property by individuals, and to sales of farm property.  (There are other
    restrictions on many types of transactions, such as in corporate
    reorganizations and sales of depreciable assets.)

    Thus the primary benefit probably flows to sellers of farms, small
    businesses, and small real estate investments.

    	Rationale

    The rationale for permitting installment sale treatment of income from
    disposition of property is to match the time of payment of tax liability with the
    cash flow generated by the disposition.  It has usually been considered unfair,
    or at least impractical, to attempt to collect the tax when the cash flow is not
    available, and some form of installment sale reporting has been permitted
    since at least the Revenue Act of 1921.  It has frequently been a source of
    complexity and controversy, however, and has sometimes been used in tax
    shelter and tax avoidance schemes.

    Installment sale accounting was greatly liberalized and simplified in the
    Installment Sales Revision Act of 1980 (P.L. 96-471).  It was significantly
    restricted by a complex method of removing some of its tax advantages in the
    Tax Reform Act of 1986, and it was repealed except for the limited uses in
    the Omnibus Budget Reconciliation Act of 1987.  Further restrictions
    applicable to accrual method taxpayers were enacted in the Work Incentives
    Improvement Act of 1999 (P.L. 106-170).  The 1999 Act prohibited most
    accrual basis taxpayers from using the installment method of accounting.
    Concern, however, in the small business community over these changes led to
    the passage, in December 2000,  of the Installment Tax Correction Act of
    2000 (P.L. 106-573).  The 2000 Act repealed the restrictions on the
    installment method of accounting imposed by the 1999 Act.  The repeal was
    made retroactive to the date of enactment of the 1999 change.

    	Assessment

    The installment sales rules have always been pulled between two opposing
    goals: taxes should not be avoidable by the way a deal is structured, but they
    should not be imposed when the money to pay them is not available.
    Allowing people to postpone taxes simply by taking a note instead of cash in
    a sale leaves obvious room for tax avoidance.

    Trying to collect taxes from taxpayers who do not have the cash to pay is
    administratively difficult and strikes many as unfair.  After having tried many
    different ways of balancing these goals, lawmakers have settled on a
    compromise that denies the advantage of the method to taxpayers who would
    seldom have trouble raising the cash to pay their taxes (retailers, dealers in
    property, investors with large amounts of sales) and permits its use to small,
    non-dealer transactions (with "small" rather generously defined).

    Present law results in modest revenue losses and probably has little effect
    on economic incentives.

    	Selected Bibliography

    Esenwein, Gregg.  Recent Tax Changes Affecting Installment Sales.
    Library of Congress, Congressional Research Service Report RS20432.
    Washington, DC: January 2002.
    U.S. Congress, Joint Committee on Taxation.  Overview of the Issues
    Relating to the Modification of the Installment Sales Rules by the Ticket to
    Work Incentives Improvement Act of 1999, Report JCX-15-00, February
    2000.
    -.  General Explanation of Tax Legislation Enacted in the 106th Congress.
     JCS-2-01.  April 2001.  p. 176.
    U.S. Congress, House.  Omnibus Budget Reconciliation Act of 1987,
    Conference Report to Accompany H.R. 3545.  100th Congress, 1st session,
    Report 100-495, pp.  926-931.
    -.  Committee on Ways and Means.  Installment Sales Revision Act of
    1980, Report to Accompany H.R. 6883. 98th Congress, 2nd session, Report
    96-1042.

    Internal Revenue Service.  Installment Sales. Publication 537, for use in
    preparing 2005 returns.
    U.S. Congress, Joint Committee on Taxation.  Comparison Of Certain
    Provisions Of H.R. 4520 As Passed By The House Of Representatives And As
    Amended By The Senate: Revenue Provisions, Report  JCX-64-04, September
    2004, p. 57.

    Commerce and Housing:
    Other Business and Commerce

    DEFERRAL OF GAIN ON LIKE-KIND EXCHANGES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.8

    2.0

    2.8

    2007

    0.8

    2.1

    2.9

    2008

    0.9

    2.2

    3.1

    2009

    0.8

    2.4

    3.2

    2010

    1.0

    2.5

    3.5

    Authorization

    Section 1031.

    	Description

    When business or investment property is exchanged for property of a "like-
    kind," no gain or loss is recognized on the exchange and therefore no tax is
    paid at the time of the exchange on any appreciation.  This is in contrast to the
    general rule that any sale or exchange for money or property is a taxable
    event.

    It is also an exception to the rules allowing tax-free exchanges when the
    property is "similar or related in service or use," the much stricter standard
    applied in other areas, such as replacing condemned property (section 1033).
    The latter is not considered a tax expenditure, but the postponed tax on
    appreciated property exchanged for "like-kind" property is.

    	Impact

    The like-kind exchange rules have been liberally interpreted by the courts
    to allow tax-free exchanges of property of the same general type but of very
    different quality and use.  All real estate, in particular, is considered "like-
    kind," allowing a retiring farmer from the Midwest to swap farm land for a
    Florida apartment building or a right to pump water tax-free.

    The provision is very popular with real estate interests, some of whom
    specialize in arranging property exchanges.  It is useful primarily to persons
    who wish to alter their real estate holdings without paying tax on their
    appreciated gain.  Stocks and financial instruments are not eligible for this
    provision, so it is not useful for rearranging financial portfolios.

    	Rationale

    A provision allowing tax-free exchanges of like-kind property was
    included in the first statutory tax rules for capital gains in the Revenue Act of
    1921 and has continued in some form until today.  Various restrictions over
    the years took many kinds of property and exchanges out of its scope, but the
    rules for real estate, in particular, were broadened over the years by court
    decisions.

    In moves to reduce some of the more egregious uses of the rules, the
    Deficit Reduction Act of 1984 set time limits on completing exchanges and
    the Omnibus Budget Reconciliation Act of 1989 outlawed tax-free exchanges
    between related parties.  The general rationale for allowing tax-free
    exchanges is that the investment in the new property is merely a continuation
    of the investment in the old.

    A tax-policy rationale for going beyond this, to allowing tax-free
    adjustments of investment holdings to more advantageous positions, does not
    seem to have been offered.  It may be that this was an accidental outgrowth of
    the original rule.

    The most recent legislative change was a provision of the American Jobs
    Creation Act of 2004, as amended in Gulf Opportunity Zone Act of 2005,
    affecting the recognition of a gain on a principal residence acquired in a like-
    kind exchange.  The exclusion for gain on the sale of a principal residence no
    longer applies if the principal residence was acquired in a like-kind exchange
    within the past five years.  In effect, this requires the taxpayer to hold the
    exchanged property for a full five years before it would qualify as a principal
    residence.

    	Assessment

    From an economic perspective, the failure to tax appreciation in property
    values as it occurs defers tax liability and thus offers a tax benefit.  (Likewise,
    the failure to deduct declines in value is a tax penalty.)  Continuing the
    "nonrecognition" of gain, and thus the tax deferral, for a longer period by an
    exchange of properties adds to the tax benefit.

    This treatment does, however, both simplify transactions and make it less
    costly for businesses and investors to replace property.  Taxpayers gain
    further benefit from the loose definition of "like-kind" because they can also
    switch their property holdings to types they prefer without tax consequences.
    This might be justified as reducing the inevitable bias a tax on capital gains
    causes against selling property, but it is difficult to argue for restricting the
    relief primarily to those taxpayers engaged in sophisticated real estate
    transactions.

    	Selected Bibliography

     Carnes, Gregory A., and Ted D. Englebrecht.  "Like-kind Exchanges -
    Recent Developments, Restrictions, and Planning Opportunities," CPA
    Journal.  January 1991, pp. 26-33.
    U.S. Congress, Congressional Budget Office.  Budget Options.  February
    2001, p. 423.
    U.S. Congress, House Committee on Ways and Means.  Omnibus Budget
    Reconciliation Act of 1989.  Conference Report to Accompany H.R. 3299,
    Report 101-386, November 21, 1989, pp. 613-614.
    U.S. Congress, Joint Committee on Taxation.  Study of the Overall State of
    the Federal Tax System and Recommendations for Simplification, Pursuant
    to Section 8022(3)(B) of the Internal Revenue Code of 1986, Volume II, JCS-
    3-01, pp. 300-305, April 2001.
    -, Description of Revenue Provisions to Be Considered in Connection With
    the Markup of the Miscellaneous Trade and Technical Corrections Act of
    1999, JCS-2-00, p. 494, March 2000.
    -, Description of Possible Options to Increase Revenues Prepared for the
    Committee On Ways and Means.  JCS-17-87, June 25, 1987, pp. 240-241.
    -, General Explanation of the Revenue Provisions of the Deficit Reduction
    Act of 1984.  JCS-41-84, December 31, 1984, pp. 243-247.
    Woodrum, William L., Jr.  "Structuring an Exchange of Property to Defer
    Recognition of Gain," Taxation for Accountants.  November 1986, pp.
    334-339.
    Internal Revenue Service.  Sales and Other Dispositions of Assets.
    Publication 544, for use in preparing 2005 returns.
    U.S. Congress, Joint Committee on Taxation.  Comparison Of Certain
    Provisions Of H.R. 4520 As Passed By The House Of Representatives And As
    Amended By The Senate: Revenue Provisions, Report  JCX-64-04, September
    2004, p. 25.

    Esenwein, Gregg A.  The Sale of a Principal Residence Acquired Through
    a Like-Kind Exchange.  Library of Congress, Congressional Research Service
    Report RS22113.  Washington DC: 2005.

    Commerce and Housing:
    Other Business and Commerce

    DEPRECIATION OF BUILDINGS OTHER
    THAN RENTAL HOUSING IN EXCESS OF
    ALTERNATIVE DEPRECIATION SYSTEM

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.4

    0.4

    0.8

    2007

    0.5

    0.6

    1.1

    2008

    0.7

    0.8

    1.5

    2009

    1.0

    1.1

    2.1

    2010

    1.3

    1.4

    2.7

    H.R. 6111 (December 2006) increases the cost from FY2007-FY2010 by
    $0.4, $0.5, $0.6, and $0.6 respectively.

    Authorization

    Section 167 and 168.

    	Description

    Taxpayers are allowed to deduct the costs of acquiring depreciable assets
    (assets that wear out or become obsolete over a period of years) as
    depreciation deductions. The tax code currently allows new buildings other
    than rental housing to be written off over 39 years, using a "straight line"
    method where equal amounts are deducted in each period.  There is also a
    prescribed 40 year write-off period for these buildings under the alternative
    minimum tax (also based on a straight-line method).   Improvements required
    for a new leasehold for a non-residential structure and certain restaurant
    improvements made at least three years after original construction may be
    depreciated over 15 years.  This provision applies through 2007.

    The tax expenditure measures the revenue loss from current depreciation
    deductions in excess of the deductions that would have been allowed under
    this longer 40-year period.  The current revenue effects also reflect different
    write-off methods and lives prior to the 1993 revisions, which set the 39-year
    life, since many buildings pre-dating that time are still being depreciated.

    Prior to 1981, taxpayers were generally offered the choice of using the
    straight-line method or accelerated methods of depreciation, such as double-
    declining balance and sum-of-years digits, in which greater amounts are
    deducted in the early years.  Non-residential buildings were restricted in 1969
    to 150-percent declining balance (used buildings were restricted to straight-
    line).  The period of time over which deductions were taken varied with the
    taxpayer's circumstances.

    Beginning in 1981, the tax law prescribed specific write-offs which
    amounted to accelerated depreciation over periods varying from 15 to 19
    years.  In 1986, all depreciation on nonresidential buildings was calculated on
    a straight-line basis over 31.5 years, and that period was increased to 39 years
    in 1993.

    Example: Suppose a building with a basis of $10,000 was subject to
    depreciation over 39 years.  Depreciation allowances would be constant at
    1/39 x $10,000 = $257.  For a 40-year life the write-off would be $250 per
    year.  The tax expenditure in the first year would be measured as the
    difference between the tax savings of deducting $250, instead of $257, or $7.

    	Impact

    Because depreciation methods that are faster than straight-line allow for
    larger deductions in the early years of the asset's life and smaller depreciation
    deductions in the later years, and because shorter useful lives allow quicker
    recovery, accelerated depreciation results in a deferral of tax liability.

    It is a tax expenditure to the extent it is faster than economic (i.e., actual)
    depreciation, and evidence indicates that the economic decline rate for non-
    residential buildings is much slower than that reflected in tax depreciation
    methods.

    The direct benefits of accelerated depreciation accrue to owners of
    buildings, and particularly to corporations.  The benefit is estimated as the tax
    saving resulting from the depreciation deductions in excess of straight-line
    depreciation.  Benefits to capital income tend to concentrate in the higher-
    income classes (see discussion in the Introduction).

    	Rationale

    Prior to 1954, depreciation policy had developed through administrative
    practices and rulings.  The straight-line method was favored by IRS and
    generally used.  Tax lives were recommended for assets through "Bulletin F,"
    but taxpayers were also able to use a facts and circumstances justification.

    A ruling issued in 1946 authorized the use of the 150-percent declining
    balance method.  Authorization for it and other accelerated depreciation
    methods first appeared in legislation in 1954 when the double declining
    balance and other methods were enacted.  The discussion at that time focused
    primarily on whether the value of machinery and equipment declined faster in
    their earlier years.  However, when the accelerated methods were adopted,
    real property was included as well.

    By the 1960s, most commentators agreed that accelerated depreciation
    resulted in excessive allowances for buildings.  The first restriction on
    depreciation was to curtail the benefits that arose from combining accelerated
    depreciation with lower capital gains taxes when the building was sold.

    In 1964, 1969, and 1976 various provisions to "recapture" accelerated
    depreciation as ordinary income in varying amounts when a building was sold
    were enacted.  In 1969, depreciation for nonresidential structures was
    restricted to 150-percent declining balance methods (straight-line for used
    buildings).

    In the Economic Recovery Tax Act of 1981, buildings were assigned
    specific write-off periods that were roughly equivalent to 175-percent
    declining balance methods (200 percent for low-income housing) over a 15-
    year period under the Accelerated Cost Recovery System (ACRS).  These
    changes were intended as a general stimulus to investment.

    Taxpayers could elect to use the straight-line method over 15 years, 35
    years, or 45 years. (The Deficit Reduction Act of 1984 increased the 15-year
    life to 18 years; in 1985, it was increased to 19 years.)  The recapture provi-
    sions would not apply if straight-line methods were originally chosen.  The
    acceleration of depreciation that results from using the shorter recovery period
    under ACRS was not subject to recapture as accelerated depreciation.

    The current straight-line treatment was adopted as part of the Tax Reform
    Act of 1986, which lowered tax rates and broadened the base of the income
    tax.  A 31.5-year life was adopted at that time; it was increased to 39 years by
    the Omnibus Budget Reconciliation Act of 1993.

    In 2002, certain qualified leasehold improvements in non-residential
    buildings were made eligible for a temporary bonus depreciation (expiring
    after 2004) allowing 30 percent of the cost to be deducted when incurred.
    The percentage was increased to 50 percent in 2003.

    The provision allowing a 15-year recovery period for qualified leasehold
    improvements and restaurant improvements was adopted in 2004 but
    suspended after 2005.  H.R. 6111 (December 2006) extended the provision
    through 2007.

    Assessment

    Evidence suggests that the rate of economic decline of rental structures is
    much slower than the rates allowed under current law, and this provision
    causes a lower effective tax rate on such investments than would otherwise be
    the case.  This treatment in turn tends to increase investment in nonresidential
    structures relative to other assets, although there is considerable debate about
    how responsive these investments are to tax subsidies.

    At the same time, the more rapid depreciation roughly offsets the
    understatement of depreciation due to the use of historical cost basis
    depreciation, assuming inflation is at a rate of two percent or so. Moreover,
    many other assets are eligible for accelerated depreciation as well, and the
    allocation of capital depends on the relative treatment.

    Much of the previous concern about the role of accelerated depreciation in
    encouraging tax shelters in commercial buildings has faded because the
    current depreciation provisions are less rapid than those previously in place
    and because there is a restriction on the deduction of passive losses.

    	Selected Bibliography

    Auerbach, Alan, and Kevin Hassett.  "Investment, Tax Policy, and the Tax
    Reform Act of 1986," Do Taxes Matter: The Impact of the Tax Reform Act of
    1986, ed. Joel Slemrod.  Cambridge, Mass: The MIT Press, 1990, pp. 13-49.
    Board of Governors of the Federal Reserve System.  Public Policy and
    Capital Formation.  April 1981.
    Brannon, Gerard M.  "The Effects of Tax Incentives for Business
    Investment: A Survey of the Economic Evidence," U.S. Congress, Joint
    Economic Committee, The Economics of Federal Subsidy Programs, Part 3:
    "Tax Subsidies."  July 15, 1972, pp. 245-268.
    Brazell, David W. and James B. Mackie III.  "Depreciation Lives and
    Methods: Current Issues in the U.S. Capital Cost Recovery System," National
    Tax Journal, v. 53 (September 2000), pp. 531-562.

    Break, George F.  "The Incidence and Economic Effects of Taxation," The
    Economics of Public Finance.  Washington, DC: The Brookings Institution,
    1974.
    Burman, Leonard E., Thomas S. Neubig, and D. Gordon Wilson.  "The
    Use and Abuse of Rental Project Models," Compendium of Tax Research
    1987, Office of Tax Analysis, Department of The Treasury.  Washington,
    DC: U.S. Government Printing Office, 1987, pp. 307-349.
    Cummins, Jason G., Kevin Hassett and R. Glenn Hubbard.  "Have Tax
    Reforms Affected Investment?" in James M. Poterba, Tax Policy and The
    Economy, v. 9, Cambridge: MIT Press, 1994.
    -.  A Reconsideration of Investment Behavior Using Tax Reforms as
    Natural Experiments, Brookings Papers on Economic Activity no. 2, 1994,
    pp. 1-74.
    Deloitte and Touche.  Analysis of the Economic Depreciation of Structure,
    Washington, DC: June 2000.
    Feldstein, Martin.  "Adjusting Depreciation in an Inflationary Economy:
    Indexing Versus Acceleration," National Tax Journal, v. 34.  March 1981,
    pp. 29-43.
    Follain, James R., Patric H. Hendershott, and David C. Ling, "Real Estate
    Markets Since 1980: What Role Have Tax Changes Played?" National Tax
    Journal, vol. 45, September 1992, pp. 253-266.
    Fromm, Gary, ed.  Tax Incentives and Capital Spending.  Washington, DC:
    The Brookings Institution, 1971.
    Fullerton, Don, Robert Gillette, and James Mackie, "Investment Incentives
    Under the Tax Reform Act of 1986," Compendium of Tax Research 1987,
    Office of Tax Analysis, Department of The Treasury.  Washington, DC: U.S.
    Government Printing Office, 1987, pp. 131-172.
    Fullerton, Don, Yolanda K. Henderson, and James Mackie, "Investment
    Allocation and Growth Under the Tax Reform Act of 1986," Compendium of
    Tax Research 1987, Office of Tax Analysis, Department of The Treasury.
    Washington, DC: U.S. Government Printing Office, 1987, pp. 173-202.
    Gravelle, Jane G.  "Differential Taxation of Capital Income: Another Look
    at the Tax Reform Act of 1986,"  National Tax Journal, v. 63.  December
    1989, pp. 441-464.
    -. Depreciation and the Tax Treatment of Real Estate. Library of
    Congress, Congressional Research Service Report RL30163.  Washington,
    DC: October 25, 2000.
    -.  Economic Effects of Taxing Capital Income, Chapter 6. Cambridge,
    MA: MIT Press, 1994.
    -.  "Whither Tax Depreciation?"  National Tax Journal, vol. 54,
    September, 2001, pp. 513-526.
    Harberger, Arnold.  "Tax Neutrality in Investment Incentives," The
    Economics of Taxation, eds. Henry J. Aaron and Michael J. Boskin.
    Washington, DC: The Brookings Institution, 1980.
    Hulten, Charles, ed.  Depreciation, Inflation, and the Taxation of Income
    From Capital. Washington, DC: The Urban Institute, 1981.
    Hulten, Charles R., and Frank C. Wykoff.  "Issues in Depreciation
    Measurement." Economic Inquiry, v. 34, January 1996, pp. 10-23.

    Jorgenson, Dale W.  "Empirical Studies of Depreciation." Economic
    Inquiry, v. 34, January 1996, pp. 24-42.
    Mackie, James.  "Capital Cost Recovery," in The Encyclopedia of Taxation
    and Tax Policy, eds. Joseph J. Cordes, Robert O. Ebel, and Jane G. Gravelle.
     Washington, DC: Urban Institute Press, 2005.
    Nadiri, M. Ishaq, and Ingmar R. Prucha.  "Depreciation Rate Estimation of
    Physical and R&D Capital." Economic Inquiry, v. 34, January 1996, pp. 43-
    56.
    Taubman, Paul and Robert Rasche.  "Subsidies, Tax Law, and Real Estate
    Investment," U.S. Congress, Joint Economic Committee,  The Economics of
    Federal Subsidy Program," Part 3: "Tax Subsidies."  July 15, 1972, pp.
    343-369.
    U.S. Congress, Congressional Budget Office.  Real Estate Tax Shelter
    Subsidies and Direct Subsidy Alternatives.  May 1977.
    -. Joint Committee on Taxation.  General Explanation of the Tax Reform
    Act of 1986.  May 4, 1987, pp. 89-110.
    U.S. Department of the Treasury.  Report to the Congress on Depreciation
    Recovery Periods and Methods.  Washington, DC: June 2000.

    Commerce and Housing:
    Other Business and Commerce

    DEPRECIATION ON EQUIPMENT IN EXCESS OF
    ALTERNATIVE DEPRECIATION SYSTEM

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    -2.2

      5.7

    3.5

    2007

      0.1

     11.0

     11.1

    2008

     2.2

     17.7

    19.9

    2009

     4.3

    23.4

    27.7

    2010

     6.1

    27.7

    33.8

    Authorization

    Section 167 and 168.

    	Description

    Taxpayers are allowed to deduct the cost of acquiring depreciable assets
    (assets that wear out or become obsolete over a period of years) as
    depreciation deductions.  How quickly the deductions are taken depends on
    the period of years over which recovery occurs and the method used.
    Straight-line methods allow equal deductions in each year; accelerated
    methods, such as declining balance methods, allow larger deductions in the
    earlier years.

    Equipment is currently divided into six categories to be depreciated over 3,
    5, 7, 10, 15, and 20 years.  Double declining balance depreciation is allowed
    for all but the last two classes, which are restricted to 150 percent declining
    balance.  A double declining balance method allows twice the straight-line
    rate to be applied in each year to the remaining undepreciated balance; a 150-
    percent declining balance rate allows 1.5 times the straight-line rate to be
    applied in each year to the remaining undepreciated balance.  At some point,
    the taxpayer can switch to straight-line-write off the remaining
    undepreciated cost in equal amounts over the remaining life.

    The 1986 law also prescribed a depreciation system for the alternative
    minimum tax, which applies to a broader base.  The alternative depreciation
    system requires recovery over the midpoint of the Asset Depreciation Range,
    using straight-line depreciation.  The Asset Depreciation Range was the set of
    tax lives specified before 1981 and these lives are longer than the lives
    allowed under the regular tax system.

    This tax expenditure measures the difference between regular tax
    depreciation and the alternative depreciation system.  The tax expenditure
    also reflects different write-off periods and lives for assets acquired prior to
    the 1986 provisions.  For most of these older assets, regular tax depreciation
    has been completed, so that the effects of these earlier vintages of equipment
    would be to enter them as a revenue gain rather than as a loss.

    In the past, taxpayers were generally offered the choice of using the
    straight-line method or accelerated methods of depreciation such as double-
    declining balance and sum-of-years digits, in which greater amounts are
    deducted in the early years.  Tax lives varied across different types of
    equipment under the Asset Depreciation Range System, which prescribed a
    range of tax lives.  Equipment was restricted to 150-percent declining balance
    by the 1981 Act, which shortened tax lives to five years.

    Example: Consider a $10,000 piece of equipment that falls in the five-year
    class (with double declining balance depreciation) with an eight-year
    midpoint life.  In the first year, depreciation deductions would be 2/5 times
    $10,000, or $4,000.  In the second year, the basis of depreciation is reduced
    by the previous year's deduction to $6,000, and depreciation would be $2400
    (2/5 times $6,000).

    Depreciation under the alternative system would be 1/8th in each year, or
    $1,250.  Thus, the tax expenditure in year one would be the difference
    between $4,000 and $1,250, multiplied by the tax rate.  The tax expenditure
    in year two would be the difference between $2,400 and $1,250 multiplied by
    the tax rate.

    Fifty percent of investment in advanced mine safety equipment may be
    expensed from the date of enactment of H.R. 6111 (December2006 through
    20082006

    	Impact

    Because depreciation methods that are faster than straight-line allow for
    larger depreciation deductions in the early years of the asset's life and smaller
    deductions in the later years, and because shorter useful lives allow quicker
    recovery, accelerated depreciation results in a deferral of tax liability.  It is a
    tax expenditure to the extent it is faster than economic (i.e., actual)
    depreciation, and evidence indicates that the economic decline rate for
    equipment is much slower than that reflected in tax depreciation methods.

    The direct benefits of accelerated depreciation accrue to owners of assets
    and particularly to corporations.  The benefit is estimated as the tax saving
    resulting from the depreciation deductions in excess of straight-line
    depreciation under the alternative minimum tax.  Benefits to capital income
    tend to concentrate in the higher-income classes (see discussion in the
    Introduction).

    	Rationale

    Prior to 1954, depreciation policy had developed through administrative
    practices and rulings.  The straight-line method was favored by IRS and
    generally used.  Tax lives were recommended for assets through "Bulletin F,"
    but taxpayers were also able to use a facts and circumstances justification.

    A ruling issued in 1946 authorized the use of the 150-percent declining
    balance method.  Authorization for it and other accelerated depreciation
    methods first appeared in legislation in 1954 when the double-declining
    balance and other methods were enacted.  The discussion at that time focused
    primarily on whether the value of machinery and equipment declined faster in
    their earlier years.

    In 1962, new tax lives for equipment assets were prescribed that were
    shorter than the lives existing at that time.  In 1971, the Asset Depreciation
    Range System was introduced by regulation and confirmed through
    legislation.   This system allowed taxpayers to use lives up to twenty percent
    shorter or longer than those prescribed by regulation.

    In the Economic Recovery Tax Act of 1981, equipment assets were
    assigned fixed write-off periods which corresponded to 150-percent declining
    balance over five years (certain assets were assigned three-year lives).  These
    changes were intended as a general stimulus to investment and to simplify the
    tax law by providing for a single write-off period.  The method was
    eventually to be phased into a 200-percent declining balance method, but the
    150-percent method was made permanent by the Tax Equity and Fiscal
    Responsibility Act of 1982.  The current treatment was adopted as part of the
    Tax Reform Act of 1986, which lowered tax rates and broadened the base of
    the income tax.

    A temporary provision allowed a write-off of 30% of the cost in the first
    year (for 36 months beginning September 10th, 2001), adopted in 2002 as an
    economic stimulus.  The percentage was increased to 50% in 2003 and
    expired in 2004.

    Assessment

    Evidence suggests that the rate of economic decline of equipment is much
    slower than the rates allowed under current law, and this provision causes a
    lower effective tax rate on such investments than would otherwise be the case.
     The effect of these benefits on investment in equipment is uncertain,
    although more studies find equipment somewhat responsive to tax changes
    than they do structures.  Equipment did not, however, appear to be very
    responsive to the temporary expensing provisions adopted in 2003 and
    expanded in 2003.

    The more rapid depreciation more than offsets the understatement of
    depreciation due to the use of historical cost basis depreciation, if inflation is
    at a rate of about two percent or so for most assets.  Under these
    circumstances the effective tax rate on equipment is below the statutory tax
    rate and the tax rates of most assets are relatively close to the statutory rate.
    Thus, equipment tends to be favored relative to other assets and the tax
    system causes a misallocation of capital.

    Some arguments are made that investment in equipment should be
    subsidized because it is more "high tech";  conventional economic theory
    suggests, however, that tax neutrality is more likely to ensure that investment
    is allocated to its most productive use.

    	Selected Bibliography

    Auerbach, Alan, and Kevin Hassett. "Investment, Tax Policy, and the Tax
    Reform Act of 1986," Do Taxes Matter: The Impact of the Tax Reform Act of
    1986, ed. Joel Slemrod.  Cambridge, Mass: MIT Press, 1990, pp. 13-49.
    Board of Governors of the Federal Reserve System.  Public Policy and
    Capital Formation.  April 1981.
    Brannon, Gerard M. "The Effects of Tax Incentives for Business
    Investment: A Survey of the Economic Evidence," U.S. Congress, Joint
    Economic Committee, The Economics of Federal Subsidy Programs, Part 3:
    "Tax Subsidies."  July 15, 1972, pp. 245-268.
    Brazell, David W. and James B. Mackie III.  "Depreciation Lives and
    Methods: Current Issues in the U.S. Capital Cost Recovery System," National
    Tax Journal, v. 53 (September 2000), pp. 531-562.
    Break, George F.  "The Incidence and Economic Effects of Taxation," The
    Economics of Public Finance.  Washington, DC: The Brookings Institution,
    1974.

    Clark, Peter K.  Tax Incentives and Equipment Investment, Brookings
    Papers on Economic Activity no. 1, 1994, pp. 317-339.
    Cohen, Darryl and Jason Cummins.  A Retrospective Evaluation of the
    Effects of Temporary Partial Expensing, Federal Reserve Board Staff
    Working Paper 2006-19, Washington, D.C., April, 2006.
    Cummins, Jason G., Kevin Hasset and R. Glenn Hubbard.  "Have Tax
    Reforms Affected Investment?" in James M. Poterba, Tax Policy and The
    Economy, v. 9, Cambridge: MIT Press, 1994.
    -.  A Reconsideration of Investment Behavior Using Tax Reforms as
    Natural Experiments, Brookings Papers on Economic Activity, no. 2, 1994,
    pp. 1-74.
    Dunn, Wendy E., Mark E. Doms, Stephen D. Oliner, and Daniel E.
    Sichel.  "How Fast Do Personal Computers Depreciate? Concepts and
    New Estimates," National Bureau of Economic Research Working Paper
    No. 10521, Cambridge, MA., May 2004.
    Feldstein, Martin.  "Adjusting Depreciation in an Inflationary Economy:
    Indexing Versus Acceleration," National Tax Journal, v. 34.  March 1981,
    pp. 29-43.
    Fullerton, Don, Robert Gillette, and James Mackie.  "Investment Incentives
    Under the Tax Reform Act of 1986," Compendium of Tax Research 1987,
    Office of Tax Analysis, Department of The Treasury.  Washington, DC: U.S.
    Government Printing Office, 1987, pp. 131-172.
    Fullerton, Don, Yolanda K. Henderson, and James Mackie. "Investment
    Allocation and Growth Under the Tax Reform Act of 1986," Compendium of
    Tax Research 1987, Office of Tax Analysis, Department of The Treasury.
    Washington, DC: U.S. Government Printing Office, 1987, pp. 173-202.
    Gravelle, Jane G.  "Differential Taxation of Capital Income: Another Look
    at the Tax Reform Act of 1986," National Tax Journal, v. 63.  December
    1989, pp. 441-464.
    -. Depreciation and the Tax Treatment of Real Estate. Library of
    Congress, Congressional Research Service Report RL30163.  Washington,
    DC: October 25, 2000.
    -.  Economic Effects of Taxing Capital Income, Chapters 3 and 5.
    Cambridge, MA: MIT Press, 1994.
    -.  "Whither Tax Depreciation?"  National Tax Journal, vol. 54,
    September, 2001, pp. 513-526.
    Harberger, Arnold, "Tax Neutrality in Investment Incentives," The
    Economics of Taxation, eds. Henry J. Aaron and Michael J. Boskin.
    Washington, DC: The Brookings Institution, 1980,  pp. 299-313.
    Hendershott, Patric and Sheng-Cheng Hu, "Investment in Producers'
    Durable Equipment," How Taxes Affect Economic Behavior, eds. Henry J.
    Aaron and Joseph A. Pechman.  Washington, DC: The Brookings Institution,
    1981, pp. 85-129.
    Hulten, Charles, ed.  Depreciation, Inflation, and the Taxation of Income
    From Capital.   Washington, DC: The Urban Institute, 1981.
    Hulten, Charles R., and Frank C. Wykoff.  "Issues in Depreciation
    Measurement." Economic Inquiry, v. 34, January 1996, pp. 10-23.

    Jorgenson, Dale W.  "Empirical Studies of Depreciaton." Economic
    Inquiry, v. 34, January 1996, pp. 24-42.
    Mackie, James.  "Capital Cost Recovery," in The Encyclopedia of Taxation
    and Tax Policy, eds. Joseph J. Cordes, Robert O. Ebel, and Jane G. Gravelle.
     Washington, DC: Urban Institute Press, 2005.
    Nadiri, M. Ishaq, and Ingmar R. Prucha.  "Depreciation Rate Estimation of
    Physical and R&D Capital." Economic Inquiry, v. 34, January 1996, pp. 43-
    56.
    Oliner, Stephen D.  "New Evidence on the Retirement and Depreciation of
    Machine Tools."  Economic Inquiry, v. 34, January 1996, pp.57-77.
    U.S. Congress, Joint Committee on Taxation.  General Explanation of the
    Tax Reform Act of 1986.  May 4, 1987, pp. 89-110.
    U.S. Department of the Treasury.  Report to the Congress on Depreciation
    Recovery Periods and Methods.  Washington, DC: June 2000.

    	Commerce and Housing:
    	Other Business and Commerce

    	EXPENSING OF DEPRECIABLE
    	BUSINESS PROPERTY

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    2.8

    0.6

    3.4

    2007

    2.6

    0.6

    3.2

    2008

    0.1

    -0.1

    0.0

    2009

    -0.8

    -0.4

    -1.2

    2010

    -0.4

    -0.2

    -0.6

    These figures do not reflect the revenue effects of the changes in the
    section 179 expensing allowance made by the Tax Increase Prevention and
    Reconciliation Act of 2005, which increased the total revenue loss by $2.8
    billion in 2008, $4.5 billion in 2009, and $0.2 billion in 2010.

    Authorization

    Section 179.

    Description

    A business taxpayer (other than a trust or estate) may deduct (or expense)
    no less than $100,000 of the cost of qualifying depreciable property in the tax
    year when it is placed in service.  In 2006, the maximum expensing allowance
    for most firms able to claim it is $108,000.  (The allowance is higher for firms
    located in so-called Enterprise and Empowerment Zones, Renewal
    Communities, the areas affected by Hurricane Katrina, and the portion of
    Manhattan directly affected by the terrorist attacks of September 11, 2001.)
    Under current federal tax law, this treatment is available from May 2003
    through the end of 2009.  The alternative to expensing is to recover the cost
    over a longer period according to current depreciation schedules.  Beginning
    in 2010 and beyond, the maximum expensing allowance will drop to $25,000.

    For the most part, qualifying property is new and used machinery,
    equipment, and computer software purchased for use in a trade or business.
    Software is eligible for expensing only from 2003 through 2009.

    The amount that may be expensed is subject to two important limitations: a
    dollar limitation and an income limitation.  Under the former, the maximum
    expensing allowance is reduced, dollar for dollar, by the amount by which the
    total cost of qualifying property placed in service in a tax year from 2003
    through 2009 exceeds a threshold of not less than $400,000 (an amount that is
    also known as the phase-out threshold).  In 2006, this threshold is $430,000
    for most firms able to claim the allowance.  (The threshold is higher for firms
    located in Empowerment and Enterprise Zones, Renewal Communities, the
    areas affected by Hurricane Katrina, and the portion of Manhattan affected by
    the terrorist attacks of September 11, 2001.)  Beginning in 2010 and beyond,
    the threshold will drop to $200,000.  As a result of the dollar limitation, none
    of the cost of qualifying property may be expensed once the total cost reaches
    $538,000 in 2006.  Under the income limitation, the expensing allowance
    may not exceed the taxable income a business taxpayer earns from the active
    conduct of the trade or business in which the qualifying property is used.
    Business taxpayers may not carry forward expensing allowances lost because
    of the dollar limitation, but they may carry forward those denied because of
    the income limitation.

    	Impact

    In the absence of section 179, the cost of depreciable business property
    would have to be recovered over longer periods.  Thus, the provision greatly
    accelerates the depreciation of relatively small purchases of qualified business
    assets.  This effect has important implications for the cash flow of firms, since
    the present value of the taxes owed on the stream of income earned by a
    depreciable asset decreases as the rate of depreciation rises.  In theory,
    expensing has the potential to stimulate increased business investment, as it is
    equivalent to taxing the income earned from eligible business assets at a
    marginal effective tax rate of zero.

    The allowance offers another benefit to firms able to take advantage of it:
    it simplifies their tax accounting.

    Because the allowance has a phase-out threshold, most of the firms that
    take advantage of it are relatively small in asset, employment, or revenue size.

    Benefits to capital income tend to concentrate in the higher income classes
    (see discussion in the Introduction).

    	Rationale

    The expensing allowance originated as a special first-year depreciation
    deduction that was enacted as part of the Small Business Tax Revision Act of
    1958.  The deduction was equal to 20 percent of the first $10,000 of spending
    ($20,000 in the case of a joint return) on new and used business equipment
    and machinery with a tax life of six or more years.  It was intended to provide
    tax relief and an investment incentive for small firms, and to simplify their tax
    accounting.

    The deduction remained intact until the Economic Recovery Tax Act of
    1981 (ERTA) replaced it with a maximum expensing allowance of $5,000.
    ERTA also established a timetable for increasing the allowance to $10,000 by
    1986 and an investment tax credit.  Business taxpayers were not permitted to
    claim both the allowance and the credit for acquisitions of the same assets.
    As a result, relatively few firms took advantage of the allowance until the
    investment tax credit was repealed by the Tax Reform Act of 1986.

    A provision of the Deficit Reduction Act of 1984, postponed the scheduled
    increase in the maximum allowance to $10,000 from 1986 to 1990.  The
    allowance did reach $10,000 in 1990, as scheduled.

    It remained at that amount until 1993, when President Clinton proposed a
    temporary investment credit for equipment for large firms and a permanent
    one for small firms.  The credits were not adopted, but the Omnibus Budget
    Reconciliation Act of 1993 increased the expensing allowance to $17,500, as
    of January 1, 1993.

    With the enactment of the Small Business Job Protection Act of 1996, the
    size of the allowance embarked on an accelerated upward path:  it rose to
    $18,000 in 1997, $18,500 in 1998, $19,000 in 1999, $20,000 in 2000,
    $24,000 in 2001 and 2002, and $25,000 in 2003 and thereafter.

    The maximum allowance would still be $25,000, were it not for the
    enactment of the Jobs and Growth Tax Relief Reconciliation Act of 2003
    (JGTRRA).  The act made three important changes in the allowance. First, it
    raised the maximum amount that can be expensed to $100,000 and the phase-
    out threshold to $400,000, for 2003 through 2005.  Second, JGTRRA
    indexed both amounts for inflation in 2004 and 2005.  Finally, it added
    purchases of off-the-shelf computer software for business use to the list of
    depreciable assets eligible for expensing in 2003 through 2005.

    Under the American Jobs Creation Act of 2004, all the changes in the
    allowance made by JGTRRA are extended through 2007.

    The Tax Increase Prevention and Reconciliation Act of 2005 extended
    these changes through 2009.

    Assessment

    The expensing allowance under section 179 has important implications for
    tax administration and economic efficiency.  With regard to the former, it
    simplifies tax accounting for firms able to take advantage of the allowance.
    With regard to the latter, the provision encourages increased investment by
    smaller firms in a way that might divert financial capital away from more
    productive uses.  Nonetheless, its overall influence on tax administration and
    the allocation of economic resources is limited because most large firms are
    unable to take advantage of the allowance.

    Although some argue that investment in and by smaller firms should be
    fostered because they tend to create more jobs and generate more
    technological innovation than larger firms, evidence on this issue is mixed.  In
    addition, conventional economic analysis offers no support for investment tax
    subsidies targeted at such firms.  In theory, taxing the returns to all
    investments at the same rate does less harm to social welfare than does
    making the tax rate on those returns dependent on a firm's size.

    Some question the efficacy of expensing as a policy tool for encouraging
    higher levels of business investment in plant and equipment.  A better
    approach, in the view of these skeptics, would be to enact permanent
    reductions in corporate and individual tax rates.

    The economic effects of expensing may receive greater congressional
    consideration in coming months.  In November 2005, an advisory panel on
    federal tax reform created by President George W. Bush the previous January
    issued its final report.  After evaluating a number of reform proposals, the
    panel recommended two reform plans:  the "Simplified Income Tax Plan" and
    the Growth and Investment Tax Plan."  While plans would modify the current
    rules governing the tax treatment of depreciation, only the Growth and
    Investment Plan would allow all new investments by firms of all sizes to be
    expensed.

    	Selected Bibliography

    Armington, Catherine, and Marjorie Odle.  "Small Business--How Many
    Jobs?" The Brookings Review, v. 1, no. 2.  Winter 1982, pp. 14-17.

    Cahlin, Richard A.  "Current Deduction Available for Many Costs That
    Are Capital in Nature," Taxation for Accountants, v. 29.  November 1982, pp.
    292-295.
    Cash, Stephen L. and Thomas L. Dickens, "Depreciation After the 2003
    Tax Act - Part 1: Taxes," Strategic Finance, October 1, 2003, p. 17.
    Cordes, Joseph J., "Expensing," in The Encyclopedia of Taxation and Tax
    Policy, Joseph J. Cordes, Robert D. Ebel, and Jane G. Gravelle, eds.,
    Washington, DC: Urban Institute Press,1999, p. 114.
    Gaffney, Dennis J., Maureen H. Smith-Gaffney, and Bonnie M. Moe,
    "JGTRRA Increases in Accelerated Capital Recovery Provisions Are
    Generally Taxpayer Friendly," Journal of Taxation, July, 2003, p. 20.
    Gravelle, Jane G.  Small Business Tax Subsidy Proposals, Library of
    Congress, Congressional Research Service Report 93-316.  Washington, DC:
    March 15, 1994.
    Guenther, Gary.  Small Business Expensing Allowance:  Current Status,
    Legislative Proposals, and Economic Effects, Library of Congress,
    Congressional Research Service, Report RL31852, Washington, DC: October
    3, 2006.
    Holtz-Eakin, Doug.  "Should Small Business be Tax-Favored?"  National
    Tax Journal, v. 48, September 1995, pp. 447-462.
    Neubig, Tom.  "Where's the Applause?  Why Most Corporations Prefer a
    Lower Rate."  Tax Notes, April 24, 2006.  pp. 483-486.
    President's Advisory Panel on Federal Tax Reform.  Simple, Fair, and
    Pro-Growth: Proposals to Fix America's Tax System.  Washington, DC:
    November 2005.
    U.S. Congress, Senate Committee on Finance hearing 104-69.  Small
    Business Tax Incentives.  Washington, DC:  U.S. Government Printing
    Office, June 7, 1995.

    Commerce and Housing:
    Other Business and Commerce

    AMORTIZATION OF BUSINESS START-UP COSTS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.7

    (1)

    0.7

    2007

    0.7

    (1)

    0.7

    2008

    0.8

    (1)

    0.8

    2009

    0.8

    (1)

    0.8

    2010

    0.9

    (1)

    0.9

    (1)Less than $50 million.

    Authorization

    Section 195.

    Description

    In general, business taxpayers are allowed to deduct all normal and
    reasonable expenses they incur in conducting their trade or business.  This
    rule implies that costs incurred before the start of a business should not be
    considered deductible because they were not incurred in connection with
    carrying on an active trade or business.  Instead, start-up costs should be
    capitalized and added to a taxpayer's basis in the business.  Yet under section
    195, a business taxpayer may deduct up to $5,000 in qualified start-up
    expenditures and amortize any remaining amount over 15 years.  In the
    absence of such an option, no deduction would be allowed for start-up
    expenditures.

    Start-up expenditures must satisfy two requirements to qualify for this
    preferential treatment.  First, they must be related to one or more of the
    following activities:  looking into the creation or acquisition of an active trade
    or business; creating an active trade or business; or engaging in what the
    Internal Revenue Service sees as "a profit-seeking or income-producing
    activity" before an active trade or business commences.  Second, the
    expenditures must be tied to costs that would be deductible if they were paid
    or incurred in connection with an existing trade or business.  Excluded from
    qualifying start-up expenditures are interest payments on debt, tax payments,
    and spending on research and development that is deductible under section
    174.

    	Impact

    The election to deduct and amortize business start-up costs removes an
    impediment to the formation of new businesses by permitting the immediate
    deduction of expenses that otherwise could not be recovered until the owner
    sold his or her interest in the business.

    Benefits to capital income tend to concentrate in the higher income classes
    (see discussion in the Introduction).

    	Rationale

    Before the enactment of section 195 in 1980, the question of whether an
    expense incurred in connection with starting a new trade or business was
    currently deductible or should be capitalized was a source of controversy and
    costly litigation between business taxpayers and the Internal Revenue Service
    (IRS).  Business taxpayers had the option of treating certain organizational
    expenditures for the formation of a corporation or partnership as deferred
    expenses on an elective basis and amortizing them over a period of not less
    than 60 months (Code sections 248 and 709).

    Section 195 first entered the federal tax code through the Miscellaneous
    Revenue Act of 1980.  The original provision allowed business taxpayers to
    amortize start-up expenditures over a period of not less than 60 months.  It
    defined start-up expenditures as any expense "paid or incurred in connection
    with investigating the creation or acquisition of an active trade or business, or
    creating an active trade or business."  In addition, the expense had to be one
    that would have been immediately deductible if it were paid or incurred in
    connection with the expansion of an existing trade or business.  Congress
    added section 195 to facilitate the creation of new businesses and reduce the
    likelihood of protracted legal disputes over the tax treatment of start-up
    expenditures.

    Nevertheless, in spite of the changes enacted in 1980, numerous disputes
    continued to arise over whether certain business start-up costs should be
    expensed under section 162, capitalized under section 263, or amortized
    under section 195.  In an attempt to diminish the controversy and litigation
    surrounding the interpretation of section 195, Congress added a provision to
    the Deficit Reduction Act of 1984 clarifying the definition of start-up
    expenditures.  Specifically, the provision required taxpayers to treat start-up
    expenditures as deferred expenses, which meant that they were to be
    capitalized unless a taxpayer elected to amortize them over a period of not
    less than 60 months.  It also broadened the definition of start-up expenditures
    to include any expenses incurred in connection with activities aimed at
    earning a profit or producing income before the day when the active conduct
    of a trade of business commenced; the expenses had to be incurred in
    anticipation of entering the trade or business.

    No changes were made in section 195 until the enactment of the American
    Jobs Creation Act of 2004.  The act included a provision limiting the scope of
    the amortization of business start-up costs under prior law.  Specifically, the
    provision permitted business taxpayers to deduct up to $5,000 in eligible
    start-up costs in the tax year when their trade or business began.  This amount
    must be reduced (but not below zero) by the amount by which these costs
    exceed $50,000.  Any remaining amount must be amortized over 15 years,
    beginning with the month in which the active conduct of the trade or business
    commenced.  The definition of start-up costs was left unchanged.  In making
    these modifications to section 195, Congress seemed to have two aims.  One
    was to encourage the formation of new firms that do not require substantial
    start-up costs by allowing a large share of those costs to be deductible in the
    tax year when the firms begin to operate.  The second aim was to make the
    amortization period for start-up costs consistent with that for intangible assets
    under section 197, which was (and is) 15 years.

    Assessment

    In theory, business start-up costs should be written off over the life of the
    business on the grounds that they are a capital expense.  Such a view,
    however, does raise the thorny problem of determining the useful life of a
    business at its outset.

    Section 195 has two distinct advantages.  First, it substantially lowers the
    likelihood of costly and drawn-out legal disputes involving business taxpayers
    and the IRS over the tax treatment of start-up costs.  Second, the provision
    does so at a relatively small revenue cost.

    	Selected Bibliography

    Davis, Jon E., "Amortization of Start-Up Costs," Tax Adviser, April 1999,
    p. 222.
    Fiore, Nicholas J., "IRS Issues Guidance on Amortizable Start-Up Cost,"
    Tax Adviser, July 1999, pp. 527-532.
    Garris, Henry A., "Update and Review of Start-Up Expenditures," CPA
    Journal, March 1991, p. 60.
    Guenther, Gary.  Small Business Tax Benefits: Overview and Economic
    Analysis, Library of Congress, Congressional Research Service Report
    RL32254, Washington, DC:  March 3, 2004.
    Internal Revenue Service, Starting a Business and Keeping Records,
    publication 583, Washington, D.C.: March 2006.
    Kalinka, Susan, "When Will Business Investigatory Expenditures Be
    Amortizable Start-Up Costs?," Taxes, September 1998, pp. 5-9.
    Kline, Robin, "Disallowed Start-Up Expenses," Tax Adviser, October
    1998, pp. 666-667.
    Paul, Michael S., "Elect to Amortize Nondeductible Start-Up Expenses,"
    Taxation for Accountants, August 1995, pp. 68-73.
    Persellin, Mark B. and Shawn E. Novak, "Start-Up Expenditures:
    Compliance and Planning Issues," Journal of Corporate Taxation, Summer
    1995, p. 141.
    Schnee, Edward J., "Speed Up the Deduction of Business Expansion
    Costs," Practical Tax Strategies, July 1999, pp. 4-12.
    Thornton, David A., "IRS Clarifies the Applicability of Section 195 to
    Business Acquisitions," Tax Adviser, September 1999, pp. 625-626.
    U.S. Congress, House Committee on Ways and Means.  Miscellaneous
    Revenue Act of 1980.  Report 96-1278, pp. 9-13.
    -, Senate Committee on Finance.  Jumpstart Our Business Strength (Jobs)
    Act.  Report 108-192, pp. 196-197.
    -, Joint Committee on Taxation.  General Explanation of the Revenue
    Provisions of the Deficit Reduction Act of 1984.  Committee Print, 98th
    Congress, 2nd Session, December 31, 1984, pp. 295-297.
    Wilcox, Gary B.  "Start-Up Cost Treatment Under Section 195: Tax
    Disparity in Disguise," Oklahoma Law Review, v. 36.  Spring 1983, pp.
    449-466.

    Commerce and Housing Credit:
    Other Business and Commerce

    REDUCED RATES ON FIRST $10,000,000
    OF CORPORATE TAXABLE INCOME

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    -

    4.3

    4.3

    2007

    -

    4.3

    4.3

    2008

    -

    4.3

    4.3

    2009

    -

    4.3

    4.3

    2010

    -

    4.3

    4.3

    Authorization

    Section 11.

    Description

    Corporations with less than $10 million in taxable income are taxed
    according to a complicated graduated rate structure.  Under the existing
    structure, the tax rate is 15 percent on the first $50,000 of income, 25 percent
    on the next $25,000, and an average of 34 percent thereafter.  To offset the
    benefit from the lower rates, a tax rate of 39 percent is imposed on corporate
    taxable income between $100,000 and $335,000.  As a result, the benefit of
    the lower rates vanishes for corporations with taxable income in excess of
    $335,000:  they pay a flat average rate of 34 percent.  The tax rate on taxable
    income between $335,000 and $10 million is 34 percent.  It rises to 35
    percent for taxable income from $10 million to $15 million.  When taxable
    income falls between $15 million and $18,333,333, the rate jumps to 38
    percent.  And a flat rate of 35 percent applies to taxable income above
    $18,333,333.  Thus, the benefit of the 34 percent rate is phased out when
    income reaches $18,333,333.

    The graduated rates do not apply to the taxable income of personal-service
    corporations; instead, it is taxed at a flat rate of 35 percent.  In addition, there
    are restrictions on eligibility for the lower rates to prevent abuse by related
    corporations.

    The tax expenditure for section 11 lies in the difference between taxes paid
    and the taxes that would be owed if all corporate income were taxed at a flat
    35 percent rate.

    	Impact

    The reduced rates mainly affect smaller corporations.  This is because the
    graduated rate structure limits the benefits of the rates under 35 percent to
    corporations with taxable incomes below $335,000.

    The graduated rates encourage firms to use the corporate form of legal
    organization and allow some small corporations that might otherwise operate
    as passthrough entities (e.g., sole proprietorships or partnerships) to provide
    fringe benefits.  They also encourage the splitting of operations between sole
    proprietorships, partnerships, S corporations and regular C corporations.
    Most businesses are not incorporated; so only a small fraction of firms are
    affected by this provision.

    This provision is likely to benefit higher-income individuals who are the
    primary owners of capital (see Introduction for a discussion).

    Rationale

    In the early years of the corporate income tax, exemptions from the tax
    were allowed in some years.  A graduated rate structure was first adopted in
    1936.  From 1950 to 1974, corporate income was subject to a "normal tax"
    and a surtax, and the first $25,000 of income was exempt from the surtax.
    The exemption was intended to provide tax relief for small businesses.

    Not surprisingly, this dual structure led many large firms to reorganize their
    operations into numerous smaller corporations in order to avoid paying the
    surtax.  Some steps to remedy this loophole were taken in 1963.  But the most
    important correction came in 1969, when legislation was enacted that limited
    clusters of corporations controlled by the same interest to a single exemption.

    In 1975, a graduated rate structure with three brackets was adopted.  In
    1984, a law was enacted which included a provision phasing out the
    exemption for taxable incomes between $1 million and $1.405 million.  The
    act also lowered the rates that applied to incomes up to $100,000.

    The present graduated rate structure for corporate taxable income below
    $10 million came into being with the passage of the Tax Reform Act of 1986.
     More specifically, the act lowered the ceilings on the rates and accelerated
    the phase-out of the reduced rates so that their benefits gradually disappeared
    between $100,000 and $335,000.  In taking these steps, Congress was
    attempting to target the benefits of the graduated rate structure more precisely
    at smaller firms.  Motivated by a desire to reduce a large and growing budget
    deficit by raising revenue, Congress added the 35-percent corporate tax rate
    through the Omnibus Budget Reconciliation Act of 1993.

    Assessment

    A principal justification for the graduated rates is that they provide needed
    assistance to small businesses.  The rates do so by lowering their cost of
    capital for new investments and increasing their cash flow during periods
    when many of them struggle to survive.  But can the graduated rates be
    justified on economic grounds?

    Unlike the graduated rates of the individual tax, the corporate graduated
    rate structure cannot be justified on the basis of a firm's ability to pay.  The
    reason is two-fold:   individuals and not corporations end up paying corporate
    taxes, and owners of small corporations are likely to be very well off.  In
    addition, graduated rates can serve as a means of reducing the tax burden of
    small business owners.  Such a reduction is possible when the individual
    income of owners of small corporations is taxed at a higher rate than the
    income of their corporations.  These considerations suggest that tax relief for
    small firms cannot be justified on the grounds of equity.

    Can such tax relief be justified on the basis of economic efficiency?  Once
    again, the case seems weak or less than persuasive.  Although some argue that
    government policy should support investment in and by small firms because
    they tend to create more jobs and generate more technological innovations
    than larger firms, evidence on this issue is decidedly mixed.  Conventional
    economic analysis implies that maximum output is likely to be produced
    when the returns to all investments are taxed at the same rate.  A graduated
    rate structure discourages investments in and by firms subject to the higher
    marginal tax rates of the phase-out range.  Such an incentive effect can distort
    the allocation of economic resources by diverting the flow of financial capital
    from its most productive uses.  Graduated rates also give large corporations
    an incentive to operate for tax purposes as multiple smaller units, where
    economies of scale have less of an impact on the returns to investment.

    Graduated rates do, however, make it possible for owners of businesses in
    the lower income brackets to operate as corporations.  Generally, business
    owners are free to operate their firms as a regular C corporation or some kind
    of passthrough entity (i.e., sole proprietorship, partnership, limited liability
    company, or S corporation) for legal purposes.  Income earned by
    passthrough entities is attributed to the owners (whether or not it is
    distributed) and taxed at individual income tax rates.  Depending on the
    amount, it is possible for income earned by corporations to be taxed at lower
    rates than income earned by passthrough entities.  Differences between the
    two rates create opportunities for the sheltering of income in corporations.
    There may be some circumstances, however, where operating as a
    passthrough entity is not feasible.  For instance, corporate status may be
    indispensable if more than one class of stock or favorable tax treatment of
    employee fringe benefits is desired.

    	Selected Bibliography

    Armington, Catherine, and Marjorie Odle.  "Small Business--How Many
    Jobs?"  Brookings Review, v. 1, no. 2.  Winter 1982, pp. 14-17.
    Brumbaugh, David.  Federal Business Taxation: The Current System, Its
    Effects, and Options for Reform.  Library of Congress, Congressional
    Research Service Report RL33171.  Washington, DC: September 21, 2006.
    Gravelle, Jane G.  Small Business Tax Subsidy Proposals.  Library of
    Congress, Congressional Research Service Report 93-316.  Washington, DC:
    March 15, 1994.
    -.  "The Corporate Income Tax: Where Has It Been and Where Is It
    Going?."  National Tax Journal, vol. 57, December 2004.  pp. 903-923.
    Guenther, Gary.  Small Business Tax Benefits: Overview and Economic
    Analysis.  Library of Congress, Congressional Research Service Report
    RL32254.  Washington, DC: March 3, 2004.
    Pechman, Joseph A.  Federal Tax Policy.  Washington, DC: The
    Brookings Institution, 1987, pp. 302-305.
    Plesko, George A.  "`Gimme Shelter?' Closely Held Corporations Since
    Tax Reform," National Tax Journal, v. 48.  September 1995, pp. 409-416.
    Holtz-Eakin, Douglas.  "Should Small Business be Tax-Favored?"
    National Tax Journal, v. 48, September 1995, pp. 447-462.
    Schnee, Edward J.  "Refining the Definition of a Personal Service
    Corporation."  Journal of Accountancy, vol. 202, no. 3,  September 1, 2006.
    p. 74
    U.S. Congress, Congressional Budget Office.  Reducing the Deficit:
    Spending and Revenue Options,.  Washington, DC: U.S. Government
    Printing Office, March 1997, p. 337.
    -, Joint Committee on Taxation.  General Explanation of the Tax Reform
    Act of 1986, 99th Congress, 2nd session.  May 4, 1987: pp. 271-273.
    -, Senate Committee on Finance hearing 104-69.  Small Business Tax
    Incentives.  Washington, DC: U.S. Government Printing Office, June 7, 1995.
    U.S. Department of the Treasury.  Tax Reform for Fairness, Simplicity,
    and Economic Growth, v. 2, General Explanation of the Treasury
    Department Proposals.  November, 1974, pp. 128-129.

    	 Commerce and Housing:
    	Other Business and Commerce

    	PERMANENT EXEMPTION
    	FROM IMPUTED INTEREST RULES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.4

    (1)

    0.4

    2007

    0.4

    (1)

    0.4

    2008

    0.4

    (1)

    0.4

    2009

    0.4

    (1)

    0.4

    2010

    0.5

    (1)

    0.5

    (1)less than $50 million

    	Authorization

    Sections 163(e), 483, 1274, and 1274A.

    	Description

    The failure to report interest as it accrues can allow the deferral of taxes.
    The tax code generally requires that debt instruments bear a market rate of
    interest at least equal to the average rate on outstanding Treasury securities of
    comparable maturity.  If an instrument does not, the Internal Revenue Service
    imputes a market rate to it.  The imputed interest must be included as income
    to the recipient and is deducted by the payer.

    There are several exceptions to the general rules for imputing interest on
    debt instruments.  Debt associated with the sale of property when the total
    sales price is no more than $250,000, the sale of farms or small businesses by
    individuals when the sales price is no more than $1 million, and the sale of a
    personal residence, is not subject to the imputation rules at all.  Debt
    instruments for amounts not exceeding an inflation-adjusted maximum (about
    $4.6 million or $3.3 million, depending on the kind of the debt instrument),
    given in exchange for real property, may not have imputed to them an interest
    rate greater than 9 percent.

    This tax expenditure is the revenue loss in the current year from the
    deferral of taxes caused by these exceptions.

    	Impact

    The exceptions to the imputed interest rules are generally directed at "seller
    take-back" financing, in which the seller of the property receives a debt
    instrument (note, mortgage) in return for the property.  This is a financing
    technique often used in selling personal residences or small businesses or
    farms, especially in periods of tight money and high interest rates, both to
    facilitate the sales and to provide the sellers with continuing income.

    This financing mechanism can also be used, however, to shift taxable
    income between tax years and thus delay the payment of taxes.  When interest
    is fully taxable but the gain on the sale of the property is taxed at reduced
    capital gains rates, as in current law, taxes can be eliminated, not just
    deferred, by characterizing more of a transaction as gain and less as interest
    (that is, the sales price could be increased and the interest rate decreased).

    With only restricted exceptions to the imputation rules, and other recent tax
    reforms, the provisions now cause only modest revenue losses and have
    relatively little economic impact.

    	Rationale

    Restrictions were placed on the debt instruments arising from seller-
    financed transactions beginning with the Revenue Act of 1964, to assure that
    taxes were not reduced by manipulating the purchase price and stated interest
    charges. These restrictions still allowed considerable creativity on the part of
    taxpayers, however, leading ultimately to the much stricter and more
    comprehensive rules included in the Deficit Reduction Act of 1984.

    The 1984 rules were regarded as very detrimental to real estate sales and
    they were modified almost immediately (temporarily in 1985 [P.L. 98-612]
    and permanently in 1986 [P.L. 99-121]).  The exceptions to the imputed
    interest rules described above were introduced in 1984 and 1986 (P.L. 99-
    121) to allow more flexibility in structuring sales of personal residences,
    small businesses, and farms by the owners, and to avoid the administrative
    problems that might arise in applying the rules to other smaller sales.

    	Assessment

    The imputed interest and related rules dealing with property-for-debt
    exchanges were important in restricting unwarranted tax benefits before the
    Tax Reform Act of 1986 eliminated the capital gains exclusion and
    lengthened the depreciable lives of buildings.

    Under pre-1986 law, the seller of commercial property would prefer a
    higher sales price with a smaller interest rate on the associated debt, because
    the gain on the sale was taxed at lower capital gains tax rates.  The buyer
    would at least not object to, and might prefer, the same allocation because it
    increased the cost of property and the amount of depreciation deductions
    (i.e., the purchaser could deduct the principal, through depreciation
    deductions, as well as the interest).  It was possible to structure a sale so that
    both seller and purchaser had more income at the expense of the government.

    Under current depreciation rules and low interest rates, this allocation is
    much less important.  In addition, the 9-percent cap on imputed interest for
    some real estate sales has no effect when market interest rates are below that
    figure.

    	Selected Bibliography

    U.S. Congress, Joint Committee on Taxation.  Description of the Tax
    Treatment of Imputed Interest on Deferred Payment Sales of Property,  JCS-
    15-85.  May 17, 1985.
    -.  General Explanation of the Revenue Provisions of the Deficit Reduction
    Act of 1984, JCS-41-84.  December 31, 1984, pp.108-127.
    Internal Revenue Service.  Installment Sales. Publication 537, for use in
    preparing 2005 returns, p. 9.

    Commerce and Housing:
    Other Business and Commerce

    EXPENSING OF MAGAZINE CIRCULATION EXPENDITURES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    (1)

    (1)

    (2)

    2007

    (1)

    (1)

    (2)

    2008

    (1)

    (1)

    (2)

    2009

    (1)

    (1)

    (2)

    2010

    (1)

    (1)

    (2)

    (1)Less than $50 million.
    (2)Less than $100 million

    Authorization

    Section 173.

    Description

    In general, publishers of newspapers, magazines, and other periodicals are
    allowed to deduct their expenditures to maintain, establish, or increase
    circulation in the year when the expenditures are made.

    Current deductions of these expenditures are permitted even though
    expenditures to establish or increase circulation would otherwise be treated as
    capital expenditures under section 263.  Expenditures eligible for this
    preferential treatment do not include purchases of land and depreciable
    property or the expansion of circulation through the purchase of another
    publisher or its list of subscribers.

    The tax expenditure in section 173 lies in the difference between the
    current deduction of costs and the present value of the depreciation
    deductions that would be taken if these costs were capitalized.

    	Impact

    Publishers are permitted a current deduction for circulation costs, including
    some that otherwise should be treated as capital in nature.  Such preferential
    treatment speeds up the recovery of those costs, increasing cash flow and
    reducing the cost of capital for publishers.  Investment in maintaining and
    expanding circulation is a critical element of the competitive strategies for
    publishers of newspapers and magazines. The number of readers is an
    important source of revenue in and of itself, and the advertising rates
    publishers can charge typically are based on the volume of sales and
    readership.

    Like many other business tax expenditures, the benefit tends to accrue to
    high-income individuals (see Introduction for a discussion).

    Rationale

    Section 173 was added to the federal tax code through the Revenue Act of
    1950.  In taking this step, Congress was hoping to eliminate some of the
    problems associated with distinguishing between expenditures to maintain
    circulation, which had been treated as currently deductible, and those to
    establish or develop new circulation, which had to be capitalized.  Numerous
    legal disputes between publishers and the Internal Revenue Service over the
    application and interpretation of such a distinction had arisen as far back as
    the late 1920s.

    Section 173 remained unchanged until the passage of the Tax Equity and
    Fiscal Responsibility Act of 1982.  Among other things, the act made the
    expensing of circulation expenditures a preference item under the alternative
    minimum tax (AMT) for individuals and required affected individuals to
    amortize any such expenditures over 10 years.  Congress lowered the recovery
    period to three years in the Deficit Reduction Act of 1984, where it now
    stands.  The Tax Reform Act of 1986 further clarified the treatment of
    circulation expenditures under the individual AMT:  specifically, the act
    allowed taxpayers who recorded a loss on the disposition of property related
    to such expenditures (e.g., a newspaper) to claim as a deduction against the
    AMT all remaining circulation expenditures that have yet to be deducted for
    the purpose of the minimum tax.

    Assessment

    Although section 173 provides a significant tax benefit for publishers in
    that it allows them to expense the acquisition of an asset (i.e., lists of
    subscribers) that yield returns in future tax years, it simplifies tax compliance
    and accounting for them and tax administration for the IRS.  Without such
    treatment, it would be necessary for IRS or Congress to clarify how to
    distinguish between expenditures for establishing or expanding circulation
    and expenditures for maintaining circulation.

    	Selected Bibliography

    Commerce Clearing House.  "'50 Act Clarified Tax Treatment of
    Circulation Expenses of Publishers," Federal Tax Guide Reports, v. 48.
    September 9, 1966, p. 2.
    Davidson, James H.  "A Publisher's Guide to Tax Reform - Part 2," Folio:
    The Magazine for Magazine Management, February 1987.
    U.S. Congress, Joint Committee on Internal Revenue Taxation.  Summary
    of H.R. 8920, "The Revenue Act of 1950,"  as agreed to by the Conferees.
    September 1950, p. 12.
    Joint Committee on Taxation.  General Explanation of the Revenue
    Provisions of the Deficit Reduction Act of 1984, Committee Print, 98th
    Congress, 2nd session.  December 31, 1984, p. 986
    -, General Explanation of the Tax Reform Act of 1986, Committee Print,
    99th Congress, 2nd Session, May 4, 1987, p. 445.
    Washburn, David.  "Newspapers Hope Online Readers Will Keep Them
    Profitable."  Copley News Service.  December 4, 2005.  Available at
    www.copleynews.com.

    	Commerce and Housing:
    	Other Business and Commerce

    	SPECIAL RULES FOR MAGAZINE,
    	PAPERBACK BOOK, AND RECORD RETURNS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    (1)

    (1)

    (1)

    2007

    (1)

    (1)

    (1)

    2008

    (1)

    (1)

    (1)

    2009

    (1)

    (1)

    (1)

    2010

    (1)

    (1)

    (1)

    (1)Less than $50 million.

    	Authorization

    Section 458.

    	Description

    In general, if a buyer returns goods to the seller, the seller's income is
    reduced in the year in which the items are returned.  If the goods are returned
    after the tax year in which the goods were sold, the seller's income for the
    previous year is not affected.

    An exception to the general rule has been granted to publishers and
    distributors of magazines, paperbacks, and records, who may elect to exclude
    from gross income for a tax year the income from the sale of goods that are
    returned after the close of the tax year.  The exclusion applies to magazines
    that are returned within two months and fifteen days after the close of the tax
    year, and to paperbacks and records that are returned within four months and
    fifteen days after the close of the tax year.

    To be eligible for the special election, a publisher or distributor must be
    under a legal obligation, at the time of initial sale, to provide a refund or
    credit for unsold copies.

    	Impact

    Publishers and distributors of magazines, paperbacks, and records who
    make the special election are not taxed on income from goods that are
    returned after the close of the tax year.  The special election mainly benefits
    large publishers and distributors.

    	Rationale

    The purpose of the special election for publishers and distributors of
    magazines, paperbacks, and records is to avoid imposing a tax on accrued
    income when goods that are sold in one tax year are returned after the close of
    the year.

    The special rule for publishers and distributors of magazines, paperbacks,
    and records was enacted by the Revenue Act of 1978.

    	Assessment

    For goods returned after the close of a tax year in which they were sold, the
    special  exception allows publishers and distributors to reduce income for the
    previous year.  Therefore, the special election is inconsistent with the general
    principles of accrual accounting.

    The special tax treatment granted to publishers and distributors of
    magazines, paperbacks, and records is not available to producers and
    distributors of other goods.  On the other hand, publishers and distributors of
    magazines, paperbacks, and records often sell more copies to wholesalers and
    retailers than they expect will be sold to consumers.

    One reason for the overstocking of inventory is that it is difficult to predict
    consumer demand for particular titles.  Overstocking is also used as a
    marketing strategy that relies on the conspicuous display of selected titles.
    Knowing that unsold copies can be returned, wholesalers and retailers are
    more likely to stock a larger number of titles and to carry more copies of
    individual titles.

    For business purposes, publishers generally set up a reserve account in the
    amount of estimated returns.  Additions to the account reduce business
    income for the year in which the goods are sold.  For tax purposes, the special
    election for returns of magazines, paperbacks, and records is similar, but not
    identical, to the reserve account used for business purposes.

    	Selected Bibliography

    U.S. Congress, Joint Committee on Taxation.  General Explanation of the
    Revenue Act of 1978, 95th Congress, 2nd session.  March 12, 1979, pp. 235-
    41.
    -,  Tax Reform Proposals: Accounting Issues, Committee Print, 99th
    Congress, 1st session.  September 13, 1985.
    U.S. Department of the Treasury, Internal Revenue Service.  "Certain
    Returned Magazines, Paperbacks or Records," Federal Register, v. 57,
    August 26, 1992, pp. 38595-38600.

    	 Commerce and Housing:
    	Other Business and Commerce

    	COMPLETED CONTRACT RULES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    (1)

    0.3

    0.3

    2007

    (1)

    0.3

    0.3

    2008

    (1)

    0.4

    0.4

    2009

    (1)

    0.4

    0.4

    2010

    (1)

    0.5

    0.5

    (1)Less than $50 million

    	Authorization

    Section 460.

    	Description

    Some taxpayers with construction or manufacturing contracts extending for
    more than one tax year are allowed to report some or all of the profit on the
    contracts under special accounting rules rather than the normal rules of tax
    accounting.  Many such taxpayers use the "completed contract" method.

    A taxpayer using the completed contract method of accounting reports
    income on a long-term contract only when the contract has been completed.
    All costs properly allocable to the contract are also deducted when the
    contract is completed and the income reported, but many indirect costs may
    be deducted in the year paid or incurred.  This mismatching of income and
    expenses allows a deferral of tax payments that creates a tax advantage in this
    type of reporting.

    Most taxpayers with long-term contracts are not allowed to use the
    completed contract method and must capitalize indirect costs and deduct them
    only when the income from the contract is reported.  There are exceptions,
    however.  Home construction contracts may be reported according to the
    taxpayer's "normal" method of accounting and allow current deductions for
    costs that others are required to capitalize.

    Other real estate construction contracts may also be subject to these more
    liberal rules if they are of less than two years duration and the contractor's
    gross receipts for the past three years have averaged $10 million or less.
    Contracts entered into before March 1, 1986, if still ongoing, may be reported
    on a completed contract basis, but with full capitalization of costs.

    Contracts entered into between February 28, 1986, and July 11, 1989, and
    residential construction contracts other than home construction may be
    reported in part on a completed contract basis, but may require full cost
    capitalization.  This tax expenditure is the revenue loss from deferring the tax
    on those contracts still allowed to be reported under the more liberal
    completed contract rules.

    	Impact

    Use of the completed contract rules allows the deferral of taxes through
    mismatching income and deductions because they allow some costs to be
    deducted from other income in the year incurred, even though the costs
    actually relate to the income that will not be reported until the contract's
    completion, and because economic income accrues to the contractor each year
    he works on the contract but is not taxed until the year the contract is
    completed. Tax deferral is the equivalent of an interest-free loan from the
    Government of the amount of the deferred taxes.  Because of the restrictions
    now placed on the use of the completed contract rules, most of the current tax
    expenditure relate to real estate construction, especially housing.

    	Rationale

    The completed contract method of accounting for long-term construction
    contracts has been permitted by Internal Revenue regulations since 1918, on
    the grounds that such contracts involved so many uncertainties that profit or
    loss was undeterminable until the contract was completed.

    In regulations first proposed in 1972 and finally adopted in 1976, the
    Internal Revenue Service extended the method to certain manufacturing
    contracts (mostly defense contracts), at the same time tightening the rules as
    to which costs must be capitalized.  Perceived abuses, particularly by defense
    contractors, led the Congress to question the original rationale for the
    provision and eventually led to a series of ever more restrictive rules.  The
    Tax Equity and Fiscal Responsibility Act of 1982 (P.L. 97-248) further
    tightened the rules for cost capitalization.

    The Tax Reform Act of 1986 (P.L. 99-514) for the first time codified the
    rules for long-term contracts and also placed restrictions on the use of the
    completed contract method.  Under this Act, the completed contract method
    could be used for reporting only 60 percent of the gross income and
    capitalized costs of a contract, with the other 40 percent reported on the
    "percentage of completion" method, except that the completed contract
    method could continue to be used by contractors with average gross receipts
    of $10 million or less to account for real estate construction contracts of no
    more than two years duration.  It also required more costs to be capitalized,
    including interest.

    The Omnibus Budget Reconciliation Act of 1987 (P.L. 100-203) reduced
    the share of a taxpayer's long-term contracts that could be reported on a
    completed contract basis from 60 percent to 30 percent.  The Technical and
    Miscellaneous Revenue Act of 1988 (P.L. 100-647) further reduced the
    percentage from 30 to 10, (except for residential construction contracts, which
    could continue to use the 30 percent rule) and also provided the exception for
    home construction contracts.

    The Omnibus Budget Reconciliation Act of 1989 (P.L. 101-239) repealed
    the provision allowing 10 percent to be reported by other than the percentage
    of completion method, thus repealing the completed contract method, except
    as noted above.

    The most recent legislative change was a provision of the American Jobs
    Creation Act of 2004, later amended in the Gulf Opportunity Zone Act of
    2005, permitting naval shipbuilders to use the completed contract method.

    	Assessment

    Use of the completed contract method of accounting for long-term
    contracts was once the standard for the construction industry.  Extension of
    the method to defense contractors, however, created a perception of wide-
    spread abuse of a tax advantage.  The Secretary of the Treasury testified
    before the Senate Finance Committee in 1982 that "virtually all" defense and
    aerospace contractors used the method to "substantially reduce" the taxes they
    would otherwise owe.

    The principal justification for the method had always been the uncertainty
    of the outcome of long-term contracts, an argument that lost a lot of its force
    when applied to contracts in which the Government bore most of the risk.  It
    was also noted that even large construction companies, who used the method
    for tax reporting, were seldom so uncertain of the outcome of their contracts
    that they used it for their own books; their financial statements were almost
    always presented on a strict accrual accounting basis comparable to other
    businesses.

    Since the use of the completed contract rules is now restricted to a very
    small segment of the construction industry, it produces only small revenue
    losses for the Government and probably has little economic impact in most
    areas.  One area where it is still permitted, however, is in the construction of
    single-family homes, where it adds some tax advantage to an already heavily
    tax-favored sector.

    	Selected Bibliography

    Knight, Ray A., and Lee G. Knight.  Recent Developments Concerning the
    Completed Contract Method of Accounting, The Tax Executive, v. 41,  Fall
    1988, pp. 73-86.
    U.S. Congress, House of Representatives Committee on the Budget.
    Omnibus Budget Reconciliation Act of 1989.  September 1989, p. 1347.
    -, Joint Committee on Taxation.  General Explanation of the Revenue
    Provisions of the Tax Equity and Fiscal Responsibility Act of 1982.  JCS-38-
    82, December 31, 1982, pp. 148-154.
    -.  General Explanation of the Tax Reform Act of 1986.  JCS-10-87, May
    4, 1987, pp. 524-530.
    -.  Tax Reform Proposals: Accounting Issues.  JCS-39-85, September 13,
    1985, pp. 45-49.
    U.S. General Accounting Office,  Congress Should Further Restrict Use of
    the Completed Contract Method.  Report GAO/GGD-86-34, January 1986.

    Commerce and Housing:
    Other Business and Commerce

    CASH ACCOUNTING,
    OTHER THAN AGRICULTURE

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.8

    (1)

    0.8

    2007

    0.8

    (1)

    0.8

    2008

    0.8

    (1)

    0.8

    2009

    0.9

    (1)

    0.9

    2010

    0.9

    (1)

    0.9

    (1)Less than $50 million.

    	Authorization

    Sections 446 and 448.

    	Description

    Under the cash method of accounting, income is reported in the year in
    which it is received and deductions are taken in the year in which expenses
    are paid.  Under the accrual method of accounting, income is generally
    recognized when it is earned, whether or not it has actually been received.
    Deductions for expenses are generally allowed in the year in which the costs
    are actually incurred.

    All taxpayers (except some farmers) must use the accrual method of
    accounting for inventories and for some income and expenses that span tax
    years (e.g., depreciation and prepaid expenses).  Tax shelters, C corporations,
    partnerships that have C corporations as partners, and certain trusts must use
    the accrual method of accounting.  Individuals and many businesses may use
    the cash method of accounting, however.  The cash method may be used by
    small businesses, qualified personal service corporations, and certain farm
    and timber interests (discussed under "Agriculture" above).

    A small business is a business with average annual gross receipts of $10
    million or less for the three preceding tax years.  Qualified personal service
    corporations are employee-owned service businesses in the fields of health,
    law, accounting, engineering, architecture, actuarial science, performing arts,
    or consulting.

    	Impact

    For tax purposes, most individuals and many businesses use the cash
    method of accounting because it is less burdensome than the accrual method
    of accounting.  The revenue losses mainly benefit the owners of smaller
    businesses and professional service corporations of all sizes.

    	Rationale

    Individuals and many businesses are allowed  to use the cash method of
    accounting because it generally requires less record-keeping than other
    methods of accounting.

    According to the Revenue Act of 1916, a taxpayer may compute income
    for tax purposes using the same accounting method used to compute income
    for business purposes.  The Internal Revenue Code of 1954 allowed taxpayers
    to use a combination of accounting methods for tax purposes.  The Tax
    Reform Act of 1986 prohibited tax shelters, C corporations, partnerships that
    have C corporations as partners, and certain trusts from using the cash method
    of accounting.

    	Assessment

    The choice of accounting methods may affect the amount and timing of a
    taxpayer's Federal income tax payments.  Under the accrual method, income
    for a given period is more clearly matched with the expenses associated with
    producing that income.  Therefore, the accrual method more clearly reflects a
    taxpayer's net income for a given period.  For business purposes, the accrual
    method also provides a better indication of a firm's economic performance for
    a given period.

    Under the cash method of accounting, taxpayers have greater control over
    the timing of receipts and payments.  By shifting income or deductions from
    one tax year to another, taxpayers can defer the payment of income taxes or
    take advantage of lower tax rates.  On the other hand, because of its relative
    simplicity, the cash method of accounting involves lower costs of compliance.
     The cash method is also the method most familiar to the individuals and
    businesses to whom its use is largely confined.

    	Selected Bibliography

    Tinsey, Frederick C.  "Many Accounting Practices Will Have to be
    Changed as a Result of the Tax Reform Act," Taxation for Accountants, v.
    38.  January 1987, pp. 48-52.
    U.S. Congress, Joint Committee on Taxation.  Tax Reform Proposals:
    Accounting Issues, Committee Print, 99th Congress, 1st session. September
    13, 1985.
    -. Technical Explanation of S.3152, The "Community Renewal and New
    Markets Act of 2000."  JCX-105-00, October 2000, p. 77.
    -. Technical Explanation of the "Economic Security and Worker
    Assistance Act of 2002."  JCX-6-02, February 13, 2002,  p. 62.
    -, General Explanation of Tax Legislation Enacted in the 107th Congress.
    JCS-1-03, January 2003, pp. 240-242.
    U.S. Department of the Treasury.  Announcement 2002-45.  Revenue
    Procedure 2002-14.  April 12, 2002.
    U.S. Department of the Treasury.  Internal Revenue Service.  Accounting
    Periods and Methods.  Publication 538.  2004.

    Commerce and Housing:
    Other Business and Commerce

    EXCLUSION OF INTEREST ON
    STATE AND LOCAL GOVERNMENT SMALL-ISSUE
    QUALIFIED PRIVATE ACTIVITY BONDS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.3

    0.1

    0.4

    2007

    0.3

    0.1

    0.4

    2008

    0.3

    0.1

    0.4

    2009

    0.4

    0.1

    0.5

    2010

    0.4

    0.1

    0.5

    Authorization

    Sections 103, 141, 144, and 146.

    	Description

    Interest income on State and local bonds used to finance business loans of
    $1 million or less for construction of private manufacturing facilities is tax
    exempt.  These small-issue industrial development bonds (IDBs) are
    classified as private-activity bonds rather than governmental bonds because a
    substantial portion of their benefits accrues to individuals or business rather
    than to the general public.  For more discussion of the distinction between
    governmental bonds and private-activity bonds, see the entry under General
    Purpose Public Assistance: Exclusion of Interest on Public Purpose State
    and Local Debt.

    The $1 million loan limit may be raised to $10 million ($20 million in
    certain economically distressed areas) if the aggregate amount of related
    capital expenditures (including those financed with tax-exempt bond
    proceeds) made over a six-year period is not expected to exceed $20 million.
    The bonds are subject to the State private-activity bond annual volume cap.

    	Impact

    Since interest on the bonds is tax exempt, purchasers are willing to accept
    lower before-tax rates of interest than on taxable securities.  These low
    interest rates enable issuers to offer loans to manufacturing businesses at
    reduced interest rates.

    Some of the benefits of the tax exemption also flow to bondholders.  For a
    discussion of the factors that determine the shares of benefits going to
    bondholders and business borrowers, and estimates of the distribution of tax-
    exempt interest income by income class, see the "Impact" discussion under
    General Purpose Public Assistance: Exclusion of Interest on Public Purpose
    State and Local Debt.

    	Rationale

    The first bonds for economic development were issued without any Federal
    restrictions.  State and local officials expected that reduced interest rates on
    business loans would increase investment and jobs in their communities.  The
    Revenue and Expenditure Control Act of 1968 imposed several targeting
    requirements, limiting the tax exempt bond issue to $1 million and the
    amount of capital spending on the project to $5 million over a six-year period.
     The Revenue Act of 1978 increased the $5 million limit on capital
    expenditures to $10 million, and to $20 million for projects in certain
    economically distressed areas.  The American Jobs Creation Act of 2004
    (P.L. 108-357) increased the related expenditures limit to $20 million for all
    qualified projects.

    Several tax acts in the 1970s and early 1980s denied use of the bonds for
    specific types of business activities.  The Deficit Reduction Act of 1984
    restricted use of the bonds to manufacturing facilities, and limited any one
    beneficiary's use to $40 million of outstanding bonds.  The annual volume of
    bonds issued by governmental units within a State first was capped in 1984,
    and then included by the Tax Reform Act of 1986 under the unified volume
    cap on private-activity bonds.  This cap is equal to the greater of $80 per
    capita or $246.6 million in 2006.  The cap has been adjusted for inflation
    since 2003.

    Small-issue IDBs long had been an "expiring tax provision" with a sunset
    date.   IDBs first were scheduled to sunset on December 31, 1986 by the Tax
    Equity and Fiscal Responsibility Act of 1982.  Additional sunset dates have
    been adopted three times when Congress has decided to extend small-issue
    IDB eligibility for a temporary period. The Omnibus Budget Reconciliation
    Act of 1993 made IDBs permanent.  The American Jobs Creation Act of
    2004 increased the total capital expenditure limitation from $10 million to
    $20 million for small-issue IDBs.  Congress, at the time, thought it was
    appropriate because the $10 million limit had not been changed for many
    years.

    	Assessment

    It is not clear that the Nation benefits from these bonds.  Any increase in
    investment, jobs, and tax base obtained by communities from their use of
    these bonds probably is offset by the loss of jobs and tax base elsewhere in
    the economy.  National benefit would have to come from valuing the
    relocation of jobs and tax base from one location to another, but the use of the
    bonds is not targeted to a subset of geographic areas that satisfy explicit
    Federal criteria such as income level or unemployment rate.  Any jurisdiction
    is eligible to utilize the bonds.

    As one of many categories of tax-exempt private-activity bonds, small-
    issue IDBs have increased the financing costs of bonds issued for public
    capital.  With a greater supply of public bonds, the interest rate on bonds
    necessarily increases to lure investors.  In addition, expanding the availability
    of tax-exempt bonds also increases the assets available to individuals and
    corporations to shelter their income from taxation.

    	Bibliography

    Anderson, John E., and Robert W. Wassmer.  Bidding for Business: The
    Efficacy of Local Economic Development Incentives in a Metropolitan Area.
    Kalamazoo, MI: W.E. Upjohn Institute for Employment Research, 2000, pp.
    1-24.
    Maguire, Steven.  Private Activity Bonds: An Introduction.  Library of
    Congress, Congressional Research Service Report RL31457.  June 9, 2006.
    -.  Tax-Exempt Bonds: A Description of State and Local Government
    Debt.  Library of Congress, Congressional Research Service Report
    RL30638.  March 10, 2006.
    Stutzer, Michael J.  "The Statewide Economic Impact of Small-Issue
    Industrial Development Bonds," Federal Reserve Bank of Minneapolis
    Quarterly Review, v. 9.  Spring 1985, pp. 2-13.
    Temple, Judy.  "Limitations on State and Local Government Borrowing for
    Private Purposes." National Tax Journal, vol 46, March 1993, pp. 41-53.
    U.S. Congress, Congressional Budget Office.  Statement of Donald B.
    Marron before the Subcommittee on Select Revenue Measures Committee on
    Ways and Means U.S. House of Representatives.  "Economic Issues in the
    Use of Tax-Preferred Bond Financing," March 16, 2006.
    U.S. Congress, Congressional Budget Office.  The Federal Role in State
    Industrial Development Programs, 1984.

    -.  Small Issue Industrial Revenue Bonds, April 1981.
    U.S. Congress,  Joint Committee on Taxation, Present Law and
    Background Related to State and Local Government Bonds, Joint Committee
    Print JCX-14-06, March 16, 2006.
    Zimmerman, Dennis.  The Private Use of Tax-Exempt Bonds: Controlling
    Public Subsidy of Private Activity.  Washington, DC: The Urban Institute
    Press, 1991.
    -.  "Federal Tax Policy, IDBs and the Market for State and Local Bonds,"
    National Tax Association--Tax Institute of America Symposium: Agendas for
    Dealing with the Deficit, National Tax Journal, v. 37.  September 1984, pp.
    411-420.

    Commerce and Housing:
    Other Business and Commerce

    EXCEPTION FROM NET OPERATING LOSS LIMITATIONS
    FOR CORPORATIONS IN BANKRUPTCY PROCEEDINGS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    -

    0.6

    0.6

    2007

    -

    0.6

    0.6

    2008

    -

    0.6

    0.6

    2009

    -

    0.6

    0.6

    2010

    -

    0.6

    0.6

    Authorization

    Section 382(l)(5).

    Description

    In general, net operating losses of corporations may be carried back three
    years or carried forward fifteen years to offset taxable income in those years.
    If one corporation acquires another, the tax code has rules to determine
    whether the acquiring corporation inherits the tax attributes of the acquired
    corporation, including its net operating loss carryforwards, or whether the tax
    attributes of the acquired corporation disappear.

    The acquiring corporation will inherit the tax attributes of the acquired
    corporation if the transaction qualifies as a tax-free reorganization.  To qualify
    as a reorganization, the acquired corporation must essentially (or largely)
    continue in operation but in a different form.  The owners of the acquired
    corporation must become owners of the acquiring corporation, and the
    business of the acquired corporation must be continued.  An example is a
    merger of one corporation into another by exchanging stock of the acquiring
    corporation for stock of the acquired corporation.

    While net operating loss carryforwards from an acquired corporation may
    be used to offset taxable income of the acquiring corporation after a
    reorganization, limitations are imposed.  In general, the amount of income of
    the acquiring corporation that may be offset each year is determined by
    multiplying the value of the stock of the acquired corporation immediately
    before the ownership change by a specified long-term interest rate.

    The purpose of the limitation is to prevent reorganized corporations from
    being able to absorb net operating loss carryforwards more rapidly than an
    approximation of the pace at which the acquired corporation would have
    absorbed them had it continued in existence.

    If certain conditions are met, subsection 382(l)(5) provides an exception to
    the general limitation on net operating loss carryforwards for cases in which
    the acquired corporation was in bankruptcy proceedings at the time of the
    acquisition.  In this case (unless the corporation elects otherwise), the
    limitation on net operating loss carryforwards does not apply.  In some cases,
    however, certain adjustments are made to the amount of loss carryforwards of
    the acquired corporation that may be used by the successor corporation.

    Impact

    Section 382(l)(5) allows the use of pre-acquisition net operating loss
    carryforwards in circumstances in which they could not be used, in most
    cases, under the general rule.

    The general rule determines the amount of the carryforwards which may be
    used to offset income based on the equity value of the acquired corporation at
    the time of acquisition.  But most corporations in bankruptcy have zero or
    negative equity value.  Hence, absent this exception, their successor
    corporations would be denied use of any of the carryovers.

    Rationale

    The rationale for the bankruptcy exception to the limitation on net
    operating loss carryovers is that the creditors of the acquired corporation who
    become shareholders in the bankruptcy reorganization may have, in effect,
    become the owners before the reorganization and borne some of the losses of
    the bankrupt corporation.  In this case, the effective owners of the acquired
    corporation become owners of the acquiring corporation even though an
    ownership change appears to have occurred.  Limitations are imposed to
    prevent abusive transactions.

    Assessment

    While the rationale for the provision is reasonable, the exception is not
    structured to be fully consistent with the rationale.  There is no test to
    determine what portion, if any, of the preacquisition net operating loss
    carryforwards was borne by creditors who became shareholders.

    Selected Bibliography

    Peaslee, James M., and Lisa A. Levy.  "Section 382 and Separate
    Tracking," Tax Notes.  September 28, 1992, pp. 1779-1790.
    U.S. Congress, Joint Committee on Taxation.  General Explanation of the
    Tax Reform Act of 1986.  100th Congress, 1st session, May 4, 1987, pp.
    288-327.
    U.S. Senate, Committee on Finance.  The Subchapter C Revision Act of
    1985.  99th Congress, 1st session, May 1985.

    Commerce and Housing
    Other Business and Commerce

    TAX CREDIT FOR EMPLOYER-PAID
    FICA TAXES ON TIPS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.3

    0.2

    0.5

    2007

    0.4

    0.2

    0.6

    2008

    0.4

    0.2

    0.6

    2009

    0.4

    0.2

    0.6

    2010

    0.5

    0.3

    0.8

    	Authorization

    Section 45B.

    	Description

    All employee tip income is treated as employer-provided wages for
    purposes of the Federal Unemployment Tax Act (FUTA) and the Federal
    Insurance Contributions Act (FICA).  For purposes of the minimum wage
    provisions, the reported tips are treated as employer-provided wages to the
    extent they do not exceed one-half of the minimum wage rate.

    A general business tax credit (Section 38) is provided for food or beverage
    establishments in an amount equal to the employer's FICA tax obligation
    attributable to reported tips in excess of those treated as wages for purposes of
    satisfying the minimum wage provisions of the Fair Labor Standards Act.
    Tips taken into account are those received from customers in connection with
    the providing, delivering, or serving of food or beverages for consumption if
    the tipping of employees delivering or serving food or beverages by
    customers is customary.  A deduction is not permitted for any amount taken
    into account in determining the credit.  Unused FICA credits may not be
    carried back to any taxable year which ended before the date of enactment.

    The U.S. Supreme Court held on June 17, 2002, that the Internal Revenue
    Service (IRS) may use the aggregate estimation method to calculate a
    restaurant's FICA tax liability for unreported tip income.  The Supreme
    Courts' decision rested on whether the law authorized the IRS to base the
    FICA assessment upon its aggregate estimate of all tips paid to its employees,
    or whether the law required IRS to determine total tip income by determining
    each individual employee's tip income separately, then adding those
    determinations together.  The Supreme Court found that IRS could use an
    estimate as long as the method used was reasonable.

    Impact

    The provision lessens the cost to business firms that serve food and
    beverages for a portion of the employer's portion of their employee's Social
    Security taxes.  The tax credit operates to reduce tax liability, but not to less
    than zero because the credit is non-refundable as a general business credit.
    However, the credit may be carried back to tax years ending after August 10,
    1993 and forward for 15 years.

    The direct beneficiaries of this provision are food and beverage operators.
    Some believe that prior law had the unintended effect of employers
    discouraging the reporting of all tip income by their employees so as to reduce
    the employer's Social Security tax payments.  To the extent that tip income is
    not reported, both income and Social Security tax revenues are reduced.
    Current law poses no additional tax burdens on food and beverage operators
    for complete reporting of tip income.  To the extent that tips are reported and
    Social Security taxes paid, employees may be eligible for larger payments
    from the Social Security system when they retire.

    	Rationale

    The credit for employer-paid FICA taxes on tips was first provided by the
    Omnibus Budget Reconciliation Act of 1993 (P.L. 101-508).  The provision
    was not included in the House bill nor in the Senate's amendment.  The
    provision appeared and was included in the Conference Committee report
    without a rationale being offered.  Popular press reports indicated that the
    purpose was to soften the impact on the restaurant industry for the reduction
    of the deductible amount of business meals from 80 to 50 percent also
    included in that act.

    A provision included in the Small Business Job Protection Act of 1996
    (P.L. 104-188) made modifications to the effective date and extended the
    provision to employees delivering food or beverages.  (Prior law provided the
    credit only for tips earned on the premises of an establishment.)  The
    legislative history of these changes indicates an intent to change the effective
    date and that the Treasury's interpretation was not consistent with the
    provision as adopted.  The Ways and Means committee report stated that it
    was appropriate "to apply the credit to all persons who provide food and
    beverages, whether for consumption on or off the premises."

    Assessment

    It is generally argued that tip income is earnings and should be treated the
    same as other forms of compensation.  Waiters and waitresses as well as
    delivery persons are not self-employed individuals and their tip income is part
    of their total compensation.  Thus, tips are seen as a surrogate wage that
    employers might have to pay in their absence.  It is argued that all employers
    should share equally in the costs of future benefits their employees will
    receive under the Social Security program.

    Because Social Security taxes are determined with respect to the entire
    amount of earnings (including tip income), current law in effect provides a
    benefit only to food and beverage employers whose employees receive part of
    their compensation in the form of tips.  Even other businesses whose
    employees receive a portion of their compensation in the form of tip income
    (such as cab drivers, hairdressers, etc.) are barred from use of this tax credit.
    Thus, the provision violates the principle of horizontal equity.  Since all other
    employers pay Social Security taxes on the entire earnings of their employees,
    it may place them at a competitive disadvantage.  For example, a carry-out
    food concern where tipping is not usual pays the full costs of Social Security
    taxes while a sit-down diner does not.  In effect, a portion of the Social
    Security taxes paid by food and beverage employers reduces business income
    taxes.  To the extent business taxes are reduced, funds are taken from federal
    tax receipts to fund future Social Security benefits. Thus, taxpayers at large
    are paying a portion of the Social Security taxes of those firms using the
    employer tip tax credit.

    The restaurant industry maintains that tip income is not a wage but a gift
    between their employees and the customers that they serve.  They also
    contend that if the tip income is seen as compensation, then they should be
    able to count all tip income in determining the minimum wage (current law
    allows only one-half the minimum wage to be counted from tip income).  The
    industry argues that having to report the tip income of their employees places
    large administrative costs upon their operations and has shifted the burdens of
    reporting and collection from the individual to the restaurant.

    	Selected Bibliography

    Allen, Robin Lee. "FICA Troubles are Back:  Operators Arm for Fight"
    Nation's Restaurant News, vol. 28, January 31, 1994, pp. 1, 52.
    Bennett, Alison.  "IRS to Resume Employer-Only Tip Audits; Agency
    Expanding Tip Reporting Program," Daily Tax Report, Bureau of National
    Affairs, Inc., No. 82, April 27, 2000, pp. GG-1-GG-2.
    Crowson, Christopher. "Service with a Chagrin: The Problem of Aggregate
    Estimates of Unreported Tips in the United States v. Fior D'Italia, Inc.," The
    Campbell Law Review, vol. 25, no. 93, Fall 2002, pp. 93-114.
    Donovan, Jeremiah  S.  "Tax-Exempt Organizations and Claiming the Tip
    Credit," Tax Adviser, vol. 30, August 1999, pp. 552-553.
    Erickson, Jennifer M. "Fior D'Italia: The "Taxing" Problem of Unreported
    Tip Income," Iowa Law Review, vol. 88, no. 655, March 2003, pp. 655-679.
    Fesler, Dan R. and Larry Maples.  "Fior D'Italia: Supreme Court Approves
    Aggregate Method on Tips," Taxes, vol. 80, no. 11, November 2002, pp. 53-
    59.
    McInnes, John T. "Internal Revenue - IRS Aggregate Estimates of
    Unreported Employee Tip Income to Determine Employer FICA Liability
    Now Constitutional - United States v. Fior D'Italia, Inc.," Suffolk Journal of
    Trail and Appellate Advocacy, vol. 8, 2003, pp. 179-188.
    Myers, Robert J.  "Social Security in the Pork Barrel:  The Restaurateurs
    Try To Raid the Treasury,"  Tax Notes, v 59, April 19, 1993.  p. 427-428.
    Peckron, Harold S. "The Tip Police: Aftermath of the Fior D'Italia Rule,"
    Catholic University Law Review, vol. 52, no. 1, Fall 2002, pp. 1-36.
    Raby, Burgess J.W. and William L. Raby.  "The War on Unreported Cash
    Tips," Tax Notes, vol. 81, November 2, 1998, pp. 605-609.
    Rosenthal, Ellin.  "IRS, Restaurateurs Clash Over FICA Credit on Tip
    Income," Tax Notes, vol. 63, April 4, 1994.  Pp. 16-17.
    Sher, David Lupi.  "Forces are Mounting Against IRS's Tip Income
    Policies," Tax Notes, vol. 84, August 2, 1999, pp. 675-680.
    Simpson, Glenn R.  "Special Delivery; Pizza Makers' Success On Tax
    Break Reveals a Slice of Political Life; Bet Before 1994 Elections Paid Off
    Big After GOP Took Control of Congress; Roots in Health-Care Debate,"
    Wall Street Journal, September 9, 1996, pp. A1, A7.
    Suelzer, Ray.  "IRS Hopes to Get Employee TIP Reporting on `TRAC',"
    Taxes, vol. 73, August 1995, pp. 463-467.
    U.S. Congress, Congressional Budget Office.  Budget Options.  "Replace
    the Income Tax Credit with a Business Deduction for Employer FICA on
    Certain Tip Income."  Washington, DC: February 2001, p. 436.
    U.S. Congress, Joint Committee on Taxation.  "Present Law and
    Background Relating to the Tax Treatment of Tip Income."  Washington,
    DC: July 13, 2004, pp. 1-7.
    Wolf, Kelley.  "IRS May Collect Employment Taxes on Aggregated
    Amount of Unreported Tip Income," Taxes, vol. 78, June 2000, pp. 35-38.

    Commerce and Housing:
    	Other Business and Commerce

     PRODUCTION ACTIVITY DEDUCTION

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.9

    2.7

    3.6

    2007

    1.3

    3.9

    5.2

    2008

    1.8

    5.5

    7.3

    2009

    2.0

    5.9

    7.9

    2010

    2.6

    7.4

    10.0

    H.R. 6111 (December 2006) increased the cost by $0.1 billion in
    FY2007 and FY 2006.

    Authorization

    Section 199.

    Description

    Qualified production activities income is allowed a deduction from taxable
    income of 3% in 2005-2006, 6% in 2007-2009, and 9% thereafter.  The
    deduction cannot exceed total taxable income of the firm and is limited to
    50% of wages related to the qualified activity.

    Production property is property manufactured, produced, grown or
    extracted within the United States.  Eligible property also includes domestic
    film, energy, and construction, and engineering and architectural services.
    For the latter, the services must be produced in the United States for
    construction projects located in the United States.  The law specifically
    excludes the sale of food and beverages prepared at a retail establishment,
    transmission and distribution of electricity, gas, and water, and receipts from
    property leased, licensed, or rented to a related party.  The benefits are also
    allowed for Puerto Rico for 2007 and 2008.

    There are rules that allow the allocation of the deduction to pass through
    entities and cooperatives.  The provision also allows the revocation without
    penalty of a prior election to treat timber cutting as the sale of a capital asset.
    The deduction is also allowed under the alternative minimum tax.  The tax
    expenditure is the tax savings due to the deduction.

    Impact

    This provision lowers the effective tax rate on the favored property, in most
    cases when fully phased in, from the top corporate tax rate of 35% to 31.85%.
     The deduction is available to both corporations and unincorporated
    businesses, but primarily benefits corporations.  For the many proprietorships
    that have few or no employees, the benefit will be limited or absent because
    of the wage requirement unless the firm incorporates.

    In a letter dated September 22, 2004 to Mark Prator and Patrick Heck,
    responding to a query about the similar (although slightly different) Senate
    version of the provision, the Joint Tax Committee indicated that three quarters
    of the benefit would have gone to corporations, 12 percent would have gone
    to Subchapter S firms (smaller incorporated firms that elect to be treated as
    partnerships) and cooperatives, 9 percent would have gone to partnerships,
    and 4 percent to sole proprietorships.  Based on the revenue estimates ($3
    billion for 2006) and projected corporate tax receipts of $249 billion for that
    year, the implication is that around a third of corporate activity qualifies.

    The beneficial treatment given to income from these activities will
    encourage more investment in manufacturing and other production activities
    and less in sales and services.  It will also encourage more equity investment
    in the affected sectors.

    	Rationale

    This provision was enacted as part of the American Jobs Creation Act of
    2004 (P.L. 108-357), a bill that repealed the Extraterritorial Income provision
    that was found to be an unacceptable export subsidy by the World Trade
    Organization.  The stated purpose was to enhance the ability of firms to
    compete internationally and to create and preserve manufacturing jobs.

    The Tax Increase Prevention Act of 2006 modified the provision by
    clarifying that wages for purposes of the deduction limit were those relating to
    domestic production activities.  H.R. 6111 (December 2006) added the
    benefit for Puerto Rico.

    Assessment

    The provision should somewhat expand the sector qualifying for the
    benefit and contract other sectors. It will introduce some inefficiency into the
    economy by diverting investment into this area, although it will also primarily
    lower the burden on corporate equity investment which is more heavily taxed
    than other forms of investment and among qualifying firms reduce the
    incentive for debt finance.  This latter effect would product an efficiency gain.

    Economists in general do not expect that there is a need to use tax
    incentives to create jobs in the long run because job creation occurs naturally
    in the economy.  Nor can tax provisions permanently affect the balance of
    trade, since exchange rates would adjust.

    There has been concern about the difficulty in administering a tax
    provision that provides special benefits for a particular economic activity.
    Firms will have an incentive to characterize their activities as eligible and to
    allocate as much profit as possible into the eligible categories.  A number of
    articles written by tax practitioners and letters written to the Treasury indicate
    that many issues of interpretation have arisen relating to the definition of
    qualified activity, treatment of related firms, and specific products such as
    computer software and films and recording.  Canada had adopted a similar
    provision several years ago and repealed it because of the administrative
    complications.

    	Selected Bibliography

    Deloitte Tax LLP. "Producing Results: An Analysis of the New Production
    Activities Deduction," Tax Notes, February 21, 2005, pp. 961-984.
    Dilley, Steven C. and Fred Jacobs, "The Qualified Production Activities
    Deduction: Some Planning Tools," Tax Notes, July 4, 2005, pp. 87-98.
    Gravelle, Jane G.  Comparison of Tax Incentives for Domestic
    Manufacturing in Current Legislative Proposals. Library of Congress,
    Congressional Research Service Report RL32103,  Washington, DC: October
    1, 2004.
    Jenks, Carl M. "Domestic Production Deduction: FAQs and a Few
    Answers," Tax Notes, August 28, 2006, pp. 751-757.
    Rojas, Warren.  "New Manufacturing Deduction Presents Many Open
    Questions." Tax Notes, October 18, 2004, pp. 279-280.
    U.S. Congress, House, Conference Report on the American Jobs Creation
    Act, Report 108-77, Washington, DC: U.S. Government Printing Office,
    2004.

    Commerce and Housing:
    Other Business and Commerce

    DEDUCTION OF CERTAIN FILM AND TELEVISION
    PRODUCTION COSTS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    (1)

    0.1

    0.1

    2007

    (1)

    0.1

    0.1

    2008

    (1)

    0.1

    0.1

    2009

    (1)

    (1)

    (1)

    2010

    (1)

    (1)

    (1)

    (1) Less than $50 million.

    Authorization

    Section 181.

    Description

    The cost of producing films and television programs must be depreciated
    over a period of time using the income forecast method (which allows
    deductions based on the pattern of expected earnings).  This provision allows
    production costs for qualified film and television shows to be deducted when
    incurred.  Eligible productions are restricted to those with a cost of $15
    million or less ($20 million if produced in certain designated low income
    areas) and in which at least 75 percent of the compensation is for services
    performed in the United States.  The provision expires after 2008.  Only the
    first 44 episodes of a television series qualify, and sexually explicit
    productions are not eligible.

    Impact

    Expensing provides a benefit because deductions can be taken earlier.  For
    example, at a seven percent interest rate, the value of taking a deduction
    currently is 40 percent greater than taking a deduction five years from now
    (1+.07)5.  The benefit is greatest per dollar of investment for those
    productions whose expected income is spread out over a long period of time
    and whose production period is lengthy.  This provision  encourages film and
    television producers to locate in the United States and counters the growth in
    so-called "runaway" production.

    The dollar ceiling targets the benefit to smaller productions.  The average
    cost of producing a movie for theatrical release in 2003 (by members of the
    Motion Picture Association of America) was $63.8 million, so that many of
    these movie productions would not qualify.  One study found that made-for-
    television  movies and mini-series, in particular,  have experienced relocation
    abroad, and that most of this business has gone to Canada.  Many countries,
    including Canada, provide subsidies for production.

     	Rationale

    This provision was enacted as part of the American Jobs Creation Act of
    2004 (P.L. 108-357).  The purpose was to discourage the "runaway"
    production of film and television production to other countries, where tax and
    other incentives are often offered.

    Assessment

    This provision will provide an incentive to remain in the United States, at
    least for firms that are  profitable enough to have tax liability.  The magnitude
    of the benefit depends on the average lag time from production to earning
    income.  If that lag is five years and the discount rate is seven percent, for
    example, the value of the deduction is increased by 40 percent, and with a 35-
    percent tax rate, the reduction in cost would be about 14 percent.   If the
    average lag is only a year, the reduction is slightly over two percent.

    In general, special subsidies to industries and activities tend to lead to
    inefficient allocation of resources.  Moreover, in the long run, providing
    subsidies to counter those provided by other countries will not necessarily
    improve circumstances, unless they induce both parties to reduce or eliminate
    their subsidies. At the same time, individuals who have specialized in film
    and television production are harmed when production shifts to other
    countries, and the disruption can be significant when caused through
    provision of large subsidies or tax incentives.

    Because tax subsidies cannot benefit firms that do not have tax liability, the
    scope of this provision may be narrower than would be the case with a direct
    subsidy.

    	Selected Bibliography

    Beer, Steen C. and Maria Miles, "Relief Effort," Filmmaker Magazine,
    Winter 2005, http://www.filmmakermagazine.com/winter2005/
    line_items/relief_effort.php
    Monitor Corporation, U.S. Runaway Film and Television Production Study
    Report, Prepared for the Screen Actors Guild and Directors Guild of America,
    Cambridge MA, 1999.
    Moore, Schuyler M.  "Film-Related Provisions of the American Jobs
    Creation Act," Tax Notes, December 20, 2204, pp. 1667-1671.
    Motion Picture Association of America.  Worldwide Market Research, U.S.
    Entertainment Industry: 2003 MPA Market Statistics, 2004.
    U.S. Congress, House, Conference Report on the American Jobs Creation
    Act, Report 108-77, Washington, DC: U.S. Government Printing Office,
    2004.
    U.S. Department of Commerce. The Migration of U.S. Film and Television
    Production: Impact of "Runaways" on Workers and Small Business in the
    U.S. Film Industry, January 18,2001.

    	Commerce and Housing:
    	Other Business and Commerce

    	TAX CREDIT FOR THE COST OF CARRYING TAX-PAID
    	DISTILLED SPIRITS IN WHOLESALE INVENTORIES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    --

    (1)

    (1)

    2007

    --

    (1)

    (1)

    2008

    --

    (1)

    (1)

    2009

    --

    (1)

    (1)

    2010

    --

    (1)

    (1)

    (1)Less than $50 million.

    	Authorization

    Section 5011.

    	Description

    This credit applies to domestically bottled distilled spirits purchased
    directly from the bottler (distilled spirits that are imported in bulk and then
    bottled domestically also qualify for the credit) .  The credit is calculated by
    multiplying the number of cases of bottled distilled spirits by the average tax
    financing cost per case for the most recent calender year ending before the
    beginning of the taxable year.  A case is 12, 80-proof 750-milliliter bottles.
    The average tax-financing cost per case is the amount of interest that would
    accrue at corporate overpayment rates during an assumed 60-day holding
    period on an assumed tax rate of $25.68 per case.

    	Impact

    The excise tax on distilled spirits is imposed when distilled spirits are
    removed from the plant where they are produced.  In the case of imported
    distilled spirits that are bottled, the excise tax is imposed when they are
    removed from a U.S. customs bonded warehouse.  For distilled spirits
    imported in bulk containers for bottling in the United States, the excise tax is
    imposed in the same way as for domestically produced distilled spirits, when
    the bottled distilled spirits are removed from the bottling plant.

    The current federal excise tax rate on distilled spirits is $13.50 per proof
    gallon.

    Assuming an interest rate in the range of 5 to 6 percent, the tax credit will
    save wholesalers approximately $0.25 a case or $0.02 per bottle of distilled
    spirit.

    	Rationale

    The tax credit is intended to help equalize the differential costs associated
    with wholesaling domestically produced distilled spirits and imported distilled
    spirits.  Under current law, wholesalers are not required to pay the federal
    excise tax on bottled imported spirits until the spirits are removed from a
    bonded warehouse and sold to a retailer.  The federal tax on domestically
    produced distilled spirits, however, is passed forward as part of the purchase
    price when the distiller transfers the product to the wholesaler.  It is argued
    that this raises the cost of domestically distilled spirits to wholesalers relative
    to the cost of bottled imported spirits.  The credit is designed to compensate
    the wholesaler for the foregone interest that could have been earned on the
    funds that were used to pay the excise taxes on the domestically produced
    distilled spirits being held in inventory.

    	Assessment

    Under current law, tax credits are not allowed for the costs of carrying
    products in inventory on which an excise tax has been levied.  Normally, the
    excise tax that is included in the purchase price of an item is deductible as a
    cost when the item is sold.

    Allowing wholesalers a tax credit for the interest costs (or float) of holding
    excise tax-paid distilled confers a tax benefit to the wholesalers of distilled
    spirits that is not available to other businesses that also carry tax-paid
    products in inventory.  For instance, wholesalers of beer and wine also hold
    excise tax-paid products in their inventories and are engaged in similar
    income producing activities as wholesalers of distilled spirits, but beer and
    wine wholesalers are not eligible for this tax credit.

    In addition, given the relatively small size of the credit, the credit is
    unlikely to have much effect on price differentials between domestically
    produced distilled spirits and imported distilled spirits.  The credit is also
    unlikely to produce much tax savings for small wholesalers.  It is likely that
    most of the tax benefits of this credit will accrue to large volume wholesalers
    of distilled spirits.

    	Selected Bibliography

    U.S. Congress, Joint Committee on Taxation.  Summary Description of the
    "Highway Reauthorization and Excise Tax Simplification Act of 2005," Title
    V of H.R. 3, as Passed by the Senate on May 17, 2005.  JCX-41-05, June 13,
    2005, pp. 9-10.
    -, Committee of Conference.  Safe, Accountable, Flexible, Efficient
    Transportation Equity Act:  A Legacy for Users.  Report 109-203, July 28,
    2005, pp. 1132-1133.

    Commerce and Housing:
    Other Business and Commerce

    TAX BENEFITS RELATED TO 2005 HURRICANE DISASTER
    COSTS: EXPENSING OF CLEAN-UP COSTS, ADDITIONAL
    FIRST YEAR DEPRECIATION, CARRYBACK OF LOSSES; TAX
    CREDIT FOR EMPLOYEE RETENTION

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    (1)

    0.1

    0.1

    2007

    (1)

    0.1

    0.1

    2008

    (1)

    0.1

    0.1

    2009

    (1)

    (1)

    (1)

    2010

    (1)

    (1)

    (1)

    (1) Less than $50 million.

    H.R. 6111 (December 2006) increased the cost by $0.2 billion in
    FY2009 and FY2010.

    Authorization

    Section 1400N.

    Description

    Several provisions provide special allowances for deducting costs relating
    to businesses in the Gulf Opportunity Zone (GO Zone), an area of the
    Hurricane Katrina official disaster area (which caused significant damage to
    the Gulf Coast, including New Orleans,  in August of 2005).  An employee
    retention tax credit is provided for areas affected by subsequent Hurricanes
    Wilma and Rita, affecting the Gulf Coast and Florida, as well as Katrina.  The
    GO Zone is also the core disaster area designated by the Federal Emergency
    Management Authority (FEMA) and covers the southern part of Louisiana
    and Mississippi, and southwestern counties in Alabama.

    The cost of demolition of buildings and the removal of some debris is
    normally added to the basis of land which is not depreciable;  50% of the
    costs of this nature incurred in the GO Zone after August 28, 2005 and
    through 2007 may be deducted.   Taxpayers are also allowed to deduct 50%
    of the cost of investment in depreciable property (machinery, equipment, and
    buildings), with the remaining property depreciated under normal rules.
    Property qualifying must commence original use in the GO Zone (used
    property qualifies if not previously used in the GO Zone) and must be related
    to an active trade or business in the Zone.  Property must be placed in service
    after August 28, 2005, and before the end of 2007 for equipment and before
    the end of 2010 for buildings.

    Several provisions increase loss carryback allowances.  Generally firms
    with losses can carry back losses two years to offset against prior year income,
    and forward for 20 years.  Certain losses attributable to a disaster can be
    treated as if they occurred in the previous taxable year.  A three year
    carryback is provided for individual casualty losses and for farming
    businesses or small businesses in a disaster area.  Farming losses can be
    carried back five years.  For the GO Zone, casualty losses for public utilities,
    up to the amount of any net operating loss, may be carried back 10 years, and
    public utility casualty losses in general may be treated as if they occurred in
    the fifth previous year (effectively a five-year carryback position).  For all
    businesses, losses attributable to casualty, moving expense for employees,
    temporary housing for employees, depreciation and repairs, up to the current
    net operating loss can be carried back five years.

    Employers are allowed a credit of 40% of up to $6,000 of qualified wages
    for employees retained in the Katrina, Rita, and Wilma zone areas, during the
    period a business is inoperable.

    Impact

    The expensing, bonus depreciation, and carryback provisions allow
    taxpayers to obtain the tax benefit earlier than would otherwise be the case.
    For example, at a seven percent interest rate, the value of taking a deduction
    currently is 40 percent greater than taking a deduction five years from now
    (1+.07)5.  The benefit is greatest per dollar of cost or investment the more
    delayed the benefit.  For taxpayers who hold property for a long period of
    time, for example, the deduction for the clean-up costs will not occur until far
    in the future when the property is sold.  Bonus depreciation is more valuable
    for long-lived assets, such as buildings.  The loss carryback provisions are
    particularly important for local business in the disaster area where businesses
    are less likely to be currently profitable.  These provisions encourage
    employers to make investments and restore property in the disaster area, as
    well as providing financial relief for businesses with losses due to the
    Hurricane.

    The wage credit encourages and aids employers in keeping employees on
    the payroll who cannot perform their jobs because the business is not
    operating.

     	Rationale

    The wage retention credit was initially enacted in the Katrina Emergency
    Tax Relief Act of 2005, passed in September shortly after the Katrina
    disaster.  Most of the objective of this initial legislation was to provide tax
    relief for victims of the disaster.  The wage credit was limited to employers
    with fewer than 200 employees.  The Gulf  Opportunity Zone Act of 2005
    extended the wage credit to areas affected by Hurricanes Rita and Wilma, and
    eliminated the employee cap. This latter action, in December 2005, also
    provided the expensing, bonus depreciation, and carry-back provisions.  This
    act was more specifically directed at rebuilding the disaster area by providing
    targeted subsidies to business.  H.R. 6111 (December 2006) extended the
    placed in service date for buildings, originally through 2008, through 2010.

    Assessment

    These provisions will provide some incentive to clean up property and
    invest in the targeted area.  It will also afford relief for employers who retain
    workers as well as an incentive to do so.  The evidence based on previous
    studies of enterprise zone provisions targeted at poor areas does not indicate
    that tax incentives are very successful.  However, experience in a low-income
    area, usually of a city, may not provide sufficient evidence on the effects in a
    much larger geographic area composed of higher and lower income areas that
    is affected by a major disaster.  It is difficult to determine how effective these
    provisions are or may be.

    The extended loss provisions are likely to be important to providing any
    other tax subsidies since many firms are likely to be unprofitable in the short
    run.  Applying bonus depreciation to buildings yields a much larger cost
    reduction than for equipment, since depreciation for buildings occurs over 39
    years for commercial structures and 27.5 for residential structure.
    Depreciation for equipment is typically five to seven years.  The inclusion of
    buildings may be particularly important for New Orleans and to a disaster
    area where buildings were destroyed.

    In general, special subsidies to industries and activities tend to lead to
    inefficient allocation of resources and the argument can be made that market
    forces should be relied upon to determine what rebuilding should take place.
    At the same time, one can make the case that all taxpayers should assist in
    recovery of an area affected by such a large scale disaster, as a part of national
    risk-spreading.

    	Selected Bibliography

    Gravelle, Jane G. "Tax Incentives in the Aftermath of Hurricane Katrina,"
    Municipal Finance Journal, v. 26, Fall 2005, pp. 1-13.
    Gravelle, Jane, Tax Policy Options After Hurricane Katrina, Library of
    Congress, Congressional Research Service Report RL33088, October 23,
    2006.
    Internal Revenue Service, Information for Taxpayers Affected by
    Hurricanes Katrina, Wilma and Rita, Publication 4492, January 1, 2006.
    Richardson, James A.  "Katrina/Rita: The Ultimate Test for Tax Policy?"
    National Tax Journal, v. 59, September 2006, pp.551-560.
    Stoker, Robert P. and Michael J. Rich.   Lessons and Limits: Tax
    Incentives and Rebuilding the Gulf Coast After Katrina, Metropolitan Policy
    Program, Washington, DC: The Brookings Institution, August 2006.
    U.S. Congress, Joint Committee on Taxation, Technical Explanation of the
    Revenue Provisions of H.R. 4400, The Gulf Opportunity Zone Act of 2005, As
    Passed by the House of Representatives and the Senate, JC88-05,
    Washington, DC, December 16, 2005.

    	Transportation

    EXCLUSION OF INTEREST ON STATE AND LOCAL
    GOVERNMENT BONDS FOR HIGHWAY PROJECTS AND
    RAIL-TRUCK TRANSFER FACILITIES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    (1)

    (1)

    (1)

    2007

    (1)

    (1)

    (1)

    2008

    (1)

    (1)

    (1)

    2009

    (1)

    (1)

    (1)

    2010

    (1)

    (1)

    (1)

    (1) Less than $50 million.

    	Authorization

    Sections 103, 141, 142, and 146.

    	Description

    The Safe, Accountable, Flexible, Efficient Transportation Equity Act: A
    Legacy for Users, P.L. 109-59, enacted on August 10, 2005, created a new
    class of tax-exempt, qualified private activity bonds for the financing of
    qualified highway or surface freight transfer facilities.  Qualified facilities
    include: (1) any surface transportation project which receives federal
    assistance under title 23; (2) any project for an international bridge or tunnel
    for which an international entity authorized under federal or State law is
    responsible and which receives federal assistance under title 23; and (3) any
    facility for the transfer of freight from truck to rail or rail to truck (including
    any temporary storage facilities directly related to such transfers) which
    receives federal assistance under title 23 or title 49.  The bonds used to
    finance these facilities are classified as private-activity bonds rather than
    governmental bonds because a substantial portion of the benefits generated by
    the project(s) accrue to individuals or business rather than to the government.
     For more discussion of the distinction between governmental bonds and
    private-activity bonds, see the entry under General Purpose Public
    Assistance: Exclusion of Interest on Public Purpose State and Local Debt.

    Bonds issued for qualified highway or surface freight transfer facilities are
    not subject to the federally imposed  annual State volume cap on private-
    activity bonds.  The bonds are capped, however, by a national limitation of
    $15 billion to be allocated at the discretion of Secretary of Transportation.

    	Impact

    Since interest on the bonds is tax exempt, purchasers are willing to accept
    lower before-tax rates of interest than on taxable securities.  These low-
    interest rates allow issuers to construct highway or surface freight transfer
    facilities at lower cost.  Some of the benefits of the tax exemption and federal
    subsidy also flow to bondholders.  For a discussion of the factors that
    determine the shares of benefits going to bondholders and users of the
    highway or surface freight transfer facilities, and estimates of the distribution
    of tax-exempt interest income by income class, see the "Impact" discussion
    under General Purpose Public Assistance: Exclusion of Interest on Public
    Purpose State and Local Debt.

    	Rationale

    Before 1968, State and local governments were allowed to act as conduits
    for the issuance of tax-exempt bonds to finance privately owned and operated
    facilities.  The Revenue and Expenditure Control Act of 1968 (RECA 1968),
    however, imposed tests that restricted the issuance of these bonds.  The Act
    provided a specific exception which allowed issuance for specific projects
    such as non-government-owned docks and  wharves.  Intermodal facilities are
    similar in function to docks and wharves, yet were not included in the original
    list of qualified facilities.  The addition of truck-to-rail and rail-to-truck
    intermodal projects to the list of qualified private activities in 2005 is
    intended enhance the efficiency of the nation's long distance freight transport
    infrastructure.  With more efficient intermodal facilities, proponents suggest
    that long distance truck traffic will shift from government financed interstate
    highways to privately owned long distance rail transport.

    	Assessment

    State and local governments tend to view these facilities as potential
    economic development tools.  The desirability of allowing these bonds to be
    eligible for tax-exempt status hinges on one's view of whether the users of
    such facilities should pay the full cost, or whether sufficient social benefits
    exist to justify federal taxpayer subsidy.  Economic theory suggests that to the
    extent these facilities provide social benefits that extend beyond the
    boundaries of the State or local government, the facilities might be
    underprovided due to the reluctance of State and local taxpayers to finance
    benefits for nonresidents.

    Even if a case can be made for a federal subsidy arising from
    underinvesting at the State and local level, it is important to recognize the
    potential costs.  As one of many categories of tax-exempt private-activity
    bonds, those issued for transfer facilities increase the financing cost of bonds
    issued for other public capital.  With a greater supply of public bonds, the
    interest rate on the bonds necessarily increases to lure investors.  In addition,
    expanding the availability of tax-exempt bonds increases the assets available
    to individuals and corporations to shelter their income from taxation.

    	Selected Bibliography

    Frittelli, John.  Intermodal Connectors: A Method for Improving
    Transportation Efficiency?  Library of Congress, Congressional Research
    Service Report RL31887.  May 3, 2003.
    Frittelli, John.  Intermodal Rail Freight: A Role for Federal Funding?
    Library of Congress, Congressional Research Service Report RL31834.
    August 18, 2004.
    Maguire, Steven.  Private Activity Bonds: An Introduction.  Library of
    Congress, Congressional Research Service Report RL31457.  June 9, 2006.
    -.  Tax-Exempt Bonds: A Description of State and Local Government
    Debt.  Library of Congress, Congressional Research Service Report
    RL30638.  March 10, 2006.
    Zimmerman, Dennis.  The Private Use of Tax-Exempt Bonds: Controlling
    Public Subsidy of Private Activity.  Washington, DC: The Urban Institute
    Press, 1991.

    Transportation

    TAX CREDIT FOR
    CERTAIN RAILROAD TRACK MAINTENANCE

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    -

    0.1

    0.1

    2007

    -

    0.1

    0.1

    2008

    -

    0.1

    0.1

    2009

    -

    0.1

    0.1

    2010

    -

    (1)

    (1)

    (1) Less than $50 million.

    Authorization

    Section 45G.

    Description

    Qualified railroad track maintenance expenditures paid or incurred in a
    taxable year by eligible taxpayers are eligible for a 50-percent business tax
    credit. The credit is limited to $3,500 times the number of miles of railroad
    track owned or leased by an eligible taxpayer. Railroad track maintenance
    expenditures are amounts, which may be either repairs or capitalized costs,
    spent to maintain railroad track (including roadbed, bridges, and related track
    structures) owned or leased as of January 1, 2005, by a Class II or Class III
    railroad. Eligible taxpayers are smaller (Class II or Class III) railroads and any
    person who transports property using these rail facilities or furnishes property
    or services to such a person.

    The taxpayer's basis in railroad track is reduced by the amount of the credit
    allowed (so that any deduction of cost or depreciation is only on the cost net
    of the credit).   The credit cannot be carried back to years before 2005.  The
    credit covers expenditures from 2005-2007.

    For 2005-2008 the amount eligible is the gross expenditures not taking into
    account reductions such as discounts or loan forgiveness.

    Impact

    This provision substantially lowers the cost of track maintenance for the
    qualifying short line (regional) railroads, with tax credits covering half the
    costs for those firms and individuals with sufficient tax liability.  According
    to the Federal Railroad Administration, as of the last survey in 1993, these
    railroads accounted for 25% of the nation's rail miles.  These regional
    railroads are particularly important in providing transportation of agricultural
    products.

     	Rationale

    This provision was enacted as part of the American Jobs Creation Act of
    2004 (P.L. 108-357).  While no official rationale was provided in the bill,
    sponsors of earlier free-standing legislation and industry advocates indicated
    that the purpose was to encourage the rehabilitation, rather than the
    abandonment, of short line railroads, which were spun off in the deregulation
    of railroads in the early 1980s.  Advocates also indicated that this service is
    threatened by heavier 286,000-pound cars that must travel on these lines
    because of inter-connectivity.  They also suggested that preserving these local
    lines will reduce local truck traffic. These is also some indication that a tax
    credit was thought to be more likely to be achieved than grants.

    The temporary provision relating to discounts was added by H.R. 6111
    (December 2006).

    Assessment

    The arguments stated by the industry advocates and sponsors of the
    legislation are also echoed in assessments by the Federal Railroad
    Administration (FRA), which indicated the need for rehabilitation and
    improvement, especially to deal with heavier cars.  The FRA also suggested
    that these firms have particular difficulty with access to bank loans.

    In general, special subsidies to industries and activities tend to lead to
    inefficient investment allocation since in a competitive economy businesses
    should earn enough to maintain their capital.  Nevertheless it may be judged
    or considered desirable to subsidize rail transportation in order to reduce the
    congestion and pollution of highway traffic.  At the same time, a tax credit
    may be less suited to remedy the problem than a direct grant since firms
    without sufficient tax liability cannot use the credit.

    	Selected Bibliography

    Prater, Marvin, The Long Term Viability of Short Line and Regional
    Railroads.  U.S. Department of Agriculture, Agricultural Marketing Services,
    Washington, DC, July 1998.
    U.S. Congress, House, Conference Report on the American Jobs Creation
    Act, Report 108-77, Washington, DC: U.S. Government Printing Office,
    2004.
    U.S. Department of Transportation, Federal Railroad Administration.
    Need for Railroad Rehabilitation and Improvement Financing.  Available
    http://www.fra.dot.gov/us/home.

    Transportation

    DEFERRAL OF TAX ON CAPITAL CONSTRUCTION
    FUNDS OF SHIPPING COMPANIES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    -

    0.1

    0.1

    2007

    -

    0.1

    0.1

    2008

    -

    0.1

    0.1

    2009

    -

    0.1

    0.1

    2010

    -

    (1)

    (1)

    (1)Less than $50 million.

    Authorization

    Section 7518.

    Description

    U.S. operators of vessels in foreign, Great Lakes, or noncontiguous
    domestic trade, or in U.S. fisheries, may establish a capital construction fund
    (CCF) into which they may make certain deposits.  Such deposits are
    deductible from taxable income, and income tax on the earnings of the
    deposits in the CCF is deferred.

    When tax-deferred deposits and their earnings are withdrawn from a CCF,
    no tax is paid if the withdrawal is used for qualifying purposes, such as to
    construct, acquire, lease, or pay off the indebtedness on a qualifying vessel.
    A qualifying vessel must be constructed or reconstructed in the United States,
    and any lease period must be at least five years.

    The tax basis of the vessel (usually its cost to the owner), with respect to
    which the operator's depreciation deductions are computed, is reduced by the
    amount of such withdrawal.  Thus, over the life of the vessel tax depreciation
    will be reduced, and taxable income will be increased by the amount of such
    withdrawal, thereby reversing the effect of the deposit.  However, since gain
    on the sale of the vessel and income from the operation of the replacement
    vessel may be deposited into the CCF, the tax deferral may be extended.

    Withdrawals for other purposes are taxed at the top tax rate.  This rule
    prevents firms from withdrawing funds in loss years and escaping tax entirely.
     Funds cannot be left in the account for more than 25 years.

    Impact

    The allowance of tax deductions for deposits can, if funds are continually
    rolled over, amount to a complete forgiveness of tax.  Even when funds are
    eventually withdrawn and taxed, there is a substantial deferral of tax that
    leads to a very low effective tax burden.  The provision makes investment in
    U.S.-constructed ships and registry under the U.S. flag more attractive than it
    would otherwise be.  Despite these benefits, however, there is very little (in
    some years, no) U.S. participation in the worldwide market supplying large
    commercial vessels.

    The incentive for construction is perhaps less than it would otherwise be,
    because firms engaged in international shipping have the benefits of deferral
    of tax through other provisions of the tax law, regardless of where the ship is
    constructed.  This provision is likely to benefit higher-income individuals
    who are the primary owners of capital (see Introduction for a discussion).

    Rationale

    The special tax treatment originated to ensure an adequate supply of
    shipping in the event of war.  Although tax subsidies of various types have
    been in existence since 1936, the coverage of the subsidies was expanded
    substantially by the Merchant Marine Act of 1970.

    Before the Tax Reform Act of 1976 it was unclear whether any investment
    tax credit was available for eligible vessels financed in whole or in part out of
    funds withdrawn from a CCF.  The 1976 Act specifically provided (as part of
    the Internal Revenue Code) that a minimum investment credit equal to 50
    percent of an amount withdrawn which was to purchase, construct, or
    reconstruct qualified vessels was available in 1976 and subsequent years.

    The Tax Reform Act of 1986 incorporated the deferral provisions directly
    into the Internal Revenue Code.  It also extended benefits to leasing, provided
    for the minimum 25-year period in the fund, and required payment of the tax
    at the top rate.

    Assessment

    The failure to tax income from the services of shipping normally
    misallocates resources into less efficient uses, although it appears that the
    effects on U.S. large commercial shipbuilding are relatively small.

    There are two possible arguments that could be advanced for maintaining
    this tax benefit.  The first is the national defense argument - that it is
    important to maintain a shipping and shipbuilding capability in time of war.
    This justification may be in doubt today, since U.S. firms control many
    vessels registered under a foreign flag and many U.S. allies control a
    substantial shipping fleet and have substantial ship-building capability that
    might be available to the U.S.

    There is also an argument that subsidizing domestic ship-building and
    flagging offsets some other subsidies - both shipbuilding subsidies that are
    granted by other countries, and the deferral provisions of the U.S. tax code
    that encourage foreign flagging of U.S.-owned vessels.  Economic theory
    suggests, however, that efficiency is not necessarily enhanced by introducing
    further distortions to counteract existing ones.

    Selected Bibliography

    Jantscher, Gerald R.  Chapter VI- "Tax Subsidies to the Maritime
    Industries," Bread Upon The Waters: Federal Aids to the Maritime
    Industries.  Washington, DC: The Brookings Institution, 1975.
    Madigan, Richard E.  Taxation of the Shipping Industry. Centreville, MD:
    Cornell Maritime Press, 1982.
    U.S. Congress, Joint Committee on Taxation.  General Explanation of the
    Tax Reform Act of 1986, Committee Print, 99th Congress, 2nd session.  May
    4, 1987, pp. 174-176.
    U.S. Department of Treasury.  Tax Reform for Fairness, Simplicity, and
    Economic Growth, Volume 2, General Explanation of the Treasury
    Department Proposals.  November, 1974, pp. 128-129.

    Transportation

    	EXCLUSION OF EMPLOYER-PAID
    	TRANSPORTATION BENEFITS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    4.2

    -

    4.0

    2007

    4.3

    -

    4.2

    2008

    4.4

    -

    4.3

    2009

    4.5

    -

    4.4

    2010

    4.7

    -

    4.5

    	Authorization

    Section 132(f).

    	Description

    The value of transit passes provided directly by the employer can be
    excluded from employees' income, subject to a monthly limit.  This limit was
    set at $100 per month for 2001.  Each year the limit is adjusted for inflation,
    and the adjustment is rounded to the nearest $5.  In 2006, the limit was $105
    per month.  A similar exclusion applies to van pools.  The limit applies to the
    total of van pool costs and transit passes.

    The value of employer-provided parking facilities can be excluded from
    employee's income, subject to a monthly limit.  This limit was set to $175 per
    month in 1998, and the limit is adjusted for inflation each year.  The limit was
    increased to $205 in 2006.

    The employers may choose to provide these benefits in cash, subject to a
    compensation reduction arrangement.

    	Impact

    Exclusion from taxation of transportation fringe benefits provides a subsidy
    to employment in those businesses and industries in which such fringe
    benefits are common and feasible.  The subsidy provides benefits both to the
    employees (more are employed and they receive higher compensation) and to
    their employers (who have lower wage costs).  To the extent that this
    exemption induces employees to use mass transportation and to the extent that
    mass transportation reduces traffic congestion, this exemption lowers
    commuting costs.

    The parking exclusion is more likely to benefit higher income individuals
    than the mass transit and van pool subsidies.  For those individuals receiving
    benefits, the savings rise with marginal tax rate.  The value of the benefit also
    depends on the location of the employer: the provision is targeted towards the
    taxpayers working in the urbanized areas or other places where transit is
    available or parking space is limited.

    	Rationale

    A statutory exclusion for the value of parking was introduced in 1984,
    along with exclusions for a number of other fringe benefits.  In many cases,
    these practices had been long established and generally had been treated by
    employers, employees, and the Internal Revenue Service as not giving rise to
    taxable income.

    Employees clearly receive a benefit from the availability of free or
    discounted goods or services, but the benefit may not be as great as the full
    amount of the discount.  In enacting these provisions, Congress also wanted
    to establish limits on the use of tax-free fringe benefits.  Prior to enactment of
    the provisions, the Treasury Department had been under a congressionally
    imposed moratorium on issuance of regulations defining the treatment of
    these fringes.  There was a concern that without clear boundaries on use of
    these fringe benefits, new approaches could emerge that would further erode
    the tax base and increase inequities among employees in different businesses
    and industries.

    The Comprehensive Energy Policy Act of 1992 placed a dollar ceiling on
    the exclusion of parking facilities and introduced the exclusions for mass
    transit facilities and van pools in order to encourage mass commuting, which
    would in turn reduce traffic congestion and pollution.

    In 1998 the Transportation Equity Act for the 21st Century increased the
    benefits' limits to their current levels and modified their phase-in periods and
    inflation adjustment rules.  It also allowed employees to elect cash in lieu of
    transit benefits.

    Assessment

    The exclusion subsidizes employment in those businesses and industries in
    which transportation fringe benefits are feasible and commonly used.
    Because the exclusion applies to practices which are common and may be
    feasible only in some businesses and locations, it creates inequities in tax
    treatment among different employees and employers.  One problem with
    taxing directly supplied fringe benefits, such as free or reduced price parking,
    is the administrative difficulty in determining fair market value.

    Subsidies for mass transit and van pools, and for parking when provided
    primarily for car pools, encourage use of mass transportation and may reduce
    congestion and pollution.  Reductions in commuting costs due to congestion
    benefit commuters generally.  If these subsidies induce commuters to use
    modes of transportation which impose fewer external costs on others, such as
    through traffic congestion, then economic efficiency is enhanced.  If these
    subsidies induce employees to make trips they otherwise would not make, the
    overall economic benefit depends on how the increase in personal gain
    compares to the external costs generated by such trips.

    	Selected Bibliography

    Hevener, Mary B.  "Energy Act Changes to Transportation Benefits, Travel
    Expenses, and Backup Withholding."  The Tax Executive, November-
    December 1992, pp. 463-466.
    Kies, Kenneth J.  "Analysis of the New Rules Governing the Taxation of
    Fringe Benefits," Tax Notes, v. 38.  September 3, 1984, pp. 981-988.
    McKinney, James E.  "Certainty Provided as to the Treatment of Most
    Fringe Benefits by Deficit Reduction Act," Journal of Taxation.  September
    1984, pp. 134-137.
    Sunley, Emil M., Jr.  "Employee Benefits and Transfer Payments,"
    Comprehensive Income Taxation, ed. Joseph A. Pechman.  Washington, DC:
    The Brookings Institution, 1977, pp. 90-92.
    Turner, Robert W.  "Fringe Benefits," in The Encyclopedia of Taxation
    and Tax Policy (2nd ed.), eds. Joseph J. Cordes, Robert O. Ebel, and Jane G.
    Gravelle.  Washington, DC: Urban Institute Press, 2005.
    U.S. Congress, House.  Comprehensive National Energy Policy Act,
    Report 102-474, 102d Congress, 2d Session, May 5, 1992.
    -, Joint Committee on Taxation.  General Explanation of the Revenue
    Provisions of the Deficit Reduction Act of 1984.  Committee Print, 98th
    Congress, 2nd session.  December 31, 1984, pp. 838-866.
    -, Joint Committee on Taxation.  Estimated Budget Effects of the
    Conference Agreement Relating to the Transportation Revenue and Trust
    Fund Provisions of H.R. 2400 (Title IX). JCX-43-98.  May 22, 1998.
    -, Senate Committee on Finance.  Fringe Benefits, Hearings, 98th
    Congress, 2nd session.  July 26, 27, 30, 1984.

    Internal Revenue Service.  Employer's Tax Guide to Fringe Benefits For
    Benefits Provided in 2006. Publication 15-B, revised December 2005.
    -, Revenue Procedure 2003-85, December 8, 2003.
    -, Final Regulation (T.D. 8933) on Qualified Transportation Fringe
    Benefits, January 11, 2001.
    Hevener, Mary B.  "Energy Act Changes to Transportation Benefits, Travel
    Expenses, and Backup Withholding."  The Tax Executive, November-
    December 1992, pp. 463-466.
    Kies, Kenneth J.  "Analysis of the New Rules Governing the Taxation of
    Fringe Benefits," Tax Notes, v. 38.  September 3, 1984, pp. 981-988.
    McKinney, James E.  "Certainty Provided as to the Treatment of Most
    Fringe Benefits by Deficit Reduction Act," Journal of Taxation.  September
    1984, pp. 134-137.
    Sunley, Emil M., Jr.  "Employee Benefits and Transfer Payments,"
    Comprehensive Income Taxation, ed. Joseph A. Pechman.  Washington, DC:
    The Brookings Institution, 1977, pp. 90-92.
    Turner, Robert.  "Fringe Benefits,"  in The Encyclopedia of Taxation and
    Tax Policy, eds. Joseph J. Cordes, Robert O. Ebel, and Jane G. Gravelle.
    Washington, DC: Urban Institute Press, 1999.
    U.S. Congress, House.  Comprehensive National Energy Policy Act,
    Report 102-474, 102d Congress, 2d Session, May 5, 1992.
    -, Joint Committee on Taxation.  General Explanation of the Revenue
    Provisions of the Deficit Reduction Act of 1984.  Committee Print, 98th
    Congress, 2nd session.  December 31, 1984, pp. 838-866.
    -, Joint Committee on Taxation.  Estimated Budget Effects of the
    Conference Agreement Relating to the Transportation Revenue and Trust
    Fund Provisions of H.R. 2400 (Title IX). JCX-43-98.  May 22, 1998.
    -, Senate Committee on Finance.  Fringe Benefits, Hearings, 98th
    Congress, 2nd session.  July 26, 27, 30, 1984.
    Internal Revenue Service.  Employer's Tax Guide to Fringe Benefits For
    Benefits Provided in 2004. Publication 15-B, revised January 2004.
    -, Revenue Procedure 2003-85, December 8, 2003.
    -, Final Regulation (T.D. 8933) on Qualified Transportation Fringe
    Benefits, January 11, 2001.

    Community and Regional Development

    NEW YORK CITY LIBERTY ZONE TAX INCENTIVES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    -0.1

    0.4

    0.3

    2007

    0.2

    0.2

    0.4

    2008

    0.1

    0.1

    0.2

    2009

    0.2

    (1)

    0.1

    2010

    0.1

    -0.1

    0.0

    (1) Negative tax expenditure of less than $50 million.

    Authorization

    Section 1400L.

    	Description

    The "Liberty Zone" (the Zone) is generally defined as the area in lower
    Manhattan in New York City that was directly affected by the September 11,
    2001 terrorist attacks.  Specifically, the Zone "...is the area located on or
    south of Canal Street, East Broadway (east of its intersection with Canal
    Street), or Grand Street (east of its intersection with East Broadway) in the
    Borough of Manhattan in the City of New York, New York."  The tax
    incentives include expansion of the Work Opportunity Tax Credit (WOTC)
    for small employers in the Zone, accelerated depreciation for Zone
    businesses, increased private-purpose tax-exempt bond capacity for New
    York (Liberty bonds and special one-time advance refunding); and more
    favorable tax treatment of gains realized from the replacement of property in
    the Zone.  In 2004, P.L. 108-311 extended the Liberty bond program through
    January 1, 2010 and extended the additional advance refunding allowance for
    bonds financing property in the Zone through January 1, 2006.

    	Impact

    The tax benefits will likely reduce the tax burden on businesses in the
    Zone, and some of these benefits will be passed from the business owners in
    the Zone to their customers and investors.  The impact on the Zone itself will
    be positive as business investment shifts to liberty zone businesses, their
    workers, and customers.  The impact across metropolitan New York region
    will probably be less noticeable as most investment in the Zone is likely to be
    shifted from planned investment in neighboring areas.  Some investment in
    the Zone, however, may represent new investment.

    	Rationale

    The "New York City Liberty Zone Tax Incentives" were created by the
    "Job Creation and Worker Assistance Act of 2002" (P.L. 107-147).  After the
    September 11, 2001 terrorist attacks, the livelihood of businesses and workers
    in lower Manhattan was severely tested.  The Federal Reserve Bank of New
    York (FRBNY) estimated the total cost of the September 11th attack to be
    between $33 billion and $36 billion through June 2002.  The same FRBNY
    study estimated that, as a result of the September 11 attacks,  the number of
    people working in New York City's private sector fell by 51,000 in October
    2001 and fell another 41,000 in the period between November 2001 and
    March 2002.  The Liberty Zone tax incentives are designed to address the
    relatively severe economic shock that affected the lower Manhattan region.
    Congressional leaders hope that these benefits will help lure investors into
    lower Manhattan as well as retain businesses and workers that may otherwise
    emigrate away from lower Manhattan.

    	Assessment

    The benefit of expanding the WOTC eases the tax burden on employers in
    the Zone who hire qualified new workers.  The effectiveness of WOTC,
    however, may be limited by the relative cost and complexity of administrative
    compliance.  For more on the WOTC, see the entry in this volume titled:
    "Work Opportunity Tax Credit."  The accelerated depreciation provision for
    Zone businesses will lower the cost of capital but only through deferral of the
    tax that would have been due under the normal depreciation schedule.
    Businesses that use the bonus depreciation will pay less taxes today, but the
    tax burden in the future will be slightly higher as depreciation expenses are
    smaller than they would have otherwise been (note the negative tax
    expenditure in 2009 and 2010).  The tax benefit, therefore, is the present
    value of the tax deferred.  The accelerated depreciation may induce some
    firms in the Zone to invest in new capital, however, the magnitude of the
    impact of the incentive is uncertain.  For more on accelerated depreciation for
    business property, see the entry in this volume titled: "Expensing of
    Depreciable Business Property."

    Increased tax-exempt bond capacity for projects in New York City will
    lower the cost of capital for qualified projects.  The additional public
    infrastructure spending induced by the increased capacity will likely benefit
    businesses and workers in the Zone.  Many economists, however, would
    argue that the new public investment would replace new private investment.
    Nevertheless, the subsidy responds to the relatively unique characteristics of
    the disruption caused by the September 11 attacks.  For more on the subsidy
    for tax-exempt bonds, see the entry in this volume titled: "Exclusion of
    Interest on State and Local Small-Issue Industrial Development Bonds."  The
    favorable tax treatment of gains realized from the replacement of property in
    the Zone will benefit property owners that replace property damaged in the
    Liberty Zone.  Generally, only property owners can benefit from this
    provision because renters are not eligible.  For more on this provision, see the
    entry in this volume titled: "Deferral of Gain on Involuntary Conversions
    Resulting from Presidentially-Declared Disaster."

    Generally, these geographic benefits induce investors to shift investment
    spending rather than generate new investment spending.  Thus, the localized
    tax incentives redistribute tax revenue and investment from all federal
    taxpayers to taxpayers in the Zone.  From a national perspective, the
    economic benefit of geographically based incentives is not clear.  However,
    taxpayers in the Zone are likely better off with the incentives.

    	Selected Bibliography

    Bram, Jason, "New York City's Economy Before and After September
    11," Federal Reserve Bank of New York: Current Issues in Economics and
    Finance, February 2003.
    Bram, Jason, James Orr and Carol Rappaport.  "Measuring the Effects of
    the September 11 Attack on New York City."  Federal Reserve Bank of New
    York Economic Policy Review, November 2002.
    Chernick, Howard, and Andrew F. Haughwout, "Tax Policy and the Fiscal
    Cost of Disasters: NY and 9/11," National Tax Journal, v. 59, September
    2006, pp.561-578.
    Glaeser, Edward L. and Jesse M. Shapiro.  "Cities and Warfare: The
    Impact of Terrorism on Urban Form."  NBER Working Paper Series 8696,
    National Bureau of Economic Research, December 2001.
    Maguire, Steven.  Private Activity Bonds: An Introduction.  Library of
    Congress, Congressional Research Service Report RL31457.  November 10,
    2004.
    New York City Independent Budget Office, "Despite Economic Upturn,
    City Still Faces Budget Shortfalls," Fiscal Outlook, Dec. 2003.
    Thompson, William C., "NYC Outperforms the Nation in 1Q04 - First
    Time Since 4Q99,"Economic Notes, v. 12, no. 2, June 2004.
    U.S. Congress, Joint Committee on Taxation.  Technical Explanation of
    the Job Creation and Worker Assistance Act of 2002, (JCX 12-02), March 6,
    2002.

    U.S. General Accounting Office, Tax Administration: Information is Not
    Available to Determine Whether $5 Billion in Liberty Zone Tax Benefits Will
    be Realized.  Report GAO-03-1102, October 2003.
    Wildasin, David.  "Local Public Finance in the Aftermath of September
    11."  Journal of Urban Economics, v. 51 (March 2002), pp. 225-237.

    Community and Regional Development

    EMPOWERMENT ZONE TAX INCENTIVES,
    DISTRICT OF COLUMBIA TAX INCENTIVES,
    AND INDIAN RESERVATION TAX INCENTIVES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.3

    0.7

    1.0

    2007

    0.4

    0.7

    1.1

    2008

    0.4

    0.5

    0.9

    2009

    0.4

    0.5

    0.9

    2010

    0.2

    0.3

    0.5

    Source: U.S. Congress, Joint Committee on Taxation, Estimated Revenue
    Effects Of H.R. 4297, The "Tax Relief Extension Reconciliation Act Of 2005,"
    As Reported By The Committee On Ways And Means, JCX-81-05, November
    18, 2005.  H.R. 6111 (December 2006) increased the cost for Fiscal Years
    2007-2009 by $0.6, $0.4, and $0.1, and reduced it by $0.1 in
     FY2010.

    	Authorization

    Sections 38(b), 39(d),45A, 168(j), 280C(a), 1391-1397D, 1400-1400B.

    	Description

    Empowerment Zone (EZ) and Enterprise Community (EC) tax incentives
    were originally created by the Omnibus Budget Reconciliation Act of 1993
    and expanded by the Taxpayer Relief Act  of 1997 (TRA).  The EZ/EC
    program was expanded again by the Community Renewal Act of 2000.  That
    act also harmonized the eligibility rules for EZs/ECs and created a new
    geography-based tax incentive program for so-called Renewal Communities
    (RC).   There are currently authorized 40 EZs (30 urban and 10 rural), 95 ECs
    (65 urban and 30 rural), and 40 RCs (28 urban and 12 rural).  The District of
    Columbia EZ was also authorized in the TRA and is afforded the same tax
    incentives as the other EZs.  The DC Enterprise Zone incentives were
    extended through December 31, 2005 by P.L. 108-311 and through 2007 by
    H.R. 6111 (December 2006).

    Designated areas must satisfy eligibility criteria including poverty rates and
    population and geographic size limits; they will be eligible for benefits
    through December 31, 2009.

    For empowerment zones, the tax incentives include a 20 percent employer
    wage credit for the first $15,000 of wages for zone residents who work in the
    zone, $35,000 in expensing of equipment in investment (in addition to the
    amount allowed generally) in qualified zone businesses, and expanded tax
    exempt financing for certain zone facilities, primarily qualified zone
    businesses.

    In addition, qualified public schools in enterprise communities and
    empowerment zones are allowed access to qualified zone academy bonds
    (QZABs).  QZABs are bonds designated for school modernization and
    renovation where the federal government offers annual tax credits to the
    bondholders in lieu of interest payments from the issuer.  The Federal
    Government is effectively paying the interest on the bonds for the state or
    local governments.  For more on QZABs, see the tax expenditure entry "Tax
    Credit for Holders of Qualified Zone Academy Bonds" under the Education,
    Training, Employment, and Social Services heading.

    Businesses in RC are allowed a 15 percent wage credit on the first $10,000
    of wages for qualified workers and an additional $35,000 in capital
    equipment expensing.  These qualified businesses are also allowed partial
    deductibility of qualified buildings placed in service.  Renewal community
    tax benefits are available through December 31, 2009.

    Enterprise communities receive only the tax exempt financing benefits.
    Tax exempt bonds for any one community cannot exceed $3 million and
    bonds for any one user cannot exceed $20 million for all zones or
    communities.  Businesses eligible for this financing are subject to limits that
    target businesses operating primarily within the zones or communities.

    Businesses on Indian reservations are eligible for accelerated depreciation
    and for a credit for 20 percent of the cost of the first $20,000 of wages (and
    health benefits) paid by the employer to tribal members and their spouses, in
    excess of eligible qualified wages and health insurance cost payments made in
    1993.  These benefits are available for wages paid, and for property placed in
    service before December 31, 2007.

    In 1997 several tax incentives for the District of Columbia were adopted: a
    wage tax credit of $3,000 per employee for wages paid to a District resident,
    tax-exempt bond financing, and additional first-year expensing of equipment.
     These apply to areas with poverty rates of 20 percent or more.  There is also a
    zero capital gains rate for business sales in areas with 10 percent poverty
    rates.  Those provisions were available through December 31, 2007.  (A
    credit for first-time home buyers adopted at that time is discussed under the
    Commerce and Housing heading.)

    	Impact

    Both businesses and employees within the designated areas may benefit
    from these provisions.  Wage credits given to employers can increase the
    wages of individuals if not constrained by the minimum wage, and these
    individuals tend to be lower income individuals.  If the minimum wage is
    binding (so that the wage does not change) the effects may show up in
    increased employment and/or in increased profits to businesses.

    Benefits for capital investments may be largely received by business
    owners initially, although the eventual effects may spread to other parts of the
    economy.  Eligible businesses are likely to be smaller businesses because they
    must operate within the designated area.

    	Rationale

    These geographically targeted tax provisions were adopted in 1993,
    although they had been under discussion for some time and had been included
    in proposed legislation in 1992.  Interest in these types of tax subsidies
    increased after the 1992 Los Angeles riots.

    The objective of the subsidies was to revitalize distressed areas through
    expanded business and employment opportunities, especially for residents of
    these areas, in order to alleviate social and economic problems, including
    those associated with drugs and crime.  Some of these provisions are
    temporary and have been extended, most recently in December 2006 by H.R.
    6111.

    Assessment

    The geographically targeted tax provisions should encourage increased
    employment and income of individuals living and working in the zones and
    increased incentives to businesses working in the zones.  The small
    magnitude of the program may be appropriate to allow time to assess how
    well such benefits are working;  current evidence does not provide clear
    guidelines.

    If the main target of these provisions is an improvement in the economic
    status of individuals currently living in these geographic areas, it is not clear
    to what extent these tax subsidies will succeed in that objective.  None of the
    subsidies are given directly to workers; rather they are received by businesses.
     Capital subsidies may not ultimately benefit workers; indeed, it is possible
    that they may encourage more capital intensive businesses and make workers
    worse off.  In addition, workers cannot benefit from higher wages resulting
    from an employer subsidy if the wage is determined by regulation (the
    minimum wage) and already artificially high.  Wage subsidies are more likely
    than capital subsidies to be effective in benefitting poor zone or community
    residents.

     Another reservation about enterprise zones is that they may make
    surrounding communities, that may also be poor, worse off by attracting
    businesses away from them.  And, in general, questions have been raised
    about the target efficiency of provisions that target all beneficiaries in a poor
    area rather than poor beneficiaries in general.

    	Selected Bibliography

    Bondino, Daniele and Robert T. Greenbaum, "Decomposing the Impacts:
    Lessons from a Multistate Analysis of Enterprise Zone Programs," John
    Glenn Working Paper Series, The Ohio State University, Working Paper,
    June 2005.
    Cordes, Joseph J., and Nancy A. Gardner.  "Enterprise Zones and Property
    Values: What We Know (Or Maybe Don't)." National Tax Association
    Proceedings, 94th Annual Conference on Taxation.  Washington, DC:
    National Tax Association, 2002, pp. 279-287.
    Couch, Jim F., and J. Douglas Barrett. "Alabama's Enterprise Zones:
    Designed to Aid the Needy?" Public Finance Review, v. 32, no. 1 (January
    2004), pp. 65-81.
    -,  Keith E. Atkinson, and Lewis H. Smith, "The Impact of Enterprise
    Zones on Job Creation in Mississippi," Contemporary Economic Policy, v.
    23, April, 2005, pp. 255-260.
    Fisher, Peter S., and Alan H. Peters.  "Tax and Spending Incentives and
    Enterprise Zones."  New England Economic Review (March-April 1997), pp.
    109-130.
    Garrison, Larry R.  "Tax Incentives for Doing Business on Indian
    Reservations."  Taxes-The Magazine (May 2002), pp. 39-44.
    Greenbaum, Robert.  "Siting it Right: Do States Target Economic Distress
    When Designating Enterprise Zones?"  Economic Development Quarterly
    (February 2004), pp. 67-80.
    Greenbaum, Robert T. and John B. Engberg, "The Impact of State
    Enterprise Zones on Urban Manufacturing Establishments," Journal of Policy
    Analysis and Management, v. 23, spring 2004, pp. 315-339.
    Hirasuna, Don and Joel Michel, "Enterprise Zones: A Review of the
    Economic Theory and Empirical Evidence, " Policy Brief, Minnesota House
    of Representatives Research Department, January 2005.

    Papke, Leslie. "Enterprise Zones," in The Encyclopedia of Taxation and
    Tax Policy, ed. Joseph J. Cordes, Robert W. Ebel, and Jane G. Gravelle
    (Washington, D.C.: The Urban Institute, 2005).
    - . "What Do We Know About Enterprise Zones?"  In Tax Policy and the
    Economy V. 7, ed. James Poterba, National Bureau of Economic Research,
    Cambridge: MIT Press, 1993.
    Rogers, Cynthia and Jill L. Tao, "Quasi-Experimental Analysis of Targeted
    Economic Development Programs: Lessons from Florida," Economic
    Development Quarterly, v. 18, August 2004, pp. 269-285.
    Stoker, Robert P. And Michael J. Rich.  "Lessons and Limits: Tax
    Incentives and Rebuilding the Gulf Coast After Katrina," The Brookings
    Institution, Survey Series, August 2006.
    Sullivan, Martin A.  D.C.: A Capitalist City?  Arlington, VA: Tax
    Analysts, 1997.
    U.S. Congress, House Committee on Banking, Finance and Urban Affairs,
    Subcommittee on Economic Growth and Credit Formation.  The
    Administration's Empowerment Zone and Enterprise Community Proposal.
    Hearing, 103d Congress, 1st Session, May 27 and June 8, 1993.
    -, Joint Committee on Taxation.  Description of Present Law Regarding
    Tax Incentives for Renewal Communities and Other Economically Distressed
    Areas.  (JCX-40-02), May 20, 2002.
    -, Joint Committee on Taxation.  General Explanation of Tax Legislation
    Enacted in 1997.  105th Congress, 1st Session.  Washington, DC: U.S.
    Government Printing Office, December 17, 1997.
    U.S. Government Accountability Office, Empowerment Zone and
    Enterprise Community Program: Improvements  Occurred in Communities,
    but the Effect of the Program is Unclear, GAO-06-727, September 2006.
    U.S. Department of Housing and Urban Development, Interim Assessment
    of the Empowerment Zones and Enterprise Community (EZ/EC) Program: A
    Progress Report and Appendices, November 2001.
    Wilder, Margaret G. and Barry M. Rubin, "Rhetoric versus Reality: A
    Review of Studies on State Enterprise Zone Programs."  Journal of the
    American Planning Association, v. 62, Autumn, 1996, pp. 473-490.

    Community and Regional Development

    NEW MARKETS TAX CREDIT AND
    RENEWAL COMMUNITY TAX INCENTIVES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.6

    0.4

    1.0

    2007

    0.8

    0.5

    1.3

    2008

    0.9

    0.6

    1.5

    2009

    0.9

    0.5

    1.5

    2010

    0.7

    0.5

    1.2

    H.R. 6111 (December 2006) increased the loss by $0.1 billion
    in FY2008 and $0.2 billion in FY2009.

    Authorization

    Sections 45D, 1400F, 1400H, 1400I, and 1400J.

    	Description

    The New Markets Tax Credit (NMTC) is designed to generate private
    sector equity investment to encourage private sector investment in
    low-moderate income rural and urban communities nationwide. T he NMTC
    is available for investors who invest in community development entities
    (CDEs).  The NMTC is a tax credit for investors equal to 5 percent of their
    initial investment in the calendar year they made the investment.  The credit
    rates remains at 5 percent for the next two years and is then increased to 6
    percent for each of four more years.  The maximum amount of annual
    investment eligible for the credit is $1.5 billion in 2002 and 2003; $2.0 billion
    in 2004 and 2005; and $3.5 billion in 2006 through 2008.

    In contrast to the NMTC, Renewal Community (RC) tax incentives  target
    businesses directly.  The four RC tax incentives for businesses are (1) that
    gains from the sale of assets designated as RC business are taxed at 0 percent,
    (2) that a qualified RC business is eligible for a Federal tax credit worth 15
    percent of the first $10,000 of wages for each qualified employee hired by the
    RC business, (3) that each state can allocate up to $12 million for
    "commercial revitalization expenditures" for businesses in a RC, and (4) that
    RC businesses can claim up to $35,000 in section 179 expensing for qualified
    RC property.

    	Impact

    The NMTC is an investment credit.  Thus investors, who are likely in
    higher income brackets, are the direct beneficiaries.  Business owners are the
    direct beneficiaries of the RC tax incentives.  Business owners, like investors,
    are also likely to fall in higher income brackets.  Nevertheless, the tax
    incentives would likely encourage investment spending in economically
    distressed communities.  The additional investment would indirectly benefit
    the workers and residents of these communities.  A more direct means of
    providing assistance to individuals in distressed communities might entail
    direct aid to individuals.

    	Rationale

    The Renewal Community provisions and the NMTC were enacted by the
    Community Renewal Tax Relief Act of 2000 (P.L. 106-544).  The tax
    incentives in the RC legislation are designed to lower the cost of capital and
    labor for RC businesses relative to non-RC businesses.  Policymakers hope
    the incentives will encourage investment in RC businesses and help lower the
    cost of doing business in Renewal Communities.  The NMTC is designed to
    provide tax relief to investors in economically distressed communities through
    providing a more certain rate of return with fixed credit rates.   H.R. 6111
    (December 2006) extended the RC coverage through 2008 and required that
    non-metropolitan counties receive a proportional allocation.

     	Assessment

    The NMTC program is still relatively new, so an evaluation of the
    program's effectiveness difficult.  The Community Development Financial
    Institutions Fund (the CDFI Fund), which operates the MNTC program,
    reports that as of December 31, 2004, New Markets Tax Credit allocatees had
    raised nearly $1.5 billion in private equity to invest in low income
    communities and invested $1.3 billion of that amount, with 99 percent of the
    funds going into severely distressed communities.  The CDFI also reports that
    the businesses receiving funds are projected to create 3,000 full-time
    equivalent jobs and are projected to develop or rehabilitate 13 million square
    feet of commercial real estate, while generating 33,000 construction jobs.

    The relative size of the credit program, however, may limit its influence on
    economic growth and development in distressed communities.  According to
    a 2002 General Accounting Office (GAO) report, the $15 billion of potential
    new investment over seven years must be assessed against the fact that the
    potential target area includes approximately 35 percent of the U.S. population
    and 40 percent of the land area.  In addition, the fixed credit rate, 5 percent
    for the first three years and 6 percent for the four final years, may not be
    enough to compensate investors for the underlying risk of the principal
    investment.

    The capital gain exclusion for RC businesses may shift investment into the
    RC.  Investors could invest more money in a RC business because the after-
    tax return is higher that for than similar investments in non-RC businesses.
    The higher after-tax return will, in theory, encourage more investment in RC
    businesses, perhaps at the expense of businesses just outside the RC.  The
    employee tax credit for RC businesses may encourage hiring the workers that
    qualify under the program.  The Federal tax credit should lower the per unit
    labor costs of the RC business and may lead to either more workers being
    hired or more hours worked.  The relatively small size of the credit may limit
    the impact on overall employment in the Renewal Community.

    RC businesses that realize a tax savings for rehabilitation expenses
    immediately, rather than over time, potentially encouraging more renovation.
    The RC businesses could decide to renovate because the immediate tax
    savings increases the after-tax rate of return on those expenditures.  In short, a
    tax savings today is worth more than an equal tax savings earned in the
    future.  The accelerated depreciation incentive is similar to the rehabilitation
    tax benefit.  The RC business realizes a tax saving because it can deduct the
    entire cost of the capital equipment (and receive the tax savings) immediately
    rather than in increments spread into the future.  The accelerated depreciation
    should lower the cost of capital and encourage more capital investment by RC
    businesses.

    	Selected Bibliography

    Armistead, P. Jefferson. "New Markets Tax Credits: Issues and
    Opportunities," prepared for the Pratt Institute Center for Community and
    Environmental Development, April 2005.
    Cohen, Ann Burstein.  "Community Renewal Tax Relief's Act's Incentives
    for Investors-Form over Substance?," The Tax Adviser, v. 32, no. 6 (June
    2001), pp. 383-384.
    - . "Renewal Communities," The CPA Journal, March 2004, pp. 46-53.

    Lambert, Thomas E.  And Paul A. Coomes.  "An Evaluation of the
    Effectiveness of Louisville's Enterprise Zone," Economic Development
    Quarterly, v. 15, no. 2, (May 2001), pp. 168-180.
    Myerson, Deborah L. "Capitalizing on the New Markets Tax Credit," The
    Urban Land Institute Land Use Policy Forum Report, September 2003.
    Rubin, Julia Sass and Gregory M. Stankiewicz . "The New Markets Tax
    Credit Program: A Midcourse Assessment," Federal Reserve Bank of San
    Francisco, vol. 1, iss. 1, 2005.
    Stoker, Robert P. And Michael J. Rich.  "Lessons and Limits: Tax
    Incentives and Rebuilding the Gulf Coast After Katrina," The Brookings
    Institution, Survey Series, August 2006.
    U.S. Congress, House Ways and Means Committee, Manager's Statement
    on Community Renewal Tax Relief Act of 2000, statement to accompany
    H.R. 5662 as incorporated in H.R. 4577, Dec. 15, 2001.
    U.S. Congress, Joint Committee on Taxation.  Description of Present Law
    Regarding Tax Incentives for Renewal Communities and Other Economically
    Distressed Areas, (JCX 40-02), May 20, 2002.
    - .  Summary of Provisions Contained in the Community Renewal Tax
    Relief Act of 2000, (JCX 112-00), December 15, 2000.
    U.S. Department of Housing and Urban Development.  Tax Incentive
    Guide for Businesses in Renewal Communities, Empowerment Zones, and
    Enterprise Communities, FY2002.
    U.S. Department of the Treasury, Community Development Financial
    Institutions Fund (CDFI), The Difference the CDFI Fund Makes, website,
    http://www.cdfifund.gov/impact_we_make/overview.asp, visited Oct. 20,
    2006.
    U.S. General Accounting Office.  New Markets Tax Credit Program:
    Progress Made in Implementation, But Further Actions Needed to Monitor
    Compliance, GAO-04-326, January 30, 2004.
    - .  New Markets Tax Credit: Status of Implementation and Issues Related
    to GAO's Mandated Reports, GAO-03-223R, December 6, 2002.

    	Community and Regional Development

    EXPENSING OF REDEVELOPMENT COSTS IN CERTAIN
    ENVIRONMENTALLY CONTAMINATED AREAS
    ("BROWNFIELDS")

    Estimated Revenue Loss (1)

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    2007

    2008

    2009

    2010

    (1) In Senate Budget Committee's 2004 tax expenditure compendium,
    the Joint Committee on Taxation (JCT) estimated the FY 2005 tax
    expenditure at $200 million ($100 for corporations; $100 million for
    individuals).  Before the one-year extension under the Tax Increase and Relief
    Act, that compendium reports an estimated tax expenditure for 2006 of less
    than $50 million for corporations and less than $50 million for individuals.  A
    two year extension of this provision in H.R. 6111 (December 2006) cost $557
    million in FY2007, and $123 million in FY2008, and is projected to increase
    revenue by $44 million in FY2009 and  $52 million in FY2010.

    Authorization

    Section 198, 280B, and 468, 1221(1), 1245, 1392(b)(4), and 1393(a)(9).

    	Description

    Firms that undertake expenditures to control or abate hazardous substances
    in a qualified contaminated business property or site in certain targeted
    empowerment zones and enterprise communities are allowed to expense -
    deduct the costs against income in the year incurred - those expenditures
    that would otherwise be allocated to capital account.  Upon the disposition of
    the property, the deductions are subject to recapture as ordinary income.
    Eligible expenses must be incurred before January 1, 2007.  The deduction
    applies to both the regular and the alternative minimum tax.

    A qualified contaminated site, or "brownfield," is generally defined as any
    property that 1) is held for use in a trade or business, and 2) on which there
    has been an actual or threatened release or disposal of certain hazardous
    substances as certified by the appropriate state environmental agency.
    Superfund sites - sites that are on the national priorities list under the
    Comprehensive Environmental Response, Compensation, and Liability Act of
    1980 - do not qualify as brownfields.

    	Impact

    Immediate expensing provides a tax subsidy for capital invested by
    businesses, in this case for capital to be used for environmental cleanup and
    community development. Frequently, the costs of cleaning up contaminated
    land and water in abandoned industrial or commercial sites are a major barrier
    to redevelopment of that site and of the community in general. By expensing
    rather than capitalizing these costs, taxes on the income generated by the
    capital expenditures are effectively set to zero. This should provide a financial
    incentive to businesses and encourage them to invest in the cleanup and
    redevelopment of "brownfields"- abandoned old industrial sites and dumps,
    including properties owned by the federal and subnational government, that
    could and would be cleaned up and redeveloped except for the costs and
    complexities of the environmental contamination.

    The provision broadens target areas in distressed urban and rural
    communities that can attract the capital and enterprises needed to rebuild and
    redevelop polluted sites.  The tax subsidy is thus primarily viewed as an
    instrument of community development, to develop and revitalize urban and
    rural areas depressed due to environmental contamination.  According to the
    Environmental Protection Agency, there are thousands of such sites (30,000
    by some estimates) in the United States.

          		  	Rationale

    Section 198 was added by the Taxpayer Relief Act of 1997 (P.L. 105-34).
    Its purpose is threefold:  1) As an economic development policy, its purpose
    is to encourage the redevelopment and revitalization of depressed
    communities and properties abandoned due to hazardous waste pollution; 2)
    as an environmental policy, expensing of environmental remediation costs
    provides a financial incentive to clean up contaminated waste sites; and 3) as
    tax policy, expensing of environmental remediation costs establishes clear and
    consistent rules, and reduces the uncertainty that existed prior to the law's
    enactment, regarding the appropriate tax treatment of such expenditures.

    The provision was originally to expire at the end of 2000, but was extended
    to the end of 2001 by the Tax Relief Extension Act of 1999 (P.L. 106-170). It
    was extended again by the Community Renewal Tax Relief Act of 2000 (P.L.
    106-554). The provision expired again, this time on January 1, 2003, but was
    retroactively extended through December 31, 2005, by the Working Families
    Tax Relief Act of 2004 (P.L. 108-311).  The Tax Increase Prevention and
    Relief Act (P.L. 109-222) extended it through December 31, 2006.  It also
    expanded the list of hazardous substances to include any petroleum product.
    A provision to extend expensing of brownfield costs by either one or two
    years is part of so-called "extender" legislation, but these bills have not
    moved in Congress partly because of concerns over other controversial tax
    measures (such as estate tax cuts).  H.R. 6111 in December 2006 extended
    the provision through 2007.

    	Assessment

    Section 198 specifically treats environmental remediation expenditures,
    which would otherwise be capitalized, as deductible in the year incurred.
    Such expenditures are generally recognized to be capital costs, which,
    according to standard economic principles, should be recovered over the
    income producing life of the underlying asset.  As a capital subsidy, however,
    expensing is inefficient because it makes investment decisions based on tax
    considerations rather than inherent economic considerations.
    As a community development policy, the effectiveness of the tax subsidy
    has been questioned, as many view  the main disincentive to development of
    brownfield sites not the costs but rather the potential liability under current
    environmental regulation. That is to say the main barrier to development
    appears to be regulatory rather than financial. Barring such regulatory
    disincentives, the market system ordinarily creates its own incentives to
    develop depressed areas, as part of the normal economic cycle of growth,
    decay, and redevelopment. As an environmental policy, this type of capital
    subsidy is also questionable on efficiency grounds. Many economists believe
    that expensing is a costly and inefficient way to achieve environmental goals,
    and that the external costs resulting from environmental pollution are more
    efficiently addressed by either pollution or waste taxes or tradeable permits.

    	Selected Bibliography

    Carroll, Deborah A., and Robert J. Eger III. "Brownfields, Crime, and Tax
    Increment Financing." American Review of Public Administration. December
    1, 2006. v. 36. pp. 455-477.
    Greenberg, Michael R., and Justin Hollander. "The Environmental
    Protection Agency's Brownfields Pilot Program."  American Journal of
    Public Health. February 2006. v. 96. pp. 277-282.
    Jackson, Pamela J. Temporary Tax Provisions ("Extenders") Expired in
    2005. U.S. Library of Congress. Congressional Research Service. Report
    RS32367, August 4, 2006.
    Longo, Alberto, and Anna Alberini. "What Are the Effects of
    Contamination Risks on Commercial and Industrial Properties? Evidence
    from Baltimore, Maryland." Journal of Environmental Planning and
    Management. September 2006. v.49. pp. 713-751.
    Northeast-Midwest Institute.  National Association of Local Government
    Environmental Professionals.  Unlocking Brownfields: Keys to Community
    Revitalization. October 2004.
    Reisch, Mark.  Superfund and the Brownfields Issue. Library of Congress,
    Congressional Research Service Report 97-731 ENR, Washington, DC, 1997.
    -.  Brownfields in the 109th Congress. U.S. Library of Congress.
    Congressional Research Service. Report RS22502, September 8, 2006.
    -. Environmental Cleanup and Development: Brownfield Tax Incentive
    Survey. U.S. Library of Congress. Congressional Research Service. CRS
    Report RS 21599, August 21, 2003.
    -. Brownfield Tax Incentive Extension. U.S. Library of Congress.
    Congressional Research Service. CRS Report RS 21599, October 17, 2006.
    Segal, Mark A.  "Environmental Cleanup Expenditures: An Inquiry Into
    Their Proper Tax Treatment."  Oil & Gas Tax Quarterly, v. 42, 1994: 715-
    729.
    Shi, J. Stephen, and Susan H. Cooper.  "Tax Treatment of Environmental
    Costs."  Banking Law Journal v. 112, February. 1995, pp. 165-170.
    Sims, Theodore S. "Environmental 'Remediation' Expenses and a Natural
    Interpretation of the Capitalization Requirement.  National Tax Journal, v.
    47, September 1994, pp. 703-718.
    Sterner, Thomas. Policy Instruments for Environmental and Natural
    Resource Management.   Resources for the Future, Washington, 2003.
    U.S. Congress,  Joint Committee on Taxation.  Estimated Budget Effects of
    H.R. 5970, the Estate Tax and Extension of Tax Relief Act of 2006
    ("Etetra"), as Introduced in the House of Representatives on July 28, 2006.
    JCX-34-06 July 28, 2006 Washington.
    U.S. Treasury Department.  Treasury News: Statement of Treasury
    Secretary Robert E. Rubin on a New Brownfields Tax Incentive. March 11,
    1996. Washington.
    Weld, Leonard G., and Charles E. Price.  "Questions About the Deduction
    of Environmental Cleanup Costs After Revenue Ruling 94-38."  Taxes, v. 73,
    May 1995, pp. 227-233.

    	Community and Regional Development

    EXCLUSION OF INTEREST ON STATE AND LOCAL
    GOVERNMENT BONDS FOR PRIVATE AIRPORTS, DOCKS,
    AND MASS-COMMUTING FACILITIES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.7

    0.3

    1.0

    2007

    0.8

    0.3

    1.1

    2008

    0.8

    0.3

    1.1

    2009

    0.9

    0.3

    1.2

    2010

    0.9

    0.4

    1.3

    	Authorization

    Sections 103, 141, 142, and 146.

    	Description

    Interest income on State and local bonds used to finance the construction of
    government-owned airports, docks, wharves, and mass-commuting facilities,
    such as bus depots and subway stations, is tax exempt.  These airport, dock,
    and wharf bonds are classified as private-activity bonds rather than
    governmental bonds because a substantial portion of their benefits accrues to
    individuals or business rather than to the general public.  For more discussion
    of the distinction between governmental bonds and private-activity bonds, see
    the entry under General Purpose Public Assistance: Exclusion of Interest on
    Public Purpose State and Local Debt.

    Because private-activity mass commuting facility bonds are subject to the
    private-activity bond annual volume cap, they must compete for cap
    allocations with bond proposals for all other private activities subject to the
    volume cap.  The cap is equal to the greater of $80 per capita or $246.6
    million in 2006.  The cap has been adjusted for inflation since 2003.  Bonds
    issued for airports, docks, and wharves are not, however, subject to the annual
    Federally imposed State volume cap on private-activity bonds.  The cap is
    forgone because government ownership requirements restrict the ability of the
    State or local government to transfer the benefits of the tax exemption to a
    private operator of the facilities.

    	Impact

    Since interest on the bonds is tax exempt, purchasers are willing to accept
    lower before-tax rates of interest than on taxable securities.  These low-
    interest rates enable issuers to provide the services of airport, dock, and wharf
    facilities at lower cost.  Some of the benefits of the tax exemption also flow to
    bondholders.  For a discussion of the factors that determine the shares of
    benefits going to bondholders and users of the airport, dock, and wharf
    facilities, and estimates of the distribution of tax-exempt interest income by
    income class, see the "Impact" discussion under General Purpose Public
    Assistance: Exclusion of Interest on Public Purpose State and Local Debt.

    	Rationale

    Before 1968, State and local governments were allowed to issue tax-
    exempt bonds to finance privately owned airports, docks, and wharves
    without restriction.  The Revenue and Expenditure Control Act of 1968
    (RECA 1968) imposed tests that restricted the issuance of these bonds.
    However, the Act also provided a specific exception which allowed
    unrestricted issuance for airports, docks, and wharves, and mass commuting
    facilities.

    The Deficit Reduction Act of 1984 allowed bonds for non-government-
    owned airports, docks, wharves, and mass-commuting facilities to be tax
    exempt, but required the bonds to be subject to a volume cap applied to
    several private activities.  The volume cap did not apply if the facilities were
    "governmentally owned."

    The Tax Reform Act of 1986 allowed tax exemption only if the facilities
    satisfied government ownership requirements, but excluded the bonds for
    airports, wharves, and docks from the private-activity bond volume cap.  This
    Act also denied tax exemption for bonds used to finance related facilities such
    as hotels, retail facilities in excess of the size necessary to serve passengers
    and employees, and office facilities for nongovernment employees.

    The Economic Recovery Tax Act of 1981 extended tax exemption to mass-
    commuting vehicles (bus, subway car, rail car, or similar equipment) that
    private owners leased to government-owned mass transit systems.  This
    provision allowed both the vehicle owner and the government transit system
    to benefit from the tax advantages of tax-exempt interest and accelerated
    depreciation allowances.  The vehicle exemption expired on December 31,
    1984.

    	Assessment

    State and local governments tend to view these facilities as economic
    development tools.  The desirability of allowing these bonds to be eligible for
    tax-exempt status hinges on one's view of whether the users of such facilities
    should pay the full cost, or whether sufficient social benefits exist to justify
    Federal taxpayer subsidy.  Economic theory suggests that to the extent these
    facilities provide social benefits that extend beyond the boundaries of the
    State or local government, the facilities might be underprovided due to the
    reluctance of State and local taxpayers to finance benefits for nonresidents.

    Even if a case can be made for a Federal subsidy due to underinvestment at
    the State and local level, it is important to recognize the potential costs.  As
    one of many categories of tax-exempt private-activity bonds, those issued for
    airports, docks, and wharves increase the financing cost of bonds issued for
    other public capital.  With a greater supply of public bonds, the interest rate
    on the bonds necessarily increases to lure investors.  In addition, expanding
    the availability of tax-exempt bonds increases the assets available to
    individuals and corporations to shelter their income from taxation.

    	Selected Bibliography

    Maguire, Steven.  Private Activity Bonds: An Introduction.  Library of
    Congress, Congressional Research Service Report RL31457.  June 9, 2006.
    -.  Tax-Exempt Bonds: A Description of State and Local Government
    Debt.  Library of Congress, Congressional Research Service Report
    RL30638.  March 10, 2006.
    U.S. Congress, Congressional Budget Office.  Statement of Donald B.
    Marron before the Subcommittee on Select Revenue Measures Committee on
    Ways and Means U.S. House of Representatives.  "Economic Issues in the
    Use of Tax-Preferred Bond Financing," March 16, 2006.
    U.S. Congress,  Joint Committee on Taxation, Present Law and
    Background Related to State and Local Government Bonds, Joint Committee
    Print JCX-14-06, March 16, 2006.
    Zimmerman, Dennis.  The Private Use of Tax-Exempt Bonds: Controlling
    Public Subsidy of Private Activity.  Washington, DC: The Urban Institute
    Press, 1991.

    Community and Regional Development

    QUALIFIED GREEN BUILDING AND
    SUSTAINABLE DESIGN PROJECT BONDS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    (1)

    (1)

    (1)

    2007

    (1)

    (1)

    (1)

    2008

    (1)

    (1)

    (1)

    2009

    (1)

    (1)

    (1)

    2010

    (1)

    (1)

    (1)

    (1) Less than $50 million.

    	Authorization

    Section 103, 142(l), and 146(g).

    	Description

    Interest income on State and local bonds used to finance the construction of
    "green building and sustainable design projects," as designated by the U.S.
    Environmental Protection Agency (EPA), is tax exempt.  Green buildings are
    evaluated based on these criteria:  (1) site sustainability; (2) water efficiency;
    (3) energy use and atmosphere; (4) material and resource use; (5) indoor
    environmental quality; and (6) innovative design.  The program is designed as
    a "demonstration" program, and requires that at least one designated project
    shall be located in or within a 10-mile radius of an empowerment zone and at
    least one shall be located in a rural state.  These bonds are classified as
    private-activity bonds rather than governmental bonds because a substantial
    portion of their benefits accrues to individuals or business rather than to the
    general public.  For more discussion of the distinction between governmental
    bonds and private-activity bonds, see the entry under General Purpose Public
    Assistance: Exclusion of Interest on Public Purpose State and Local Debt.

    Bonds issued for green building and sustainable design projects are not,
    however, subject to the state volume cap on private activity bonds.  This
    exclusion arguably reflects a belief that the bonds have a larger component of
    benefit to the general public than do many of the other private activities
    eligible for tax exemption.  The bonds are, however, subject to a an aggregate
    face amount of $2 billion and must be issued before October 1, 2009.

    	Impact

    Since interest on the bonds is tax exempt, purchasers are willing to accept
    lower before-tax rates of interest than on taxable securities.  These low
    interest rates enable issuers to finance green building projects at reduced
    interest rates.

    Some of the benefits of the tax exemption also flow to bondholders.  For a
    discussion of both the factors that determine the shares of benefits going to
    bondholders and users of the green buildings and associated projects, and
    estimates of the distribution of tax-exempt interest income by income class,
    see the "Impact" discussion under General Purpose Public Assistance:
    Exclusion of Interest on Public Purpose State and Local Debt.

    	Rationale

    Proponents of green bonds argue that the federal subsidy is necessary
    because private investors are unwilling to accept the risk and relatively low
    return associated with green building projects.  Proponents argue that the
    market has failed to produce green buildings because the benefits of these
    projects extend well beyond the actual building to the surrounding community
    and to the environment more generally.  The owner of the green building is
    not compensated for these external benefits, and it is unlikely, proponents
    argue, that a  private investor would agree to provide them without some type
    of government subsidy.

    	Assessment

    The legislation (P.L. 108-357) that created these bonds was enacted on
    October 22, 2004, and  the success of the program is still uncertain.  Before
    the legislation was enacted, some developers reportedly were voluntarily
    adhering to green building standards to attract tenants.  If so, the market
    failure described earlier to justify the use of federal subsidy may be less
    compelling.  In addition, as one of many categories of tax-exempt private-
    activity bonds, green bonds will likely increase the financing costs of bonds
    issued for other public capital stock and increase the supply of assets available
    to individuals and corporations to shelter their income from taxation.

    	Selected Bibliography

    Ho, Cathy Lang.  "Eco-fraud: 'Green Buildings' Might Not be all They're
    Made Out to Be."  Architecture, v. 92, July 2003, pp. 31-32.
    International City-County Management Association.  "Green Buildings."
    Public Management, v. 82, May 2000, p. 36.
    Maguire, Steven.  Private Activity Bonds: An Introduction.  Library of
    Congress, Congressional Research Service Report RL31457.  Washington,
    D.C.: June 9, 2006.
    -.  Tax-Exempt Bonds: A Description of State and Local Government
    Debt.  Library of Congress, Congressional Research Service Report
    RL30638.  Washington, D.C.: March 10, 2006.
    Temple, Judy.  "Limitations on State and Local Government Borrowing for
    Private Purposes." National Tax Journal, v. 46, March 1993, pp. 41-53.
    Weisbrod, Burton A.  The Nonprofit Economy.  Cambridge, Mass.:
    Harvard University Press, 1988.
    Zimmerman, Dennis.  The Private Use of Tax-Exempt Bonds: Controlling
    Public Subsidy of Private Activities.  Washington, DC: The Urban Institute
    Press, 1991.

    	Education, Training, Employment and Social Services:
    	Education and Training

    	EXCLUSION OF INCOME ATTRIBUTABLE TO THE
    	DISCHARGE OF CERTAIN STUDENT LOAN DEBT
    	AND NHSC EDUCATIONAL LOAN REPAYMENTS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    (1)

    -

    (1)

    2007

    (1)

    -

    (1)

    2008

    (1)

    -

    (1)

    2009

    (1)

    -

    (1)

    2009

    (1)

    -

    (1)

    (1) Less than $50 million.

    Authorization

    Section 108(f); 20 U.S.C. 1087ee(a)(5); and 42 U.S.C. 254l-1(g)(3).

    Description

    In general, cancelled or forgiven debt, or debt that is repaid on the
    borrower's behalf is included as gross income for tax purposes.
    However, section 108(f) of the IRC provides that in certain instances,
    student loan cancellation and student loan repayment assistance may
    be excluded from taxation.

    Cancelled or forgiven student loan debt may be excluded from
    gross income under section 108(f) if the relevant student loan
    contains terms providing that some or all of the loan will be cancelled
    for work for a specified period of time, in certain professions, and for
    any of a broad class of employers; and if it was made by a qualified
    lender.  Qualified lenders are the government (federal, state, local,
    or an instrumentality, agency, or subdivision thereof); tax-exempt
    public benefit corporations that have assumed control of a state,
    county, or municipal hospital and whose employees are considered
    public employees under state law; and educational institutions if the
    loan is made under an agreement with an entity described above, or
    under a program of the institution designed to encourage students to
    serve in occupations or areas with unmet needs and under the
    direction of a governmental entity or a tax-exempt 501(c)(3)
    organization.

    There are three major federal student aid (FSA) loan programs:
    the Federal Family Education Loan (FFEL) program, the William D.
    Ford Direct Loan (DL) program, and the Federal Perkins Loan
    program.  Student loans made under each of these programs contain
    provisions that if borrowers work for specified periods of time in
    certain professions, for certain broad classes of employers, all or a
    portion of their debt will be cancelled or forgiven.  For example,
    under each of the three loan programs, teachers who meet certain
    criteria may have their loans cancelled.  Some non-federal loans also
    may meet the requirements of section 108(f).

    Loans are made by different types of lenders under each of the
    three FSA programs.  Under the FFEL program, loans are
    guaranteed by the federal government, but are made by a variety of
    lenders, including commercial banks, non-profit entities, and state
    entities.  Thus, many FFEL loans are ineligible to be excluded from
    taxation when forgiven because the lender does not meet the
    requirements of section 108(f).  Under the DL program, loans are
    made directly by the federal government and are thus eligible to be
    excluded from taxation when forgiven.  Under the Federal Perkins
    Loan program, loans are made by the public, non-profit, or for-profit
    postsecondary institutions that borrowers attend.  The statute
    authorizing the Federal Perkins Loan program specifies that any part
    of a Federal Perkins Loan cancelled for certain types of public
    service shall not be considered income for purposes of the IRC (20
    U.S.C. 1087ee(a)(5)).

    Section 108(f) also excludes from income student loan repayment
    assistance provided under the National Health Service Corps (NHSC)
    Loan Repayment Program and state programs eligible to receive
    funds under the Public Health Service Act.  These two programs
    provide payment on a borrower's behalf for principal, interest, and
    related expenses of educational loans in return for the borrower's
    service in a health professional shortage area.  Government and
    commercial education loans are eligible to be repaid under the NHSC
    Loan Repayment Program.

    Impact

    Section 108(f) permits individuals to exclude loan cancellation and
    payments under the NHSC and state loan repayment programs from their
    gross income.  The benefit provided to any individual taxpayer and the
    corresponding loss of revenue to the federal government depends on the
    taxpayer's marginal tax rate.  CBO estimates that approximately 75,000
    teachers will apply for loan forgiveness each year under the FFEL and DL
    programs - the two largest FSA loan programs.  Many of these applicants
    may be able to exclude their forgiven debt from gross income.  Additional
    borrowers may be eligible to exclude debt forgiven under other loan
    programs.  It is unclear, however, how many individuals go into certain
    professions because of available loan forgiveness programs, or how many
    decide to borrow from eligible lenders because of the section 108(f) provision
    which permits discharged student loan debt to be excluded from gross
    income.

     	Rationale

    Whether to include the forgiveness of student loan debt or the repayment of
    debt through loan repayment assistance programs as part of gross income for
    purposes of taxation has been a policy issue for the past 50 years.  Following
    the Supreme Court's decision in Bingler v. Johnson (1969), the primary issue
    in determining whether loan forgiveness and loan repayment programs are
    taxable has been whether there exists a quid pro quo between the recipient
    and the lender.  Generally, if borrowers must perform service for the entity
    forgiving or repaying their loans, it is assumed that a quid pro quo exists and
    so the amount forgiven or repaid is treated as taxable income.  The policy
    issue is whether the service borrowers provide in return for the
    discharge of their loan is for the benefit of the grantor of debt
    forgiveness and thus should be considered akin to income, or if the
    service is for the benefit of the broader society and thus should
    potentially be excluded from income.  Following post-Bingler v.
    Johnson rulings by the IRS that had established the discharge of
    student loan indebtedness as taxable income, Congress has
    periodically amended the IRC to override these rulings and
    specifically exclude the discharge of broader categories of certain
    student loan debt from taxation.  As a result, the IRC currently
    provides tax treatment for qualified loan forgiveness and loan
    repayment programs that is similar to that of educational grants and
    scholarships, which are not taxable.

    Assessment

    The value to an individual of excluding the discharge of student
    loan indebtedness from gross income depends on that individual's
    marginal tax rate in the tax year in which the benefit is realized.
    Since beneficiaries generally are required to be serving in public
    service jobs or in health professional shortage areas, in most cases
    such individuals will be in lower tax brackets than if they had taken
    higher paying jobs elsewhere.  Prior to the enactment of P.L. 108-
    357, the NHSC loan repayment program provided recipients of loan
    repayment with an additional payment for tax liability equal to 39%
    of the loan repayment amount (42 U.S.C. 254l-1(g)(3)).  By
    excluding NHSC loan repayment from income, tax relief is now
    provided through foreign revenue as opposed to discretionary
    outlays.

    	Selected Bibliography

    Beck, Richard C.E., "Loan Repayment Assistance Programs for Public-
    Interest Lawyers: Why Does Everyone Think They Are Taxable?" New York
    Law School Law Review, vol. 40, (1996): 251-310.
    Bingler v. Johnson, 394 U.S. 741 (1969).
    Boe, Caroleen C., "Cancelled Student Loans: For the Benefit of the
    Grantor?" Albany Law Review, vol. 39, (1974): 35-51.
    Congressional Budget Office, Cost Estimate, "H.R. 4525: Second Higher
    Education Extension Act of 2005," (Jan. 12, 2006).
    Dauthtrey, Zoel, and Frank M. Messina, "Medical Student Loans: Making
    Repayments Tax Free," The CPA Journal, (Jan. 1999).
    Internal Revenue Service, Revenue  Ruling 73-256, State Medical
    Education Loan Scholarship Program, 1973-1 CB 56, (Jan. 01, 1973)
    McCallion, Gail, Student Loan Forgiveness Programs.  Library of
    Congress, Congressional Research Service, Washington, D.C., (July 14,
    2006).
    Philipps, J. Timothy, and Timothy G. Hatfield, "Uncle Sam Gets the
    Goldmine - Students Get the Shaft: Federal Tax Treatment of Student Loan
    Indebtedness," Seton Hall Legislative Journal, vol. 15, (1991): 249-296.
    Moloney v. Commissioner of Internal Revenue, United States Tax Court,
    Summary Opinion 2006-53.
    Oliver, Amy J., "Improving the Tax Code to Provide Meaningful and
    Effective Tax Incentives for Higher Education," University of Florida
    Journal of Law & Public Policy, vol. 12, (2000): 91-145.

    	Education, Training, Employment, and Social Services:
    	Education and Training

    	DEDUCTION FOR CLASSROOM EXPENSES OF
    	ELEMENTARY AND SECONDARY SCHOOL EDUCATORS

    Estimated Revenue Loss*

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    -

     -

    -

    2007

    -

     -

    -

    2008

    -

     -

    -

    2009

    -

     -

    -

    2010

    -

     -

    -

    *The tax credit was extended by H.R. 6111 (December 2006) for two
    years to 2006-2007 at a cost of $0.2 billion in each year.

    	Authorization

    Section 62.

    	Description

    An eligible employee of a public (including charter) and private elementary
    or secondary school may claim an above-the-line deduction for certain
    unreimbursed expenses.  An eligible educator is defined to be an individual
    who, with respect to any tax year, is an elementary or secondary school
    teacher, instructor, counselor, principal, or aide in a school for a minimum of
    900 hours in a school year.  The expenses must be associated with the
    purchase of the following items for use by the educator in the classroom:
    books; supplies (other than nonathletic supplies for health or physical
    education courses); computer equipment, software, and services; other
    equipment; and supplementary materials.  The taxpayer may deduct up to
    $250 spent on these items.

    The amount of deductible classroom expenses is not limited by the
    taxpayer's income.  Educators must reduce the total amount they expend on
    eligible items by any interest from an Education Savings Bond or distribution
    from a Qualified Tuition (Section 529) Program or Coverdell Education
    Savings Account that was excluded from income.  In other words, if
    educators or members of their tax filing units utilize earnings from these
    savings vehicles to pay tuition and other qualified educational expenses, only
    those classroom expenses that exceed the value of these income exclusions
    are deductible.

    Impact

    Educators, as an occupation, are actively involved in improving the human
    capital of the nation.  The availability of the classroom expense deduction
    may encourage educators who already are doing so to continue to use their
    own money to make purchases to enhance their students' educational
    experience, and potentially encourages other educators to start doing the
    same.  Alternatively, the deduction may be a windfall to educators.  As noted
    in the table below, more than 40% of the deductions are taken by tax filing
    units with adjusted gross incomes of at least $75,000.

    Distribution by Income Class of Classroom Expense
    Deduction at 2003 Income Levels

    Income Class
    (in thousands of $)

    Percentage
    Distribution

    Below $10

    1.3

    $10 to $20

    4.0

    $20 to $30

    6.3

    $30 to $40

    10.5

    $40 to $50

    10.1

    $50 to $75

    24.6

    $75 to $100

    22.0

    $100 to $200

    19.3

    $200 and over

    1.8

     	Source: IRS Statistics of Income.  This is not a distribution of the tax
    expenditures, but of the deduction; it is classified by adjusted gross income.
    Data are available for 2004 but are not reliable due to small sample size in the
    higher income cells.

    	Rationale

    Prior to the classroom deduction's enactment as part of the Job Creation
    and Worker Assistance Act of 2002, the only tax benefit available to
    educators for trade/business expenses was the permanent deduction at Section
    162 of the Code.  That deduction remains available to educators but in order
    to take it, the total of their miscellaneous itemized deductions must exceed
    2% of adjusted gross income.  An above-the-line deduction targeted at
    educators was considered socially desirable because teachers voluntarily
    augment school funds by purchasing items thought to enhance the quality of
    children's education.  The provision expired at the end of 2005 but was
    extended through 2007 by H.R. 6111 (December 2006).

    Assessment

    Taxpayers with teachers in their filing units who make trade/business
    purchases in excess of $250 or who have other miscellaneous itemized
    deductions may now have to compute tax liability twice - under Code
    Sections 62 and 162 - to determine which provides the greater savings.
    Taxpayers also must now consider how the educator expense deduction
    interacts with other tax provisions.  The temporary above-the-line deduction
    means, for example, that higher income families with eligible educators may
    not have to subject classroom expenditures of up to $250 to the 3% limit on
    itemized deductions.  (Higher income taxpayers must reduce total allowable
    itemized deductions by 3% of their income in excess of an inflation-adjusted
    threshold.)  By lowering adjusted gross income, the classroom expense
    deduction also allows taxpayers to claim more of those deductions subject to
    an income floor (e.g., medical expenses).

    In addition to increasing complexity, the classroom expense deduction
    treats educators differently than  others whose business-related expenses are
    subject to the 2% floor on miscellaneous itemized deductions and the 3%
    limit on total itemized deductions.  Further, the above-the-line deduction is
    allowed against the alternate minimum tax while the Section 162 deduction is
    not.

    	Selected Bibliography

    Levine, Linda.  The Tax Deduction for Classroom Expenses of Elementary
    and Secondary School Teachers.  Congressional Research Service Report
    RS21682.    Washington, DC: updated August 30, 2006.
    Joint Committee on Taxation.  Description of Revenue Provisions
    Contained in the President's Fiscal Year 2007 Budget Proposal.   Committee
    Print JCS-3-04. Washington, DC: Government Printing Office, March 2006.

    Education, Training, Employment, and Social Services:
    Education and Training

    TAX CREDITS FOR TUITION
    FOR POST-SECONDARY EDUCATION

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    4.9

    -

    4.9

    2007

    5.2

    -

    5.2

    2008

    5.1

    -

    5.1

    2009

    5.0

    -

    5.0

    2010

    5.0

    -

    5.0

    Authorization

    Section 25A.

    Description

    A Hope Scholarship Credit can be claimed for each eligible student in a
    family (including the taxpayer, the spouse, or their dependents) for two
    taxable years for qualified expenses incurred while attending an eligible
    postsecondary education program, provided the student has not completed the
    first two years of undergraduate education.  An eligible student is one
    enrolled on at least a half-time basis for at least one academic period during
    the tax year in a program leading to a degree, certificate, or credential at an
    institution eligible to participate in U.S. Department of Education student aid
    programs; these include most accredited public, private, and proprietary
    postsecondary institutions.  The per student credit is equal to 100% of the first
    $1,100 of qualified tuition and fees and 50% of the next $1,100.  The
    maximum credit is indexed for inflation.  Tuition and fees financed with
    scholarships, Pell Grants, veterans' education assistance, and other income
    not included in gross income for tax purposes  (with the exception of gifts and
    inheritances) are not qualified expenses.

    The Lifetime Learning Credit provides a 20% credit per return for the first
    $10,000 of qualified tuition and fees that taxpayers pay for themselves, their
    spouses, or their dependents.  The credit is available for any number of years
    for any level of postsecondary education at an eligible institution to acquire or
    improve an individual's job skills.

    Both credits are phased out for single taxpayers with modified adjusted
    gross income between $45,000 and $55,000 ($90,000 and $110,000 for joint
    return taxpayers).  The income thresholds are indexed to inflation.  Neither
    credit is refundable.  Both cannot be claimed for the same student in the same
    tax year.  Taxpayers claiming a credit cannot concurrently take the temporary
    deduction for qualified higher education expenses.

    Impact

    The cost of investing in postsecondary education is reduced for those
    recipients whose marginal (i.e., last) investment dollar is affected by these
    credits.  Other things equal, these individuals will either increase the amount
    they invest or participate when they otherwise would not.  However, some of
    the federal revenue loss will be received by individuals whose investment
    decisions are not altered by the credits.

    As shown in the table below, the ceilings limit the benefit available to
    higher income individuals.  The lack of refundability limits the benefit
    available to very low income individuals.

    Distribution by Income Class of Education Tax
    Credits at 2004 Income Levels

    Income Class
    (in thousands of $)

    Percentage
    Distribution

    Below $10

    0.3

    $10 to $20

    9.5

    $20 to $30

    16.1

    $30 to $40

    18.6

    $40 to $50

    13.1

    $50 to $75

    25.1

    $75 to $100

    16.5

    $100 to $200

    0.0

    $200 and over

    0.0

     	Source: IRS Statistics of Income.  This is not a distribution of the tax
    expenditures, but of the credits; it is classified by adjusted gross income.

    Rationale

    These credits were enacted in the Taxpayer Relief Act of 1997,
    along with a number of other higher education tax benefits.  Their
    intent is to make postsecondary education more affordable for
    middle-income families and students who might not qualify for much
    need-based federal student aid.

    Assessment

    A federal subsidy of higher education has three potential economic
    justifications:  a capital market failure; external benefits; and nonneutral
    federal income tax treatment of physical and human capital. Subsidies that
    correct these problems are said to provide taxpayers with "social benefits."

    Many students find themselves unable to finance their postsecondary
    education from earnings and personal or family savings.  Student mobility and
    a lack of property to pledge as loan collateral would require  commercial
    lenders to charge high interest rates on education loans in light of the high
    risk of default.  As a result, students often find themselves unable to afford
    loans from the financial sector.  This financial constraint bears more heavily
    on lower income groups than on higher income groups and accordingly, leads
    to inequality of opportunity to acquire a postsecondary education.  It also is an
    inefficient allocation of resources because these students, on average, might
    earn a higher rate of return on loans for education than the financial sector
    could earn on alternative loans.

    This "failure" of the capital markets is attributable to the legal restriction
    against pledging an individual's future labor supply as loan collateral, that is,
    against indentured servitude.  Since modern society rejects this practice, the
    federal government has strived to correct the market failure by providing a
    guarantee to absorb most of the financial sector's default risk associated with
    postsecondary loans to students.  This financial support is provided through
    the Federal Family Education Loan Program and the Direct Loan Program.
    (See the entry "Exclusion of Interest on State and Local Government Student
    Loan Bonds" for more information.)  The guarantee is an entitlement and
    equalizes the financing cost for some portion of most students' education
    investment.  When combined with Pell Grants for lower income students, it
    appears that at least some portion of the capital market failure has been
    corrected and inequality of opportunity has been diminished.

    Some benefits from postsecondary education may accrue not to the
    individual being educated, but rather to the members of society at large.  As
    these external benefits are not valued by individuals considering educational
    purchases, they invest less than is optimal for society (even assuming no
    capital market imperfections).  External benefits are variously described as
    taking the form of increased productivity  and better citizenship (for example,
    greater likelihood of participating in elections).

    Potential students induced to enroll in higher education by the Hope
    Scholarship and Lifetime Learning credits cause investment in education to
    increase.  The overall effectiveness of the tax credits depends upon whether
    the cost of the marginal investment dollar of those already investing in higher
    education is reduced, however.  It is clear from the structure of these tax
    credits that tuition and fee payments will exceed qualified tuition and fees for
    a large number of credit-eligible students, and as a result, they will not
    experience a price effect (e.g., the Hope credit will not reduce by 50% the last
    dollar these students invest in postsecondary education).  Although their
    investment decision is unaffected by the credits, these students can claim
    them (i.e., reap a "windfall gain") but federal taxpayers get no offsetting
    social benefits in the form of an increased quantity of investment.

    Selected Bibliography

    Burman, Leonard E. with Elaine Maag, Peter Orszag, Jeffrey
    Rohaly, and John O'Hare.  The Distributional Consequences of
    Federal Assistance for Higher Education: The Intersection of Tax and
    Spending Programs, The Urban Institute, Discussion Paper No. 26.
    Washington, DC: August 2005.
    Dynarski, Susan.  Hope for Whom? Financial Aid for the Middle
    Class and Its Impact on College Attendance.  National Bureau of
    Economic Research, Working Paper 7756.  Cambridge, MA: June
    2000.
    Hoblitzell, Barbara A. and Tiffany L. Smith.  Hope Works: Student
    Use of Education Tax Credits.  Indianapolis, IN:  Lumina Foundation
    for Education Inc., November 2001.
    Jackson, Pamela J.  Higher Education Tax Credits: An Economic
    Analysis.  Congressional Research Service Report RL32507.
    Washington, DC: updated January 17, 2006.
    Levine, Linda.  The Benefits of Education.  Congressional
    Research Service Report RL33238.   Washington, DC: December
    29, 2005.
    Long, Bridget Terry.  The Impact of Federal Tax Credits for
    Higher Education Expenses.  National Bureau of Economic
    Research, Working Paper 9553.  Cambridge, MA: March 2003.
    Stoll, Adam and Linda Levine.  Higher Education Tax Credits and
    Deduction: An Overview of the Benefits and Their Relationship to
    Traditional Student Aid.  Congressional Research Service Report
    RL31129.  Washington, DC: updated October 2, 2006.
    Wolanin, Thomas R.  Rhetoric and Reality: Effects and
    Consequences of the HOPE Scholarship.  Washington, DC:  Institute for
    Higher Education Policy, Working Paper, April 2001.
    Zimmerman, Dennis.  "Education Tax Credits," in Joseph J. Cordes with
    Robert D. Ebel and Jane G. Gravelle, Encyclopedia of Taxation and Tax
    Policy, Washington, DC: Urban Institute, 2005.

    Education, Training, Employment, and Social Services:
    Education and Training

    DEDUCTION FOR INTEREST ON STUDENT LOANS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.8

    -

    0.8

    2007

    0.9

    -

    0.9

    2008

    0.9

    -

    0.9

    2009

    0.9

    -

    0.9

    2010

    1.0

    -

    1.0

    Authorization

    Section 221.

    Description

    Taxpayers may deduct interest paid on qualified education loans in
    determining their adjusted gross income.  The deduction, which is limited to
    $2,500 annually, is not restricted to itemizers.  Taxpayers are not eligible for
    the deduction if they can be claimed as a dependent by another taxpayer.
    Between 2002 and  2010, the deduction is not restricted to interest paid
    within the first 60 months during which interest payments are required and
    the phase-out income thresholds are indexed for inflation.  Allowable
    deductions are phased out for taxpayers with modified adjusted gross income
    between $50,000 and $65,000 on individual returns and between $105,000
    and $135,000 on joint returns.  A sunset provision in the Economic Growth
    and Tax Relief Reconciliation Act of 2001 will cause the deduction to revert
    to its pre-2002 structure after December 31, 2010, absent further
    congressional action.

    Qualified education loans are indebtedness incurred solely to pay qualified
    higher education expenses of taxpayers, their spouse, or their dependents who
    were at the time the debt was incurred students enrolled on at least a half-time
    basis in a program leading to a degree, certificate, or credential at an
    institution eligible to participate in U.S. Department of Education student aid
    programs; these include most accredited public, private, and proprietary
    postsecondary institutions.  Other eligible institutions are hospitals and health
    care facilities that conduct internship or residency programs leading to a
    certificate or degree.  Qualified higher education expenses generally equal the
    cost of attendance (e.g., tuition, fees, books, equipment, room and board, and
    transportation) minus scholarships and other education payments excluded
    from income taxes.  Refinancings are considered to be qualified loans, but
    loans from related parties are not.

    Impact

    The deduction benefits taxpayers according to their marginal tax
    rate (see Appendix A).  Most education debt is incurred by students,
    who generally have low tax rates immediately after they leave school
    and begin loan repayment.  However, some debt is incurred by
    parents who are in higher tax brackets.

    The cap on the amount of debt that can be deducted annually
    limits the tax benefit's impact for those who have large loans.   The
    income ceilings limit the benefit's availability to higher income individuals,
    as shown in the table below.

    Distribution by Income Class of Student Loan
    Deduction at 2004 Income Levels

    Income Class
    (in thousands of $)

    Percentage
    Distribution

    Below $10

    4.1

    $10 to $20

    7.2

    $20 to $30

    11.7

    $30 to $40

    14.3

    $40 to $50

    13.6

    $50 to $75

    24.2

    $75 to $100

    24.9

    $100 to $200

    0.0

    $200 and over

    0.0

    Source: Data obtained from IRS Statistics of Income. This is not a
    distribution of the tax expenditures, but of the deductions; it is classified by
    adjusted gross income.

    Rationale

    The interest deduction for qualified education loans was authorized by the
    Taxpayer Relief Act of 1997 as one of a number of benefits intended to make
    postsecondary education more affordable for middle-income families who are
    unlikely to qualify for much need-based federal student aid.  The interest
    deduction is seen as a way to help taxpayers repay education loan debt, which
    has risen substantially in recent years.

    Assessment

    The tax deduction can be justified both as a way of encouraging persons to
    undertake additional education and as a means of easing repayment burdens
    when graduates begin full-time employment.  Whether the deduction will
    affect enrollment decisions is unknown; it might only change the way families
    finance college costs.  The deduction may allow some graduates to accept
    public service jobs that pay low salaries, although their tax savings would not
    be large.   The deduction has been criticized for providing a subsidy to all
    borrowers (aside from those with higher income), even those with little debt,
    and for doing little to help borrowers who have large loans.  It is unlikely to
    reduce loan defaults, which generally are related to low income and
    unemployment.

    Selected Bibliography

    Burman, Leonard E. with Elaine Maag, Peter Orszag, Jeffrey
    Rohaly, and John O'Hare.  The Distributional Consequences of
    Federal Assistance for Higher Education: The Intersection of Tax and
    Spending Programs, The Urban Institute, Discussion Paper No. 26.
    Washington, DC: August 2005.
    Choy, Susan P. and Xiaojie Li.  Debt Burden: A Comparison of 1992-
    93 and 1999-2000 Bachelor's Degree Recipients a Year After Graduating.
    U.S. Department of Education, National Center for Education Statistics,
    NCES 2005-170.  Washington, DC: July 7, 2005.
    Hanushek, Eric A. with Charles Ka Yui Leung and Kuzey Yilmaz.
    Borrowing Constraints, College Aid, and Intergenerational Mobility.
    National Bureau of Economic Research, Working Paper 10711.  Cambridge,
    MA: August 2004.
    Jackson, Pamela J.  An Overview of Tax Benefits for Higher Education
    Expenses.  Congressional Research Service Report RL32554.  Washington,
    DC: updated September 1, 2006.
    Levine, Linda.  Education Tax Benefits: Are They Permanent or
    Temporary?  Congressional Research Service Report RS21870.  Washington,
    DC: updated August 28, 2006.
    Project on Student Debt.  Addressing Student Loan Repayment Burdens.
    Washington, DC: February 2006.

    State PIRGs' Higher Education Project.  Paying Back, Not Giving Back:
    Student Debt's Negative Impact on Public Service Career Opportunities.
    Washington, DC: April 2006.
    Stoll, Adam.  Federal Student Loans: Terms and Conditions for
    Borrowers.  Congressional Research Service Report RL30655.  Washington,
    DC: updated January 26, 2006.

    Education, Training, Employment, and Social Services:
    Education and Training

    EXCLUSION OF EARNINGS OF
    COVERDELL EDUCATIONAL SAVINGS ACCOUNTS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.1

    -

    0.1

    2007

    0.1

    -

    0.1

    2008

    0.1

    -

    0.1

    2009

    0.2

    -

    0.2

    2010

    0.2

    -

    0.2

    Authorization

    Section 530.

    Description

    Coverdell Education Savings Accounts (ESAs), formerly known as
    "Education IRAs," are trusts or custodial accounts created solely for the
    purpose of paying qualified elementary, secondary, and postsecondary
    education expenses of designated beneficiaries.  The contribution limit was
    raised from $500 annually to $2,000 annually effective from 2002 through
    2010.  It is phased-out for single taxpayers with modified adjusted gross
    income between $95,000 and $110,000 ($190,000 and $220,000 for joint
    return taxpayers) annually during the 9-year period.  The income limits are
    not adjusted for inflation and will revert to $95,000 and $150,000,
    respectively, after December 31, 2010.  Corporations, tax-exempt
    organizations, or lower income individuals can contribute the maximum
    annual amount to accounts of children in families whose income falls in the
    phase-out range.

    A contributor may fund multiple accounts for the same beneficiary,
    and a student may be the designated beneficiary of multiple accounts.
     A 6% tax is imposed if total contributions exceed the annual per-beneficiary
    limit.  Funds withdrawn from one Coverdell ESA in a 12-month period and
    rolled over to another ESA on behalf of the same beneficiary or certain of
    their family members  are excluded from the annual contribution limit and are
    not taxable.

    Contributions may be made until beneficiaries reach age 18, although they
    may continue beyond that age for special needs beneficiaries.  Similarly, with
    the exception of special needs beneficiaries, account balances typically must
    be totally distributed when beneficiaries attain age 30.  Contributions are not
    deductible, but account earnings grow on a tax-deferred basis.  Beginning in
    2002, a contribution may be made to an ESA in the same year that a
    contribution is made to a Qualified Tuition Program for the same beneficiary.

    Distributions are excluded from gross income of the beneficiary if used for
    tuition, fees, books, supplies, and equipment required for enrollment or
    attendance; contributions to Qualified Tuition Programs; special needs
    services; and room and board expenses for students enrolled on at least a half-
    time basis at eligible institutions of higher education.  Distributions also are
    not taxed if they are used, from 2002 through 2010, toward the following
    expenses of beneficiaries pursuing elementary and secondary (K-12)
    education:  tuition, fees, books, supplies, and other equipment incurred in
    connection with enrollment or attendance; academic tutoring; special needs
    services; room and board, uniforms, transportation, and supplementary items
    or services required or provided by the school; and computer software,
    hardware, or services if used by the beneficiary and the beneficiary's family
    during any years the beneficiary is in school.

    Eligible postsecondary institutions are those eligible to participate in U.S.
    Department of Education student aid programs; these include most accredited
    public, private, and proprietary postsecondary institutions.  From 2002
    through 2010, eligible institutions have been expanded to public and private
    K-12 schools, either secular or religiously affiliated; they include
    homeschools in some states.

    Distributions are taxed to the beneficiary under section 72 annuity rules:
    thus, each distribution is treated as consisting of principal, which is not taxed,
    and earnings, some of which may be taxed depending on the amount of
    qualified education expenses.  Distributions included in gross income are
    subject to a 10% penalty tax, with some exceptions.  After 2001, beneficiaries
    can exclude from gross income distributions made in the same year that either
    the Hope Credit or the Lifetime Learning Credit is claimed (although not for
    the same expenses).  This and other previously mentioned changes to the
    Coverdell ESA that went into effect in 2002 are set to expire after December
    31, 2010 absent further congressional action.

    Impact

    Both the exclusion from gross income of account earnings withdrawn to
    pay for qualified expenses and the deferral of taxes on accumulating earnings
    confers benefits to tax filing units according to their marginal tax rate (see
    Appendix A).  These benefits are most likely to accrue to higher income
    families that have the means to save on a regular basis.

    Tax benefits from Coverdell ESAs might be offset by reductions in federal
    student aid, most of which is awarded to students based on their financial
    need.  Generally, students have need when their cost of attendance exceeds
    their expected family contribution (EFC).    For purposes of need-based
    federal student aid programs (other than Pell Grants), the Department of
    Education provided guidance in 2006 based upon  amendments to the Higher
    Education Act of 1965 included in the Deficit Reduction Act of 2005.
    According to the Department's guidance, a Coverdell ESA shall not be
    considered an asset of the student in the EFC calculation; instead, it shall be
    considered an asset of the parent if the parent is the account owner.  The
    phrase "account owner" is not normally used in connection with Coverdell
    ESAs, however.  In addition, other information the Department provides to
    families applying for federal student aid suggests that students who are the
    beneficiaries of Coverdell ESAs consider them their assets.  This distinction
    is an important one because a maximum of 5.64% of the assets of parents are
    counted toward the EFC, while a fixed 35% of the assets of students are
    counted toward the EFC.

    Rationale

    Tax-favored saving for higher education expenses was authorized by the
    Taxpayer Relief Act of 1997 as one of a number of tax benefits for
    postsecondary education.  These benefits reflect congressional concern that
    families are having increasing difficulty paying for college.  They also reflect
    an intention to subsidize  middle-income families that otherwise do not
    qualify for much need-based federal student aid.  The Economic Growth and
    Tax Relief Reconciliation Act of 2001 expanded eligible expenses to those
    incurred in connection with enrollment in public and private K-12 schools.  It
    was intended, in part, to encourage families to exercise school choice (i.e.,
    attend alternatives to the traditional public school).

    Assessment

    The tax exclusion could be justified both as a way of encouraging
    families to use their own resources for college expenses and as a
    means of easing their financing burdens.  Families that have the
    wherewithal to save are more likely to benefit.  Whether families will
    save additional sums might be doubted.  Tax benefits for Coverdell
    ESAs are not related to the student's cost of attendance or other
    family resources, as is most federal student aid for higher education.

    Higher-income families also are more likely than lower-income
    families to establish accounts for their children's K-12 education
    expenses.  The amount of the tax benefit, particularly if the
    maximum contribution to an account is not made each year, is
    probably too small to affect a family's decision about whether to send
    their children to public or private school.

    Selected Bibliography

    Davis, Albert J.  "Choice Complexity in Tax Benefits for Higher
    Education," National Tax Journal, v. 55, no. 3 (September 2002).  pp. 509-
    530.
    Dynarksi, Susan M.  Who Benefits from the Education Savings
    Incentives?  Income, Educational Expectations, and the Value of the
    529 and Coverdell.  National Bureau of Economic Research,
    Working Paper 10470.  Cambridge, MA: May 2004.
    Investment Company Institute.  Profile of Households Saving for
    College.  Washington, DC: Fall 2003.
    Levine, Linda.  Education Tax Benefits: Are They Permanent or
    Temporary?  Congressional Research Service Report RS21870.
    Washington, DC: updated August 28, 2006.
    Levine, Linda and Charmaine Mercer.  Tax-Favored Higher
    Education Savings Benefits and Their Relationship to Traditional
    Federal Student Aid.  Congressional Research Service Report
    RL32155.  Washington, DC: updated September 28, 2006.
    Levine, Linda and David Smole.  Federal Tax Benefits for Families'
    K-12 Education Expenses in the Context of School Choice.
    Congressional Research Service Report RL31439.  Washington, DC:
    updated January 27, 2006.
    Ma, Jennifer.  Education Savings Incentives and Household Saving:
    Evidence from the 2000 TIAA-CREF Survey of Participant Finances.
     National Bureau of Economic Research, Working Paper 9505.
    Cambridge, MA: February 2003.
    Ma, Jennifer.  To Save or Not to Save: A Closer Look at Saving and
    Financial Aid.  TIAA-CREF Institute, Working Paper 18-120103.
    NY, NY: December 2003.
    Ma, Jennifer and Douglas Fore.  "Saving for College with 529
    Plans and Other Options," Journal of Retirement Planning,
    September-October 2002.
    Wolanin, Thomas R.  "How Do Student Financial Aid and Tax Policy Fit
    Together: Relating HEA Programs to Education Tax Breaks?" in
    Reauthorizing the Higher Education Act.  Washington, DC: Institute for
    Higher Education Policy, March 2003.

    Education, Training, Employment, and Social Services:
    Education and Training

    EXCLUSION OF INTEREST
    ON EDUCATION SAVINGS BONDS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    (1)

    -

    (1)

    2007

    (1)

    -

    (1)

    2008

    (1)

    -

    (1)

    2009

    (1)

    -

    (1)

    2010

    (1)

    -

    (1)

    (1)Less than $50 million.

    Authorization

    Section 135.

    Description

    Eligible taxpayers can exclude from their gross income all or part of the
    interest on U.S. Series EE or  Series I Savings Bonds when the bonds are
    used to pay qualified higher education expenses of the taxpayer or the
    taxpayer's spouse or dependents.  Series EE Bonds are accrued bonds which
    earn a variable interest rate equal to 90% of the average yield on 5-year
    Treasury securities for the preceding six months.  Series I Bonds are accrued
    bonds which earn a fixed rate of return plus a variable semi-annual inflation
    rate.  The bonds must have been issued after 1989 and be both purchased and
    owned by persons who are age 24 or over.  If the total amount of principal
    and interest on bonds redeemed during a year exceeds the amount of qualified
    education expenses, the amount of the interest exclusion is reduced
    proportionately.

    Qualified higher education expenses generally are restricted to tuition and
    fees required for enrollment or attendance at eligible institutions.  Tuition and
    fees are not taken into account if they are paid with tax-exempt scholarships,
    veterans' education assistance, employer education assistance, and
    distributions from Qualified Tuition Programs or from Coverdell ESAs, or if
    a tax credit or deduction is claimed for them.  Expenditures for courses in
    sports, games, or hobbies are not considered unless they are part of a degree
    program.  Contributions to Qualified Tuition Programs or to Coverdell ESAs
    are considered qualified expenses if made with redeemed proceeds.  Eligible
    institutions are those eligible to participate in U.S. Department of Education
    student aid programs; these include most accredited public, private, and
    proprietary postsecondary institutions.

    The interest exclusion is phased out for middle- and upper-income
    taxpayers.  The phase-out ranges are based on the taxpayer's modified
    adjusted gross income in the year in which the bond is applied toward
    qualified expenses.  The ranges are adjusted annually for inflation.  The
    phase-out range for a married couple filing jointly and for widow(er)s is
    $94,700 to $124,700.  (Married couples must file a joint return to take the
    exclusion.)  For all others, it was $63,100 to $78,100.

    Impact

    Education Saving Bonds provide lower- and middle-income families
    with a tax-favored way to save for higher education that is convenient
    and often familiar.  The benefits are greater for families who live in
    states and localities with high income taxes because the interest
    income from Series EE and Series I Bonds is exempt from state and
    local income taxes.

    Rationale

    The interest exclusion for Education Savings Bonds was created by
    the Technical and Miscellaneous Revenue Act of 1988, making it
    among the earliest congressional efforts to assist family financing of
    postsecondary education.  It reflects a long-held congressional
    concern that families have difficulty paying for college, particularly
    with the cost of higher education often rising faster than prices in
    general.  If families would save more prior to their children's
    enrollment in college, they might find it easier to meet the cost
    without relying on student aid or borrowing.  Although the tax
    provision has been subject to a number of technical and coordinating
    amendments since its inception (e.g., to take into account more
    recently enacted education tax benefits), the basic requirements have
    remained the same.

    Assessment

    The benefits of Education Savings Bonds depend on several
    factors, including how soon taxpayers begin to save, the return on
    alternative savings plans, a taxpayer's marginal income tax rate, and
    the burden of state and local income taxes.  For many taxpayers, the
    after-tax rate of return on Education Savings Bonds is approximately
    the same as the after-tax rate of return on other government
    securities with a similar term.  Like other U.S. government securities,
    the interest income from Series EE and Series I Savings Bonds is
    exempt from state and local income taxes.

    The tax savings from the exclusion are greater for taxpayers in
    higher tax brackets.  These savings would be partially offset by the
    below-market yield of these savings bonds.  However, both Series EE
    and Series I Bonds are a safe way to save, and many taxpayers may
    find it easier to purchase and redeem them than other Treasury
    securities.

    Since the interest exclusion for Education Savings Bonds can be
    limited when the bonds are redeemed, families intending to use them
    for college expenses must predict their income eligibility far in
    advance.  They must also anticipate the future costs of tuition and
    fees and whether their children might receive scholarships.  Further,
    unless students are tax dependents of their grandparents for example,
    the relatives cannot take the exclusion on bond interest used to pay
    the students' qualified expenses.  In these respects, the bonds may
    not be as attractive an investment as some other education savings
    vehicles.

    Selected Bibliography

    Davis, Albert J.  "Choice Complexity in Tax Benefits for Higher
    Education," National Tax Journal, v. 55, no. 3 (September 2002).  pp. 509-
    530.
    Hubbard, R. Glenn and Jonathan S. Skinner.  "Assessing the
    Effectiveness of Saving Incentives," The Journal of Economic
    Perspectives,  v. 10, no. 4 (Fall 1996).  pp. 73-90.
    Investment Company Institute.  Profile of Households Saving for
    College.  Washington, DC: Fall 2003.
    Levine, Linda and Charmaine Mercer.  Tax-Favored Higher
    Education Savings Benefits and Their Relationship to Traditional
    Federal Student Aid.  Congressional Research Service Report
    RL32155.  Washington, DC: updated September 28, 2006.
    U.S. Treasury.  Bureau of the Public Debt.  Savings Bonds for
    Education.  Accessible at http://www.publicdebt.treas.gov/sav/saveduca.htm

    Education, Training, Employment, and Social Services:
    Education and Training

    DEDUCTION FOR HIGHER EDUCATION EXPENSES

    Estimated Revenue Loss*

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    -

    -

    -

    2007

    -

    -

    -

    2008

    -

    -

    -

    2009

    -

    -

    -

    2010

    -

    -

    -

    *The tax credit is effective through December 31, 2007.  H.R. 6111 which
    extended the deduction through 2006 and 2007 cost $1.6 billion in FY 2007
    and $1.7 billion in FY2008.

    Authorization

    Section 222.

    Description

    Taxpayers may deduct qualified tuition and related expenses for
    postsecondary education from their adjusted gross income.  The deduction
    is "above-the-line," that is, it is not restricted to itemizers.  Taxpayers
    are eligible for the deduction if they pay qualified expenses for
    themselves, their spouses, or their dependents.  Individuals who may
    be claimed as dependents on another taxpayer's return, married
    persons filing separately, and nonresident aliens who do not elect to
    be treated as resident aliens cannot take the deduction.

    The maximum deduction per return is $4,000 for taxpayers with
    modified adjusted gross income that does not exceed $80,000
    ($160,000 on joint returns).  Taxpayers with incomes above
    $65,000 ($130,000 for joint returns) but not above $80,000
    ($160,000 for joint returns) can deduct up to $2,000 in qualified
    expenses.  These income limits are not adjusted for inflation and
    there is no phase-out of the deduction based upon income.

    The deduction may be taken for qualified tuition and related
    expenses in lieu of claiming the Hope Scholarship Credit or Lifetime
    Learning Credit for the same student.  Taxpayers cannot deduct
    qualified expenses under Section 222 if they deduct these expenses
    under any other provision in the Code (e.g., the itemized deduction
    for education that maintains or improves skills required in a
    taxpayer's current profession).

    Before the deduction can be taken, qualified expenses must be
    reduced if financed with scholarships, Pell Grants, employer-provided
    educational assistance, veterans' educational assistance, and any
    other nontaxable income (other than gifts and inheritances).
    Qualified expenses also must be reduced if paid with tax-free interest
    from Education Savings Bonds, tax-free distributions from Coverdell
    Education Savings Accounts, and tax-free earnings withdrawn from
    Qualified Tuition Plans.

    Qualified tuition and related expenses are tuition and fees required
    for enrollment or attendance in an institution eligible to participate in
    U.S. Department of Education student aid programs; these include
    most accredited public, private, and proprietary postsecondary
    institutions.  The deduction may be taken for any year of
    undergraduate or graduate enrollment.  It is available to part-time
    and full-time students, and the program need not lead to a degree,
    credential, or certificate.

    Impact

    The deduction benefits taxpayers according to their marginal tax rate (see
    Appendix A).  Students usually have relatively low tax rates, but they may be
    part of families in higher tax brackets.  As shown in the table below, most of
    the deductions are taken by higher income families.  The maximum amount of
    deductible expenses limits the tax benefit's impact on individuals attending
    schools with comparatively high tuition and fees.  Because the income limits
    are not adjusted for inflation, the deduction might be available to fewer
    taxpayers over time.

    Distribution by Income Class of Education
    Deduction at 2004 Income Levels

    Income Class
    (in thousands of $)

    Percentage
    Distribution

    Below $10

    17.3

    $10 to $20

    8.3

    $20 to $30

    6.4

    $30 to $40

    4.6

    $40 to $50

    7.4

    $50 to $75

    13.3

    $75 to $100

    16.2

    $100 to $200

    26.4

    $200 and over

    0.0

    Source: Data obtained from IRS Statistics of Income. This is not a
    distribution of the tax expenditures, but of the deduction; it is classified by
    adjusted gross income.

    Rationale

    The temporary deduction, which was authorized by the Economic
    Growth and Tax Relief Reconciliation Act of 2001 for 2002 through
    2005, builds upon postsecondary tax benefits that were initiated by
    the Taxpayer Relief Act of 1997.  It is one additional means that
    Congress has chosen to help families who are unlikely to qualify for
    much need-based federal student aid pay for escalating college
    expenses.  H.R. 6111, passed in December 2006, extended the
    benefit through 2007.

    Assessment

    The deduction has been criticized for adding to the complexity
    faced by families trying to determine which higher education tax
    benefits they are eligible for and what combination is their optimal
    mix for financing postsecondary education.  Between 2002 and
    2005, for example, those taxpayers whose incomes fell below the
    credit's lower income cutoff could claim either a higher education
    tax credit or the deduction.  In addition, the deduction must be
    coordinated with tax-advantaged college savings vehicles (e.g., the
    Coverdell Education Savings Accounts and Qualified Tuition Plans).

    Selected Bibliography

    Burman, Leonard E. with Elaine Maag, Peter Orszag, Jeffrey
    Rohaly, and John O'Hare.  The Distributional Consequences of
    Federal Assistance for Higher Education: The Intersection of Tax and
    Spending Programs, The Urban Institute, Discussion Paper No. 26.
    Washington, DC: August 2005.
    Davis, Albert J.  "Choice Complexity in Tax Benefits for Higher
    Education," National Tax Journal, v. 55, no. 3 (September 2002).  pp. 509-
    530.
    Levine, Linda.  Education Tax Benefits: Are They Permanent or
    Temporary?  Congressional Research Service Report RS21870.
    Washington, DC: updated August 28, 2006.
    Stoll, Adam and Linda Levine.  Higher Education Tax Credits and
    Deduction: An Overview of the Benefits and Their Relationship to
    Traditional Student Aid.  Congressional Research Service Report RL31129.
    Washington, DC: updated October 2, 2006.

    Education, Training, Employment and Social Services:
    Education and Training

    EXCLUSION OF TAX ON EARNINGS
    OF QUALIFIED TUITION PROGRAMS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.7

    -

    0.7

    2007

    0.8

    -

    0.8

    2008

    0.9

    -

    0.9

    2009

    1.0

    -

    1.0

    2010

    1.0

    -

    1.0

    Authorization

    Section 529.

    Description

    There are two types of Qualified Tuition Programs (QTPs) that
    allow persons to pay in advance or save for college expenses for
    designated beneficiaries: prepaid tuition plans and college savings
    plans.  The former enable account owners to make payments on
    behalf of beneficiaries for a specified number of academic periods or
    course units at current prices, thus providing a hedge against tuition
    inflation.  The latter enable payments to be made on behalf of
    beneficiaries into a variety of investment vehicles offered by plan
    sponsors (e.g., age-based portfolios whose mix of stocks and bonds
    changes the closer the beneficiary's matriculation date or an option
    with a guaranteed rate of return); the balances in college savings
    accounts can be applied toward a panoply of qualified higher
    education expenses (e.g., tuition and fees, books, supplies, and room
    and board).

    Initially, only states could sponsor QTPs.  Starting in 2002, one or
    more eligible institutions of higher education could establish prepaid
    tuition plans.  Eligible institutions are those eligible to participate in
    U.S. Department of Education student aid programs; these include
    most accredited public, private, and proprietary postsecondary
    institutions.  States remain the sole sponsors of tax-advantaged
    college savings plans.

    To be qualified, a QTP must receive cash contributions, maintain
    separate accounting for each beneficiary, and not allow investments
    to be directed by contributors and beneficiaries.  (The last restriction
    has been loosened somewhat as account owners now can make
    tax-free transfers from one QTP to another for the same beneficiary
    once in any 12-month period).  A contributor may fund multiple
    accounts for the same beneficiary in different states, and an
    individual may be the designated beneficiary of multiple accounts.

    The specifics of plans vary greatly from one state to another.  Plan
    sponsors may establish restrictions that are not mandated either by
    the Code or federal regulation.  There are no income caps on
    contributors, unlike the limits that generally apply to taxpayers who
    want to claim the other higher education benefits.  Similarly, there is
    no annual limit on contributions, unlike the case with the Coverdell
    ESA.

    There is no federal income tax deduction for contributions to
    QTPs.  Payments to QTPs are considered completed gifts of present
    interest from the contributor to the beneficiary meaning that an
    individual could contribute up to $12,000 in 2006 (subject to
    indexation) as a tax-free gift per QTP beneficiary.  A special gifting
    provision allowed a QTP contributor to make an excludable gift of up
    to $60,000 in one year by treating the payment as if it were made
    over 5 years.  By making QTP contributions completed gifts, their
    value generally is removed from the contributor's taxable estate.

    Earnings on contributions accumulate on a tax-deferred basis.
    Starting in 2002 for state-sponsored plans and in 2004 for programs
    of higher education institutions, earnings withdrawn to pay qualified
    expenses are free from federal income tax.  This change, as well as
    other QTP amendments included in the Economic Growth and Tax
    Relief Reconciliation Act of 2001, were due to expire after
    December 31, 2010; however, Congress made the changes
    permanent in the Pension Protection Act of 2006.

    Except in the case of the beneficiary's death, disability, or receipt
    of a scholarship, veterans educational assistance allowance or other
    nontaxable payment for educational purposes (excluding a gift or
    inheritance), a 10% tax penalty is assessed on the earnings portion of
    distributions that exceed or are not used toward qualified higher
    education expenses.  Nonqualified earnings withdrawals are taxable
    to the distributee as well.  An account owner can avoid paying
    income tax and a penalty on nonqualified distributions by
    transferring the account to a new beneficiary who is a family member
    of the old beneficiary.

    Contributions can be made to a QTP and to a Coverdell ESA in the
    same year for the same beneficiary effective after 2001.  Also
    starting in 2002, the higher education tax credits can be claimed for
    tuition and fees in the same year that tax-free distributions are made
    from a QTP or a Coverdell ESA on behalf of the same beneficiary,
    provided that the distributions are not used toward the same expenses
    for which the credits/deduction are claimed.

    Impact

    The tax deferral and more recently enacted exclusion from income of
    account earnings used to pay qualified expenses benefits tax filing units
    according to their marginal tax rate (see Appendix A).  The tax benefits of
    QTPs are more likely to accrue to higher income families because they have
    higher tax rates and the means to save for college.

    Tax benefits from QTPs might be offset by reductions in federal student
    aid, much of which is awarded to students based on their financial need.
    Generally, students have need when their cost of attendance exceeds their
    expected family contribution (EFC).  Until Congress amended the Higher
    Education Act of 1965 in the Deficit Reduction Act of 2005, prepaid tuition
    plans reduced a student's financial need to a much greater extent than college
    savings plans.  Both types of QTPs now are treated the same: according to
    Department of Education guidance, the two shall be considered an asset of the
    parent  if the parent is the account owner.  Because the law states that QTPs
    shall not be considered an asset of the student, the Department's guidance
    suggests that student-owned QTPs should not be considered in the EFC
    calculation.

    Rationale

    QTPs have been established in response to widespread concern
    about the rising cost of college.  The tax status of the first program,
    the Michigan Education Trust, was the subject of several federal
    court rulings that left major issues unresolved.  Congress eventually
    clarified most questions in enacting section 529 as part of the Small
    Business Job Protection Act of 1996.

    Assessment

    The tax benefit can be justified as easing the financial burden of
    college expenses for families and encouraging savings for college.
    The benefits are generally limited to higher income individuals,
    however.

    Families have preferred college savings plans over prepaid tuition
    plans because the former potentially offer higher returns and because
    college savings plans, until recently, received more favorable
    treatment under some federal student aid programs.  Despite the
    steep decline in stock prices early in the current decade and the
    increased awareness of the fees associated with plans sold by financial
    advisors in particular, college savings accounts remain the most
    popular type of 529 plan.  (Broker-sold college savings plans impose
    investment fees in addition to the administrative and other fees
    charged by plans sold directly by the states.)  While the changed
    treatment of prepaid tuition plans in the EFC calculation could entice
    more families to invest in them, they too have suffered from the poor
    performance of the stock market (in which the funds of prepaid plans
    typically are invested).  In addition, the continuing rapid rise in
    college costs has prompted some states to change the terms of their
    prepaid tuition plans or to stop accepting contributions.

    Selected Bibliography

    Clancy, Margaret and Michael Sherraden.  The Potential for Inclusion in
    529 Savings Plans: Report on a Survey of States.  Center for Social
    Development, Washington University.  St. Louis, MO: December 2003.
    Crenshaw, Albert B.  "Prepaid Tuition A Future Flunk-Out?," Washington
    Post, Nov. 14, 2004.
    Dynarksi, Susan M.  Who Benefits from the Education Savings
    Incentives?  Income, Educational Expectations, and the Value of the
    529 and Coverdell.  National Bureau of Economic Research,
    Working Paper 10470.  Cambridge, MA: May 2004.
    Investment Company Institute.  Profile of Households Saving for
    College.  Washington, DC: Fall 2003.
    Levine, Linda.  Saving for College Through Qualified Tuition
    (Section 529) Programs.  Congressional Research Service Report
    RL31214.  Washington, DC: updated September 25, 2006.
    Levine, Linda and Charmaine Mercer.  Tax-Favored Higher
    Education Benefits and Their Relationship to Traditional Federal
    Student Aid.  Congressional Research Service Report RL32155.
    Washington, DC:  updated September 28, 2006.
    Lumina Foundation for Education.  "When Saving Means Losing:
    Weighing the Benefits of College-savings Plans," New Agenda Series,
    July 2004.
    Ma, Jennifer.  Education Savings Incentives and Household Saving:
    Evidence from the 2000 TIAA-CREF Survey of Participant Finances.
     National Bureau of Economic Research, Working Paper 9505.
    Cambridge, MA: February 2003.
    Ma, Jennifer.  To Save or Not to Save: A Closer Look at Saving and
    Financial Aid.  TIAA-CREF Institute, Working Paper 18-120103.
    NY, NY: December 2003.

    Education, Training, Employment, and Social Services:
    Education and Training

    EXCLUSION OF SCHOLARSHIP AND FELLOWSHIP INCOME

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    1.5

    -

    1.5

    2007

    1.6

    -

    1.6

    2008

    1.7

    -

    1.7

    2009

    1.8

    -

    1.8

    2010

    1.9

    -

    1.9

    Authorization

    Section 117.

    Description

    Scholarships and fellowships include awards based upon financial
    need (e.g., Pell Grants) as well as those based upon scholastic
    achievement or promise (e.g., National Merit Scholarships).  In
    recent years, interest has arisen in utilizing scholarships to promote
    school choice at the elementary and secondary levels in lieu of
    relying upon publicly funded vouchers.

    Scholarships and fellowships can be excluded from the gross
    income of students or their families provided:  (1) the students are
    pursuing degrees (or are enrolled in a primary or secondary school);
    and (2) the amounts are used for tuition and fees required for
    enrollment or for books, supplies, fees, and equipment required for
    courses at an eligible educational institution.  Eligible educational
    institutions maintain a regular teaching staff and curriculum and have
    a regularly enrolled student body attending classes where the school
    carries out its educational activities.  Amounts used for room, board,
    and incidental expenses are not excluded from gross income.

    Generally, amounts representing payment for services - teaching,
    research, or other activities - are not excludable, regardless of when
    the service is performed or whether it is required of all degree
    candidates.  An exception to the rule went into effect for awards
    received after 2001 under the National Health Service Corps
    Scholarship Program and the Armed Forces Health Professions
    Scholarship and Financial Assistance Program.

    Impact

    The exclusion reduces the net cost of education for students who
    receive financial aid in the form of scholarships or fellowships.  The
    potential benefit is greatest for students at private schools, where
    higher tuition charges increase the amount of scholarship or
    fellowship assistance that might be excluded.  For students at public
    institutions with low tuition charges, the exclusion may apply only to
    a small portion of a scholarship or fellowship award since most ot the
    award may cover room and board and other costs.

    The effect of the exclusion may be negligible for students with little
    additional income: they could otherwise use their standard deduction
    or personal exemption to offset scholarship or fellowship income
    (though their personal exemption would be zero if their parents could
    claim them as dependents).  On the other hand, the exclusion may
    result in a more substantial tax benefit for married postsecondary
    students who file joint returns with their employed spouses.

    Rationale

    Section 117 was enacted as part of the Internal Revenue Code of
    1954 in order to clarify the tax status of grants to students;
    previously, they could be excluded only if it could be established that
    they were gifts.  The statute has been amended a number of times.
    Prior to the Tax Reform Act of 1986, the exclusion was also
    available to individuals who were not candidates for a degree (though
    it was restricted to $300 a month with a lifetime limit of 36 months),
    and teaching and other service requirements did not bar use of the
    exclusion, provided all candidates had such obligations.

    Assessment

    The exclusion of scholarship and fellowship income traditionally
    was justified on the grounds that the awards were analogous to gifts.
    With the development of grant programs based upon financial need,
    which today probably account for most awards, justification now rests
    upon the hardship that taxation would impose.

    If the exclusion were abolished, awards could arguably be
    increased to cover students' additional tax liability, but the likely
    effect would be that fewer students would get assistance.
    Scholarships and fellowships are not the only educational subsidies
    that receive favorable tax treatment (e.g., government support of
    public colleges, which has the effect of lowering tuition, is not
    considered income to the students), and it might be inequitable to tax
    them without taxing the others.

    The exclusion provides greater benefits to taxpayers with higher
    marginal tax rates.  While students themselves generally have low (or
    even zero) marginal rates, they often are members of families subject
    to higher rates.  Determining what ought to be the proper taxpaying
    unit for college students complicates assessment of the exclusion.

    Selected Bibliography

    Abramowicz, Kenneth F.  "Taxation of Scholarship Income," Tax Notes, v.
    60.  November 8, 1993, pp. 717-725.
    Crane, Charlotte.  "Scholarships and the Federal Income Tax Base,"
    Harvard Journal on Legislation, v. 28.  Winter 1991, pp. 63-113.
    Dodge, Joseph M.  "Scholarships under the Income Tax," Tax Lawyer, v.
    46.  Spring, 1993, pp. 697-754.
    Evans, Richard, et. al.  "Knapp v. Commissioner of Internal
    Revenue: Tuition Assistance or Scholarship, a Question of Taxation,"
     The Journal of College and University Law, v. 16.  Spring 1990, pp.
    699-712.
    Hoeflich, Adam.  "The Taxation of Athletic Scholarships: A
    Problem of Consistency,." University of Illinois Law Review, 1991,
    pp. 581-617.
    Kelly, Marci.  "Financing Higher Education: Federal Income-Tax
    Consequences," The Journal of College and University Law, v. 17.
    Winter 1991, pp. 307-328.
    Levine, Linda and Bob Lyke.  Federal Taxation of Student Aid: An
    Overview.  Congressional Research Service Report 97-225.  Washington,
    DC.
    Levine, Linda and David Smole.  Federal Tax Benefits for Families' K-12
    Education Expenses in the Context of School Choice.  Congressional
    Research Service Report RL31439.  Washington, DC.

    	Education, Training, Employment, and Social Services:
    	Education and Training

    	EXCLUSION OF EMPLOYER-PROVIDED
    	EDUCATION ASSISTANCE BENEFITS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.8

     -

    0.8

    2007

    0.9

     -

    0.9

    2008

    0.9

     -

    0.9

    2009

    0.9

     -

    0.9

    2010

    0.9

     -

    0.9

    	Authorization

    Section 127.

    	Description

    An employee may exclude from gross income amounts paid by the
    employer for educational assistance (tuition, fees, books, supplies, etc.)
    pursuant to a written qualified educational assistance program.  The annual
    limit is $5,250.  Any excess is includable in the employee's gross income and
    is subject to both employment and income taxes.  Amounts that exceed the
    limit may be excludable if they meet the working condition fringe benefits
    provision of Code Section 132.

    Courses do not have to be job related.  Those involving sports, games, or
    hobbies are covered only if they involve the employer's business, however.
    Courses can help employees meet minimum requirements for current work or
    prepare for a new career.  Graduate education undertaken after December 31,
    2001and before January 1, 2011 is covered.

    The employer may make qualified assistance payments directly, by
    reimbursement to the employee, or may directly provide the education.  The
    plan may not discriminate in favor of highly compensated employees.  One
    requirement is that no more than 5% of the total amount paid out during the
    year may be paid to or for employees who are shareholders or owners of at
    least 5% of the business.  The employer must maintain records and file a plan
    return.

    Impact

    The exclusion of these benefit payments encourages employers to offer
    educational assistance to employees.  Availability of the benefit varies across
    firms, depending upon such things as industry and occupation of employment
    as well as firm size.  Availability also varies within firms, depending upon the
    number of hours an employee works (i.e., full-time or part-time schedules) for
    example.  The U.S. Bureau of Labor Statistics reports on the percent of
    employees in the private sector with access to employer-provided educational
    assistance.  In 2006, for example, almost one-half of employees had access to
    work-related educational assistance while only a little more than one-tenth
    had access to nonwork-related educational assistance.  In the case of work-
    related educational assistance, a much larger share of white-collar workers (60
    percent) had access to this employee benefit compared to blue-collar and
    service workers (42 percent and 30 percent, respectively).  Similarly, many
    more full-time workers (56 percent) compared to part-time workers (26
    percent) had access to work-related educational assistance in 2006.

    The exclusion allows certain employees, who otherwise might be unable to
    do so, to continue their education.  The value of the exclusion is dependent
    upon the amount of educational expenses furnished and the marginal tax rate.

    	Rationale

    Section 127 was added to the law by the passage of the Revenue Act of
    1978, effective through 1983.  Prior to enactment, the treatment of employer-
    provided educational assistance was complex, with a case-by-case
    determination of whether the employee could deduct the assistance as job-
    related education.

    Since its inception, the provision was reauthorized ten times.  It first was
    extended from the end of 1983 through 1985 by the Education Assistance
    Programs.  The Tax Reform Act of 1986 next  extended it through 1987, and
    raised the maximum excludable assistance from $5,000 to $5,250.  The
    Technical and Miscellaneous Revenue Act of 1988 reauthorized the exclusion
    retroactively to January 1, 1989 and extended it through September 30, 1990.
     The Revenue Reconciliation Act of 1990 then extended it through December
    31, 1991, and the Tax Extension Act of 1991, through June 30, 1992.  The
    Omnibus Reconciliation Act of 1993 reauthorized the provision retroactively
    and through December 31, 1994; the Small Business Job Protection Act re-
    enacted it to run from January 1, 1995 through May 31, 1997.  The Taxpayer
    Relief Act of 1997 subsequently extended the exclusion - but only for
    undergraduate education - with respect to courses beginning before June 1,
    2000.  The Ticket to Work and Work Incentives Improvement Act of 1999
    extended the exclusion through December 31, 2001.  With passage of the
    Economic Growth and Tax Relief Reconciliation Act of 2001, the exclusion
    was reauthorized to include graduate education undertaken through December
    31, 2010.   The act also extended the existing rules for employer provided
    education assistance benefits until January 1, 2011.  Congressional committee
    reports indicate that the latest extension was designed to lessen the
    complexity of the tax law and was intended to result in fewer disputes
    between taxpayers and the Internal Revenue Service.

    Assessment

    The availability of employer educational assistance encourages employer
    investment in human capital, which may be inadequate in a market economy
    because of spillover effects (i.e., the benefits of the investment extend beyond
    the individuals undertaking additional education and the employers for whom
    they work).  Because all employers do not provide educational assistance,
    however, taxpayers with similar incomes are not treated equally.

    	Selected Bibliography

    Black, Sandra and Lisa M. Lynch.  "Human-Capital Investments and
    Productivity," AEA Papers and Proceedings, v. 86 (May 1996), pp. 263-267.
    Cappelli, Peter.  Why Do Employers Pay for College?.  National Bureau of
    Economic Research.  Working Paper 9225.  Cambridge, MA: September
    2002.
    Levine, Linda.  The Benefits of Education.  Congressional Research
    Service Report RL33238.  Washington, DC: December 29, 2005.
    Lyke, Bob and Linda Levine.  The Current Tax Status of Employer
    Education Assistance.  Congressional Research Service Report 97-243.
    Washington, DC: November 7, 2005.
    Luscombe, Mark A.  "Employer Educational Assistance Programs: Can the
    Frustration of Lapses in Statutory Authority Be Avoided?" Taxes, v. 74 (April
    1996), pp. 266-268.
    Phillips, Lawrence C. and Thomas R. Robinson.  "Financial Planning for
    Education Expenditures."  The CPA Journal, v. 72, no 4, (April 2002), pp.
    34-39.
    Selingo, Jeffrey.  "Adult Education: The End of the Magic Carpet Ride?,"
    Washington Post, November 9, 2003, p. W43.

    U.S. General Accounting Office.  Tax Expenditures: Information on
    Employer-Provided Educational Assistance, GAO/GGD-97-28.  Washington,
    DC: December 1996.

    Education, Training, Employment, and Social Services:
    Education and Training

    EXCLUSION OF EMPLOYER-PROVIDED
    TUITION REDUCTION

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.2

     -

    0.2

    2007

    0.2

     -

    0.2

    2008

    0.2

     -

    0.2

    2009

    0.2

     -

    0.2

    2010

    0.2

     -

    0.2

    Authorization

    Section 11(d).

    	Description

    Tuition reductions for employees of educational institutions may be
    excluded from federal income taxes, provided they do not represent payment
    for services.  The exclusion applies as well to tuition reductions for an
    employee's spouse and dependent children.  Tuition reductions can occur at
    schools other than where the employee works, provided they are granted by
    the school attended, and not paid for by the employing school.  Tuition
    reductions cannot discriminate in favor of highly compensated employees.

    Impact

    The exclusion of tuition reductions reduces the net cost of education for
    employees of educational institutions.  When teachers and other school
    employees take reduced-tuition courses, the exclusion provides a tax benefit
    not available to other taxpayers unless their courses are job-related or
    included under an employer education assistance plan (Section 127).  When
    their spouse or children take reduced-tuition courses, the exclusion provides a
    unique benefit unavailable to other taxpayers.

    Rationale

     Language regarding tuition reductions was added by the Deficit Reduction
    Act of 1984 as part of legislation codifying and establishing boundaries for
    tax-free fringe benefits; similar provisions had existed in regulations since
    1956.

    Assessment

     Tuition reductions are provided by education institutions to employees as
    a fringe benefit, which may reduce costs of labor and turnover.  In addition,
    tuition reductions for graduate students providing research and teaching
    services for the educational institution also contribute to reducing the labor
    costs.  Both employees and graduate students may view the reduced tuition as
    a benefit of their employment that encourages education.

    	Selected Bibliography

    Lyke, Bob and Linda Levine.  The Current Tax Status of Employer
    Education Assistance.  Library of Congress, Congressional Research Service
    Report 97-243.  Washington, DC: February 4, 2002.
    U.S. Congress, Joint Committee on Taxation, General Explanation of the
    Revenue Provisions of the Deficit Reduction Act of 1984, JCS-41-84,
    December 31, 1984.

    Education, Training, Employment, and Social Services:
    Education and Training

    PARENTAL PERSONAL EXEMPTION
    FOR STUDENTS AGE 19-23

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.5

    -

    1.1

    2007

    0.2

    -

    0.5

    2008

    0.2

    -

    0.3

    2009

    0.1

    -

    0.2

    2010

    (1)

    -

    (1)

    (1)Positive tax expenditure of less than $50 million.

    Authorization
    Section 151.

    Description

    Taxpayers may claim dependency exemptions for children 19 through 23
    years of age who are full-time students at least 5 months during the year, even
    if the children have gross income in excess of the personal exemption amount
    ($3,300 in 2006) and could not normally be claimed.  Other standard
    dependency tests must be met, including the taxpayer's provision of one-half
    of the dependents' support.  These dependents cannot claim personal
    exemptions on their own returns, however, and their standard deduction may
    be lower.  In 2006, with some exceptions, the standard deduction for students
    is equal to the greater of $800 (in any combination of earned or unearned
    income) or their earned income plus up to $250 of unearned income
    providing it does not exceed the standard deduction amount of  $5,150 for
    single taxpayers.  If the student's income is greater than these amounts in
    2006, he or she must file a tax return.

    Impact

    The student dependency exemption generally results in additional tax
    savings for families with college students.  Parents typically have higher
    income and higher marginal tax rates than their student children (who may
    not even be taxed); thus, the exemption is worth more if parents claim it.
    Parents lose some or all of the student dependency exemption if their adjusted
    gross income is greater than the inflation adjusted threshold for phasing out
    personal exemptions.  In 2006 the threshold amounts begin at: $225,750 for
    joint returns, $150,500 for single returns, or $188,150 for heads of household.

    Rationale

    With the codification in 1954, the Internal Revenue Code first allowed
    parents to claim dependency exemptions for their children regardless of the
    student's gross income, provided they were less than 19 years old or were
    full-time students for at least 5 months.  Under prior law, such exemptions
    could not be claimed for any child whose gross income exceeded $600 (the
    amount of the personal exemption at the time).  Committee reports for the
    legislation noted that the prior rule was a hardship for parents with children in
    school and an inducement for the children to stop working before their
    earnings reached that level.

    Under the 1954 Code, dependents whose exemptions could be claimed by
    their parents could also claim personal exemptions on their own returns.  The
    Tax Reform Act of 1986 disallowed double exemptions, limiting claims just
    to the parents.  It did allow a partial standard deduction for students equal to
    the greater of $500 (earned and/or unearned income), or earned income up to
    the generally applicable standard deduction amount.  As a result, students
    with no earned income were able to shelter up to $500 in unearned income
    from taxation.  The $500 is indexed for inflation as is the amount of the
    standard deduction.

    The Technical and Miscellaneous Revenue Act of 1988 restricted the
    student dependency exemption to children under the age of 24.  Students who
    are older than 23 can be claimed as dependents only if their gross income is
    less than the personal exemption amount.

    The Taxpayer Relief Act of 1997 raised students' standard deduction to the
    greater of $700 ($500 adjusted for inflation) or the total of earned income
    plus $250 in unearned income provided the total did not exceed the full
    standard deduction.  This change, effective beginning in 1998, enables
    students with earned income greater than $700 but less than the standard
    deduction amount  and with little unearned income to shelter their unearned
    income from taxation and to no longer file a separate tax return (unless they
    must do so to claim a refund of withheld tax).  The limit on unearned income
    is adjusted annually for inflation.

    The Working Family Tax Relief Act of 2004 (P.L. 108-311) revised the
    definition of a child for tax purposes, beginning with tax year 2005.
    Specifically, the law replaced the definition of a dependent for the personal
    exemption with requirements (or tests) that define new categories of
    dependents.  Under this definition, a child is a qualifying child of the taxpayer
    if the child satisfies three tests: (1) the child has not yet attained a specified
    age; (2) the child has a specified relationship to the taxpayer; and (3) the child
    has the same principal place of abode as the taxpayer for more than half the
    taxable year.

    Assessment

    The student dependency exemption was created before the development of
    broad-based federal student aid programs, and some of its effects might be
    questioned in light of their objectives.  The exemption principally benefits
    families with higher incomes, and the tax savings are not related to the cost of
    education.  In contrast, most federal student aid is awarded according to
    financial need formulas that reflect both available family resources and
    educational cost.

    Nonetheless, the original rationale for the student dependency exemption
    remains valid.  If the exemption did not exist, as was the case before 1954,
    students who earned more than the personal exemption amount would cause
    their parents to lose a dependency exemption worth hundreds of dollars,
    depending on the latter's tax bracket.  Unless they would earn a lot more
    money, students who knew of this consequence might stop working at the
    point their earnings reached the personal exemption amount.

    Selected Bibliography

    Bittker, Boris I.  "Federal Income Taxation and the Family," 27 Stanford
    Law Review 1389, esp. pp. 1444-1456 (1975).
    Jackson, Pamela J.  Standard Deduction and Personal
    Dependency Amounts for Children 14 and Over or Students, Library of
    Congress, Congressional Research Service Report RS20072,  (Washington,
    DC, June 28, 2006).
    Scott, Christine. Tax Benefits for Families: Changes in the
    Definition of a Child, Library of Congress, Congressional Research
    Service Report RS22016, (Washington, DC, March 10, 2006).
    U.S. Congress, Joint Committee on Taxation.  General Explanation of the
    Tax Reform Act of 1986 (H.R. 3838, 99th Congress; Public Law 99-514),
    (Washington, DC,  May 4, 1987), pp. 22-24.

    U.S. Department of Treasury, Internal Revenue Service, Publication 501:
    Exemptions, Standard Deduction, and Filing Information, (Washington, DC:
    2005).

    	Education, Training, Employment, and Social Services:
    	Education and Training

    	EXCLUSION OF INTEREST ON STATE AND
    	LOCAL GOVERNMENT STUDENT LOAN BONDS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.3

    0.1

    0.4

    2007

    0.3

    0.1

    0.4

    2008

    0.3

    0.1

    0.4

    2009

    0.4

    0.1

    0.5

    2010

    0.4

    0.1

    0.5

    	Authorization

    Sections 103, 141, 144, and 146.

    	Description

    Since interest on student loan bonds is tax exempt, purchasers are willing
    to accept lower pre-tax rates of interest than on taxable securities.  The
    relatively low interest rate may increase the availability of student loans
    because States may be more willing to lend to more students.  The interest
    rate paid by the students is not any lower since the rate is set by Federal law.
    Student loan bonds  also create a secondary market for student loans that
    compares favorably with the private sector counterpart in the secondary
    market for such loans, the Student Loan Marketing Association.

    These student loan bonds are subject to the private-activity bond annual
    volume cap, and must compete for cap allocations with bond proposals for all
    other private activities subject to the volume cap.

    Student loan bonds are related to direct subsidy assistance provided by the
    Federal Family Education Loan Program that consists of Stafford loans
    ("subsidized" and "unsubsidized") and "PLUS loans."

    The Stafford Loan program

    (1) provides a guarantee to commercial lenders against loan default;

    (2) makes an interest-rate subsidy in the form of a Special Allowance
    Payment (SAP), which for commercial lenders (banks) fluctuates with the rate
    on 3-month commercial paper and makes up the difference between the
    interest rate the student pays and the interest that banks could earn on
    alternative investments; and

    (3) for Stafford "subsidized" loans only, forgoes both accrual and payment
    of interest and principal while the student is in school and for six months after
    the student leaves school.

    (4) for Stafford "unsubsidized" loans,  interest is paid while students are in
    school, so the Federal subsidy is less than on Stafford "subsidized" loans.

    PLUS loans are also guaranteed against default, but the maximum interest
    rates are higher, and interest is paid while students are in school.   The interest
    rates that borrowers pay under the Stafford and PLUS programs are set by law
    and are the same regardless of whether loan financing comes from taxable or
    tax-exempt sources.  Thus, tax-exempt borrowing does not provide lower
    interest rates for borrowers, but it does broaden access to loans by enabling
    State and local nonprofit authorities to make loans that may otherwise not be
    provided.

    	Impact

    Since interest on the student loan bonds is tax exempt, purchasers are
    willing to accept lower pre-tax rates of interest than on taxable securities.  The
    relatively low interest rate may increase the availability of students loans
    because States may be more willing to lend to more students.  However, the
    interest rate paid by the students is not any lower since the rate is set by
    Federal law.  Student loan bonds also create a secondary market for student
    loans that compares favorably with the private sector counterpart in the
    secondary market for students loans, the Student Loan Marketing Association.

    Some of the benefits of the tax exemption also flow to bondholders.  For a
    discussion of the factors that determine the shares of benefits going to
    bondholders and student borrowers, and for estimates of the distribution of
    tax-exempt interest income by income class, see the "Impact" discussion
    under General Purpose Public Assistance: Exclusion of Interest on Public
    Purpose State and Local Debt.

    	Rationale

    Although the first student loan bonds were issued in the mid-1960s, few
    states used them in the next ten years.  The use of student loan bonds began
    growing rapidly in the late 1970s because of the combined effect of three
    pieces of legislation.

    First, the Tax Reform Act of 1976 authorized nonprofit corporations
    established by State and local governments to issue tax-exempt bonds to
    acquire guaranteed student loans.  It exempted the special allowance payment
    from tax-code provisions prohibiting arbitrage profits (borrowing at low
    interest rates and investing the proceeds in assets (e.g., student loans) paying
    higher interest rates).  State authorities could use arbitrage earnings to make
    or purchase additional student loans or turn them over to the State
    government or a political subdivision.  This provided incentives for State and
    local governments to establish more student loan authorities.  State authorities
    could also offer discounting and other features private lenders could not
    because of the lower cost of tax-exempt debt financing.

    Second, the Middle Income Student Assistance Act of 1978 made all
    students, regardless of family income, eligible for interest subsidies on their
    loans, expanding the demand for loans by students from higher-income
    families.

    Third, legislation in late 1976 raised the ceiling on SAPs and tied them to
    quarterly changes in the 91-day Treasury bill rate.  The Higher Education
    Technical Amendments of 1979 removed the ceiling, making the program
    more attractive to commercial banks and other lenders, and increasing the
    supply of loans.

    In 1980, when Congress became aware of the profitability of tax-exempt
    student loan bond programs, it passed remedial legislation that reduced by
    one-half the special allowance rate paid on loans originating from the
    proceeds of tax-exempt bonds.

    Subsequently, the Deficit Reduction Act of 1984 mandated a
    Congressional Budget Office study of the arbitrage treatment of student loan
    bonds, and required that Treasury enact regulations if Congress failed to
    respond to the study's recommendations.

    Regulations were issued in 1989, effective in 1990, that required Special
    Allowance Payments to be included in the calculation of arbitrage profits, and
    that restricted arbitrage profits to 2.0 percentage points in excess of the yield
    on the student loan bonds.  The Tax Reform Act of 1986 allowed student
    loans to earn 18 months of arbitrage profits on unspent (not loaned) bond
    proceeds.  This special provision expired one-and-a-half years after adoption,
    and student loans are now subject to the same six-month restriction on
    arbitrage earnings as other private-activity bonds.

    The Tax Reform Act of 1986 also included student loan bonds under the
    unified volume cap on private-activity bonds.

    	Assessment

    The desirability of allowing these bonds to be eligible for tax-exempt status
    hinges on one's view of whether students should pay the full cost of their
    education, or whether sufficient social benefits exist to justify taxpayer
    subsidy.  Students present high credit risk due to their uncertain earning
    prospects, high mobility, and society's unwillingness to accept human capital
    as loan collateral (via indentured servitude or slavery).  This suggests there
    may be insufficient funds available for human, as opposed to physical, capital
    investments.

    Even if a case can be made for subsidy due to underinvestment in human
    capital, it is not clear that tax-exempt financing is necessary to correct the
    market failure.  The presence of federally subsidized guaranteed and direct
    loans already addresses the problem.  In addition, it is important to recognize
    the potential costs.  As one of many categories of tax-exempt private-activity
    bonds, bonds issued for student loans have increased the financing costs of
    bonds issued for public capital stock, and have increased the supply of assets
    available to individuals and corporations to shelter their income from
    taxation.

    	Selected Bibliography

    Maguire, Steven.  Private Activity Bonds: An Introduction.  Library of
    Congress, Congressional Research Service Report RL31457.  November 10,
    2004.
    -.  Tax-Exempt Bonds: A Description of State and Local Government
    Debt.  Library of Congress, Congressional Research Service Report
    RL30638.  October 22, 2004.
    Neubig, Tom.  "The Needless Furor Over Tax-Exempt Student Loan
    Bonds," Tax Notes, April 2, 1984, pp. 93-96.
    Oosterbeek, Hessel.  "Innovative Ways to Finance Education and Their
    Relation to Lifelong Learning,"  Education Economics, v. 6, no. 3, (Dec.
    1998), pp. 219-251.
    Stoll, Adam.  Federal Family Education Loan Program and William D.
    Ford Direct Loan Program Student Loans:  Terms and Conditions for
    Borrowers.  Library of Congress, Congressional Research Service Report
    RL33673.  September 29, 2006.

    U.S. Congress, Congressional Budget Office.  Statement of Donald B.
    Marron before the Subcommittee on Select Revenue Measures Committee on
    Ways and Means U.S. House of Representatives.  "Economic Issues in the
    Use of Tax-Preferred Bond Financing," March 16, 2006.
    -.  The Tax-Exempt Financing of Student Loans.  August 1986.
    Zimmerman, Dennis.  The Private Use of Tax-Exempt Bonds: Controlling
    Public Subsidy of Private Activity.  Washington, DC: The Urban Institute
    Press, 1991.
    -, and Barbara Miles.  "Substituting Direct Government Lending for
    Guaranteed Student Loans: How Budget Rules Distorted Economic Decision
    Making," National Tax Journal, v. 47, no. 4 (December 1994), pp. 773-787.

    	Education, Training, Employment and Social Services:
    	Education and Training

    EXCLUSION OF INTEREST ON STATE AND LOCAL
     GOVERNMENT BONDS FOR PRIVATE NONPROFIT
    AND QUALIFIED PUBLIC EDUCATIONAL FACILITIES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    1.1

    0.4

    1.5

    2007

    1.2

    0.5

    1.7

    2008

    1.2

    0.5

    1.7

    2009

    1.3

    0.5

    1.8

    2010

    1.3

    0.5

    1.8

    Authorization

    Section 103, 141, 142(k), 145, 146, and 501(c)(3).

    	Description

    Interest income on State and local bonds used to finance the construction
    of nonprofit educational facilities (usually university and college facilities
    such as classrooms and dormitories) and qualified public educational facilities
    is tax exempt.  These nonprofit organization bonds are classified as private-
    activity bonds rather than governmental bonds because a substantial portion
    of their benefits accrues to individuals or business rather than to the general
    public.  For more discussion of the distinction between governmental bonds
    and private-activity bonds, see the entry under General Purpose Public
    Assistance: Exclusion of Interest on Public Purpose State and Local Debt.

    Bonds issued for nonprofit educational facilities are not subject to the State
    volume cap on private activity bonds.  This exclusion probably reflects the
    belief that the nonprofit bonds have a larger component of benefit to the
    general public than do many of the other private activities eligible for tax
    exemption.  The bonds are subject to a $150 million cap on the amount of
    bonds any nonprofit institution can have outstanding.

    Bonds issued for qualified public education facilities are subject to a
    separate state-by-state cap: the greater of $10 per capita or $5 million
    annually.

    	Impact

    Since interest on the bonds is tax exempt, purchasers are willing to accept
    lower before-tax rates of interest than on taxable securities.  These low
    interest rates enable issuers to finance educational facilities at reduced interest
    rates.  Some of the benefits of the tax exemption also flow to bondholders.
    For a discussion of the factors that determine the shares of benefits going to
    bondholders and users of the nonprofit educational facilities, and estimates of
    the distribution of tax-exempt interest income by income class, see the
    "Impact" discussion under General Purpose Public Assistance: Exclusion of
    Interest on Public Purpose State and Local Debt.

    	Rationale

    An early decision of the U.S. Supreme Court predating the enactment of
    the first Federal income tax, Dartmouth College v. Woodward (17 U.S. 518
    [1819]), confirmed the legality of government support for charitable
    organizations that provided services to the public.  The income tax adopted in
    1913, in conformance with this principle, exempted from taxation virtually
    the same organizations now included under Section 501(c)(3).  In addition to
    their tax- exempt status, these institutions were permitted to receive the
    benefits of tax-exempt bonds under The Revenue and Expenditure Control
    Act of 1968.  Almost all States have established public authorities to issue
    tax-exempt bonds for nonprofit educational facilities.

    The interest exclusion for qualified public educational facilities was
    provided for in the Economic Growth and Tax Relief Reconciliation Act of
    2001 and is intended to extend tax preferences to public school facilities
    which are owned by private, for-profit corporations.  The school must have,
    however, a public-private agreement with the local education authority.  The
    private-activity bond status of these bonds subjects them to more severe
    restrictions in some areas, such as arbitrage rebate and advance refunding,
    than would apply if they were classified as traditional governmental school
    bonds.

    	Assessment

    Efforts have been made to reclassify nonprofit bonds as governmental
    bonds.  Central to this issue is the extent to which nonprofit organizations are
    fulfilling their public purpose rather than using their tax-exempt status to
    convert tax subsidies into subsidized goods and services for groups that might
    receive more critical scrutiny if their subsidy were provided through direct
    federal expenditure.

    As one of many categories of tax-exempt private-activity bonds, nonprofit
    educational facilities and public education bonds have increased the financing
    costs of bonds issued for public capital stock and increased the supply of
    assets available to individuals and corporations to shelter their income from
    taxation.

    	Selected Bibliography

    Maguire, Steven.  Private Activity Bonds: An Introduction.  Library of
    Congress, Congressional Research Service Report RL31457.  November 10,
    2004.
    -.  Tax-Exempt Bonds: A Description of State and Local Government
    Debt.  Library of Congress, Congressional Research Service Report
    RL30638.  October 22, 2004.
    U.S. Congress,  Joint Committee on Taxation, General Explanation of Tax
    Legislation Enacted in the 107th Congress, Joint Committee Print JCS-1-03,
    January 24, 2003.
    Weisbrod, Burton A.  The Nonprofit Economy.  Cambridge, Mass.:
    Harvard University Press, 1988.
    Zimmerman, Dennis.  "Nonprofit Organizations, Social Benefits, and Tax
    Policy," National Tax Journal.  September 1991, pp. 341-349.
    -.  The Private Use of Tax-Exempt Bonds: Controlling Public Subsidy of
    Private Activities.  Washington, DC: The Urban Institute Press, 1991.

    	Education, Training, Employment and Social Services:
    	Education and Training

    TAX CREDIT FOR HOLDERS OF
    QUALIFIED ZONE ACADEMY BONDS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    -

    0.1

    0.1

    2007

    -

    0.1

    0.1

    2008

    -

    0.1

    0.1

    2009

    -

    0.1

    0.1

    2010

    -

    0.1

    0.1

    	Authorization

    Section 1397E.

    Description

    Holders of qualified zone academy bonds (QZABs) can claim a credit
    equal to the dollar value of the bonds held multiplied by a credit rate
    determined by the Secretary of the Treasury.  The credit rate is equal to the
    percentage that will permit the bonds to be issued without discount and
    without interest cost to the issuer.  The maximum maturity of the bonds is that
    which will set the present value of the obligation to repay the principal equal
    to 50 percent of the face amount of the bond issue.  The discount rate for the
    calculation is the average annual interest rate on tax-exempt bonds issued in
    the preceding month having a term of at least 10 years.  The bonds must be
    purchased by a bank, insurance company, or a corporation in the business of
    lending money.

    A qualified zone academy must be a public school below the college level.
     It must be located in an Empowerment Zone or Enterprise Community, or
    have a student body whose eligibility rate for free or reduced-cost lunches is
    at least 35 percent.  Ninety-five percent of bond proceeds must be used within
    five years to renovate capital facilities, provide equipment, develop course
    materials, or train personnel.  The academy must operate a special academic
    program in cooperation with businesses, and private entities must contribute
    equipment, technical assistance, employee services, or other property worth at
    least 10 percent of bond proceeds.  The limit for new QZAB debt is $400
    million in each year of 1998 through  2007.

    Impact

    The interest income on bonds issued by State and local governments
    usually is excluded from Federal income tax (see the entry "Exclusion of
    Interest on Public Purpose State and Local Debt").  Such bonds result in the
    Federal Government paying a portion (approximately 25 percent) of the
    issuer's interest costs.  QZABs are structured to have the entire interest cost
    of the State or local government paid by the Federal Government in the form
    of a tax credit to the bond holders.  QZABs are not tax-exempt bonds.

    The cost has been capped at the value of federal tax credits generated by
    the $3.2 billion QZAB volume.  If the school districts in any state do not use
    their annual allotment, the unused capacity can be carried forward for up to
    two years.

    Rationale

    The Taxpayer Relief Act of 1997 created QZABs.  Some low-income
    school districts were finding it difficult to pass bond referenda to finance new
    schools or to rehabilitate existing schools.  Increasing the size of the existing
    subsidy provided by tax-exempt bonds from partial to 100 percent Federal
    payment of interest costs was expected to make school investments less
    expensive and therefore more attractive to taxpayers in these poor districts.
    The tax provision is also intended to encourage public/private partnerships,
    and eligibility depends in part on a school district's ability to attract private
    contributions that have a present value equal to at least 10 percent of the value
    of the bond proceeds.  H.R. 6111 (December 2006) extended QZAB's for
    two years, introduced the five year spending horizon, and applied arbitrage
    rules.

    Assessment

    One way to think of this alternative subsidy is that financial institutions can
    be induced to purchase these bonds if they receive the same after-tax return
    from the credit that they would from the purchase of tax-exempt bonds.  The
    value of the credit is included in taxable income, but is used to reduce regular
    or alternative minimum tax liability.  Assuming the taxpayer is subject to the
    regular corporate income tax, the credit rate should equal the ratio of the
    purchaser's forgone market interest rate on tax-exempt bonds divided by one
    minus the corporate tax rate.  For example, if the tax-exempt interest rate is 6
    percent and the corporate tax rate is 35 percent, the credit rate would be equal
    to .06/(1-.35), or about 9.2 percent.  Thus, a financial institution purchasing a
    $1,000 zone academy bond would receive a $92 tax credit for each year it
    holds the bond.

    With QZABs, the Federal Governments pays 100 percent of interest costs;
    tax-exempt bonds that are used for financing other public facilities finance
    only a portion of interest costs.   For example, if the taxable rate is 8 percent
    and the tax-exempt rate is 6 percent, the non-zone bond receives a subsidy
    equal to two percentage points of the total interest cost, the difference
    between 8 percent and 6 percent.  The zone academy bond receives a subsidy
    equal to all 8 percentage points of the interest cost.  Thus, this provision
    reduces the price of investing in schools compared to investing in other public
    services provided by a governmental unit, and other things equal should cause
    some reallocation of the units budget toward schools.  In addition, the entire
    subsidy (the cost to the Federal taxpayer) is received by the issuing
    government in the form of reduced interest costs, unlike tax-exempt bonds in
    which part of the Federal revenue loss is a windfall gain for some purchasers
    and does not act to reduce the issuing government's interest cost.

    Selected Bibliography

    Congressional Budget Office, Tax Credit Bonds and the Federal Cost
    Financing Public Expenditures, July 2004.
    Davie, Bruce, "Tax Credit Bonds for Education: New Financial
    Instruments and New Prospects," Proceedings of the 91st Annual Conference
    on Taxation, National Tax Association.
    Joint Committee on Taxation, General Explanation of Tax Legislation
    Enacted in 1997, Joint Committee Print JCS-23-97, December 17, 1997, 40-
    41.
    Joint Committee on Taxation, Present Law and Background Related to
    State and Local Government Bonds, Joint Committee Print JCX-14-06,
    March 16, 2006.
    Maguire, Steven.  Tax Credit Bonds: A Brief Explanation.  Library of
    Congress, Congressional Research Service Report RS20606.  August 21,
    2006.
    -.   Tax-Exempt Bonds: A Description of State and Local Government Debt.
    Library of Congress, Congressional Research Service Report RL30638.
    March 10, 2006.

    Education, Training, Employment, and Social Services:
    Education and Training

    DEDUCTION FOR CHARITABLE CONTRIBUTIONS
    TO EDUCATIONAL INSTITUTIONS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    5.3

    0.7

    6.0

    2007

    5.9

    0.7

    6.2

    2008

    6.3

    0.7

    7.0

    2009

    6.8

    0.8

    7.6

    2010

    7.1

    0.8

    7.9

    Authorization

    Section 170 and 642(c).

    	Description

    Subject to certain limitations, charitable contributions may be deducted by
    individuals, corporations, and estates and trusts.  The contributions must be
    made to specific types of organizations, including scientific, literary, or
    educational organizations.

    Individuals who itemize may deduct qualified contribution amounts of up
    to 50 percent of their adjusted gross income (AGI) and up to 30 percent for
    gifts of capital gain property.  For contributions to nonoperating foundations
    and organizations, deductibility is limited to the lesser of 30 percent of the
    taxpayer's contribution base, or the excess of 50 percent of the contribution
    base for the tax year over the amount of contributions which qualified for the
    50-percent deduction ceiling (including carryovers from previous years).
    Gifts of capital gain property to these organizations are limited to 20 percent
    of AGI.

    The maximum amount deductible by a corporation is 10 percent of its
    adjusted taxable income.  Adjusted taxable income is defined to mean taxable
    income with regard to the charitable contribution deduction, dividends-
    received deduction, any net operating loss carryback, and any capital loss
    carryback.  Excess contributions may be carried forward for five years.
    Amounts carried forward are used on a first-in, first-out basis after the
    deduction for the current year's charitable gifts have been taken.  Typically, a
    deduction is allowed only in the year in which the contribution occurs.
    However, an accrual-basis corporation is allowed to claim a deduction in the
    year preceding payment if its board of directors authorizes a charitable gift
    during the year and payment is scheduled by the 15th day of the third month of
    the next tax year.

    If a contribution is made in the form of property, the deduction depends on
    the type of taxpayer (i.e., individual, corporate, etc.), recipient, and purpose.

    As a result of the enactment of the American Jobs Creation Act of 2004,
    P.L. 108-357, donors of noncash charitable contributions face increased
    reporting requirements.  For charitable donations of property valued at $5,000
    or more, donors must obtain a qualified appraisal of the donated property.
    For donated property valued in excess of $500,000, the appraisal must be
    attached to the donor's tax return.  Deductions for donations of patents and
    other intellectual property are limited to the lesser of the taxpayer's basis in
    the donated property or the property's fair market value.  Taxpayers can claim
    additional deductions in years following the donation based on the income the
    donated property provides to the donee.  The 2004 act also mandated
    additional reporting requirements for charitable organizations receiving
    vehicle donations from individuals  claiming a tax deduction for the
    contribution, if it is valued in excess of $500.

    Taxpayers are required to obtain written substantiation from a donee
    organization for contributions that exceed $250.  This substantiation must be
    received no later than the date the donor-taxpayer files the required income
    tax return.  Donee organizations are obligated to furnish the written
    acknowledgment when requested with sufficient information to substantiate
    the taxpayer's deductible contribution.

    The Pension Protection Act of 2006 (P.L. 109-280) included several
    provisions that temporarily expand charitable giving incentives.  The
    provisions, effective after December 31, 2005 and before January 1, 2008,
    include enhancements to laws governing non-cash gifts and tax-free
    distributions from individual retirement  plans for charitable purposes.  The
    2006 law also tightened rules governing charitable giving in certain areas,
    including gifts of taxidermy, contributions of clothing and household items,
    contributions of fractional interests in tangible personal property, and record-
    keeping and substantiation requirements for certain charitable contributions.

    Impact

    The deduction for charitable contributions reduces the net cost of
    contributing.  In effect, the federal government provides the donor with a
    corresponding grant that increases in value with the donor's marginal tax
    bracket.  Those individuals who use the standard deduction or who pay no
    taxes receive no benefit from the provision.

    A limitation applies to the itemized deductions of high-income taxpayers.
    Under this provision, in 2006, otherwise allowable deductions are reduced by
    3 percent of the amount by which a taxpayer's adjusted gross income (AGI)
    exceeds $150,500 (adjusted for inflation in future years).  The table below
    provides the distribution of all charitable contributions, not just those to
    educational organizations.

    Distribution by Income Class of the Tax Expenditure
    for Charitable Contributions, 2005

    Income Class
    (in thousands of $)

    Percentage
    Distribution

    Below $10

    0.0

    $10 to $20

    0.1

    $20 to $30

    0.5

    $30 to $40

    1.1

    $40 to $50

    2.0

    $50 to $75

    8.3

    $75 to $100

     9.6

    $100 to $200

    28.7

    $200 and over

    49.7

    Before the 2004 enactment, donors could deduct the fair market value of
    donations of intellectual property.  The new restrictions may result in fewer
    such donations to universities and other qualified institutions.  The need to
    account for any increased income attributable to the donation might involve
    more work for recipient institutions.

    	Rationale

    This deduction was added by passage of the War Revenue Act of October
    3, 1917.  Senator Hollis, the sponsor, argued that high wartime tax rates
    would absorb the surplus funds of wealthy taxpayers, which were generally
    contributed to charitable organizations.

    It was also argued that many colleges would lose students to the military
    and charitable gifts were needed by educational institutions.  Thus, the
    original rationale shows a concern for educational organizations.  The
    deduction was extended to estates and trusts in 1918 and to corporations in
    1935.

    The provisions enacted in 2004 resulted from Internal Revenue Service
    and congressional concerns that taxpayers were claiming inflated charitable
    deductions, causing significant federal revenue loss.  In the case of patent and
    other intellectual property donations, the IRS expressed concern not only
    about overvaluation of property, but also whether consideration was received
    in return for the donation and whether only a partial interest, rather than full
    interest, of property was being transferred.  The 2006 enactments were, in
    part, a result of continued concerns from 2004.

    Assessment

    Most economists agree that education produces substantial "spillover"
    effects benefitting society in general.  Examples include a more efficient
    workforce, lower unemployment rates, lower welfare costs, and less crime.
    An educated electorate fosters a more responsive and effective government.
    Since these benefits accrue to society at large, they argue in favor of the
    government actively promoting education.

    Further, proponents argue that the Federal government would be forced to
    assume some activities now provided by educational organizations if the
    deduction were eliminated.  However, public spending might not be available
    to make up all the difference.  Also, many believe that the best method of
    allocating general welfare resources is through a dual system of private
    philanthropic giving and governmental allocation.

    Economists have generally held that the deductibility of charitable
    contributions provides an incentive effect which varies with the marginal tax
    rate of the giver.  There are a number of studies which find significant
    behavioral responses, although a study by Randolph suggests that such
    measured responses may largely reflect transitory timing effects.

    Types of contributions may vary substantially among income classes.  For
    example, contributions to religious organizations are far more concentrated at
    the lower end of the income scale than contributions to educational
    institutions.  More highly valued contributions, like intellectual property and
    patents, tend to be made by corporations to educational institutions.

    It has been estimated by the American Association of Fund-Raising
    Counsel Trust for Philanthropy, Inc. that giving to public and private colleges,
    universities, elementary schools, secondary schools, libraries, and to special
    scholarship funds, nonprofit trade schools, and other educational facilities
    amounted to $38.56 billion in calendar year 2005.

    Opponents say that helping educational organizations may not be the best
    way to spend government money.  Opponents further claim that the present
    system allows wealthy taxpayers to indulge special interests (such as gifts to
    their alma mater).

    To the extent that charitable giving is independent of tax considerations,
    federal revenues are lost without any corresponding increase in charitable
    gifts.  It is generally argued that the charitable contributions deduction is
    difficult to administer and adds complexity to the tax code.

    	Selected Bibliography

    Aprill, Ellen P.  "Churches, Politics, and the Charitable Contribution
    Deduction," Boston College Law Review, v. 42 (July 2001), pp. 843-873.
    Arnone, Michael. "Congress Approves Lower Tax Benefits for Donations
    of Intellectual Property," Chronicle of Higher Education, v. 51, iss. 9,
    October 22, 2004, p. A36.
    Broman, Amy J.  "Statutory Tax Rate Reform and Charitable
    Contributions: Evidence from a Recent Period of Reform," Journal of the
    American Taxation Association.  Fall 1989, pp. 7-21.
    Giving USA 2006, The Annual Report on Philanthropy for the Year 2005,
    The Center on Philanthropy At Indiana University.  Indiana University-
    Purdue University, Indianapolis:  2006.
    Buckles, Johnny Rex. "The Case for the Taxpaying Good Samaritan:
    Deducting Earmarked Transfers to Charity Under Federal Income Tax Law,
    Theory and Policy," Fordham Law Review, v. 70 (March 2002), pp. 1243-
    1339.
    "Bush Signs Corporate Tax Legislation Restricting Donations of
    Intellectual Property," Higher Education and National Affairs, October 27,
    2004.
    Crimm, Nina J.  "An Explanation of the Federal Income Tax Exemption
    for Charitable Organizations: A Theory of Risk Compensation," Florida Law
    Review, v. 50 (July 1998),  pp. 419-462.
    Clotfelter, Charles T.  "The Impact of Tax Reform on Charitable Giving:
    A 1989 Perspective."  In Do Taxes Matter?  The Impact of the Tax Reform
    Act of 1986, edited by Joel Slemrod, Cambridge, Mass.:  MIT Press, 1990.
    -.  "The Impact of Fundamental Tax Reform on Nonprofit Organizations."
     In Economic Effects of Fundamental Tax Reform, Eds. Henry J. Aaron and
    William G. Fale.  Washington, DC:  Brookings Institution Press, 1996, pp.
    211-246.
    Colombo, John D.  "The Marketing of Philanthropy and the Charitable
    Contributions Deduction:  Integrating Theories for the Deduction and Tax
    Exemption," Wake Forest Law Review, v. 36 (Fall 2001), pp. 657-703.

    Feenberg, Daniel.  "Are Tax Price Models Really Identified: The Case of
    Charitable Giving," National Tax Journal, v. 40, (December 1987), pp. 629-
    633.
    Feldman, Naomi and James Hines, Jr. "Tax Credits and Charitable
    Contributions in Michigan," University of Michigan, Working Paper, October
    2003.
    Fisher, Linda A.  "Donor-Advised Funds: The Alternative to Private
    Foundations," Cleveland Bar Journal, v. 72 (July/August 2001), pp. 16-17.
    Gravelle, Jane. Economic Analysis of the Charitable Contribution
    Deduction for Nonitemizers, Library of Congress Congressional Research
    Service Report RL31108, April 29, 2005.
    Green, Pamela and Robert McClelland. "Taxes and Charitable Giving,"
    National Tax Journal, v. 54 (September 2001), pp. 433-450.
    Hasselback, James R. and Rodney L. Clark.  "Colleges, Commerciality,
    and the Unrelated Business Income Tax."  Taxes, v. 74 (May 1996), pp. 335-
    342.
    Jones, Darryll K.  "When Charity Aids Tax Shelters," Florida Tax Review,
    v. 4 (2001), pp. 770-830.
    Joulfaian, David and Mark Rider. "Errors-In-Variables and Estimated
    Income and Price Elasticities of Charitable Giving,"  National Tax Journal, v.
    57 (March 2004), pp. 25-43.
    Kahn, Jefferey H.  "Personal Deductions: A Tax "Ideal" or Just Another
    "Deal"?," Law Review of Michigan State University, v. 2002 (Spring 2002),
    pp. 1-55.
    Lankford, R. Hamilton and James H. Wyckoff.  "Modeling Charitable
    Giving Using a Box-Cox Standard Tobit Model," Review of Economics and
    Statistics, v. 73 (August 1991), pp. 460-470.
    Omer, Thomas C. "Near Zero Taxable Income Reporting by Nonprofit
    Organizations," Journal of American Taxation Association, v. 25, Fall 2003,
    pp. 19-34.
    Randolph, William C. "Charitable Deductions,"  in The Encyclopedia of
    Taxation and Tax Policy, eds. Joseph J. Cordes, Robert O. Ebel, and Jane G.
    Gravelle.  Washington, DC: Urban Institute Press, 2005.
    -.  "Dynamic Income, Progressive Taxes, and the Timing of Charitable
    Contributions,"  Journal of Political Economy, v. 103, August 1995, pp. 709-
    738.
    Rose-Ackerman, Susan.  "Altruism, Nonprofits, and Economic Theory,"
    Journal of Economic Literature, v. 34 (June 1996), pp. 701-728.
    Stokeld, Fred, "ETI Repeal Bill Would Tighten Rules on Vehicle, Patent
    Donations," Tax Notes, October 18, 2004, pp. 293-294.
    "Tax Exempt Educational Organization," Journal of Law and Education,
    v. 15.  Summer 1986, pp. 341-346.
    Teitell, Conrad.  "Tax Primer on Charitable Giving," Trust & Estates, v.
    139, (June 2000), pp. 7-16.
    Tiehen, Laura. "Tax Policy and Charitable Contributions of Money,"
    National Tax Journal, v. 54 (December 2001), pp. 707-723.

    Tobin, Philip T.  "Donor Advised Funds: A Value-Added Tool for
    Financial Advisors," Journal of Practical Estate Planning, v. 3
    (October/November 2001), pp. 26-35, 52.
    U.S. Congress, Congressional Budget Office.  Budget Options.  See
    Rev-12, Limit Deductions for Charitable Giving to the Amount Exceeding 2
    Percent of Adjusted Gross Income.  Washington, DC:  Government Printing
    Office (February 2005), p 281.
    U.S. Congress, General Accounting Office.  Vehicle Donations: Benefits to
    Charities and Donors, but Limited Program Oversight, GAO Report GAO-
    04-73, Washington, DC: U.S. General Accounting Office.  November 2003,
    pp. 1-44.
    - . Vehicle Donations: Taxpayer Considerations When Donating Vehicles
    to Charities, GAO Report GAO-03-608T, Washington, DC: U.S. General
    Accounting Office.  April 2003, pp. 1-15.
    U.S. Congress, Joint Committee on Taxation, Technical Explanation Of
    H.R. 4, The "Pension Protection Act Of 2006," as Passed by the House on
    July 28, 2006, and as Considered by the Senate on August 3, 2006,
    JCX-38-06, Washington, DC: U.S. Government Printing Office, August 3,
    2006, pp. 1-386.
    - , Senate Committee on Finance.  Staff Discussion Draft: Proposals for
    Reforms and Best Practices in the Area of Tax-Exempt Organizations,
    Washington, DC, June 22, 2004, pp. 1-19.
    U.S. Department of Treasury.  "Charitable Giving Problems and Best
    Practices," testimony given by Mark Everson, Commissioner of Internal
    Revenue, Internal Revenue Service, IR-2004-81, June 22, 2004, pp. 1-17.
    Wittenbach, James L. and Ken Milani.  "Charting the Interacting
    Provisions of the Charitable Contributions Deductions for Individuals,"
    Taxation of Exempts, v. 13 (July/August 2001), pp. 9-22.
    -, "Charting the Provisions of the Charitable Contribution Deduction for
    Corporations," Taxation of Exempts, v. 13 (November/December 2001), pp.
    125-130.
    Yetman, Michelle H. and Robert J. Yetman. "The Effect of Nonprofits'
    Taxable Activities on the Supply of Private Donations," National Tax
    Journal, v. 56, March 2003, pp. 243-258.
    Zimmerman, Dennis.  "Nonprofit Organizations, Social Benefits, and Tax
    Policy," National Tax Journal, v. 44.   September 1991, pp. 341-349.

    Education, Training, Employment, and Social Services:
    Employment

    EXCLUSION OF EMPLOYEE MEALS AND LODGING
     (OTHER THAN MILITARY)

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.9

    -

    0.9

    2007

    0.9

    -

    0.9

    2008

    0.9

    -

    0.9

    2009

    1.0

    -

    1.0

    2010

    1.0

    -

    1.0

    Authorization

    Sections 119 and 132(e)(2).

    Description

    Employees do not include in income the fair market value of meals
    furnished by employers if the meals are furnished on the employer's business
    premises and for the convenience of the employer.

    The fair market value of meals provided to an employee at a subsidized
    eating facility operated by the employer is also excluded from income, if the
    facility is located on or near the employer's business, and if revenue from the
    facility equals or exceeds operating costs. In the case of highly compensated
    employees, certain nondiscrimination requirements are met to obtain this
    second exclusion.

    Section 119 also excludes from an employee's gross income the fair market
    value of lodging provided by the employer, if the lodging is furnished on
    business premises for the convenience of the employer, and if the employee is
    required to accept the lodging as a condition of employment.

    Impact

    Exclusion from taxation of meals and lodging furnished by an employer
    provides a subsidy to employment in those occupations or sectors in which
    such arrangements are common.  Live-in housekeepers or apartment resident
    managers, for instance, may frequently receive lodging and/or meals from
    their employers.  The subsidy provides benefits both to the employees (more
    are employed and they receive higher compensation) and to their employers
    (who receive the employees' services at lower cost).

    Rationale

    The convenience-of-the-employer exclusion now set forth in section 119
    generally has been reflected in income tax regulations since 1918, presumably
    in recognition of the fact that in some cases, the fair market value of
    employer-provided meals and lodging may be difficult to measure.

    The specific statutory language in section 119 was adopted in the 1954
    Code to clarify the tax status of such benefits by more precisely defining the
    conditions under which meals and lodging would be treated as tax free.

    In enacting the limited exclusion for certain employer-provided eating
    facilities in the 1984 Act, the Congress recognized that the benefits provided
    to a particular employee who eats regularly at such a facility might not qualify
    as a de minimis fringe benefit absent another specific statutory exclusion.
    The record-keeping difficulties involved in identifying which employees ate
    what meals on particular days, as well as the values and costs for each such
    meal, led the Congress to conclude that an exclusion should be provided for
    subsidized eating facilities as defined in section 132(e)(2).

    Assessment

    The exclusion subsidizes employment in those occupations or sectors in
    which the provision of meals and/or lodging is common.  Both the employees
    and their employers benefit from the tax exclusion.  Under normal market
    circumstances, more people are employed in these positions than would
    otherwise be the case and they receive higher compensation (after tax).  Their
    employers receive their services at lower cost.  Both sides of the transaction
    benefit because the loss is imposed on the U.S. Treasury in the form of lower
    tax collections.

    Because the exclusion applies to practices common only in a few
    occupations or sectors, it introduces inequities in tax treatment among
    different employees and employers.

    While some tax benefits are conferred specifically for the purpose of
    providing a subsidy, this one ostensibly was provided for administrative
    reasons (based on the difficulty in determining their fair market value), and
    the benefits to employers and employees are side effects.  Some observers
    challenge the argument that administrative problems are an adequate rationale
    for excluding employer-provided meals and lodging. They note that a value is
    placed on these services under some Federal and many State welfare
    programs.

    Selected Bibliography

    Katz, Avery, and Gregory Mankiw.  "How Should Fringe Benefits Be
    Taxed?"  National Tax Journal.  v. 38.  March 1985, pp. 37-46.
    Kies, Kenneth J.  "Analysis of the New Rules Governing the Taxation of
    Fringe Benefits," Tax Notes.  September 3, 1984, pp. 981-988.
    Layne, Jonathan Keith.  "Cash Meal Allowances Are Includible in Gross
    Income and Are Not Excludible Under I.R.C. Section 119 as That Section
    Permits an Exclusion Only for Meals Furnished in Kind," Emory Law
    Review.  Summer 1978, pp. 791-814.
    Raby, Burgess J. W. and William L. Raby.  "'Will Work for Food!': Room
    Meals, and 'Convenience of the Employer,'" Tax Notes, Vol. 100, July 14,
    2003, pp. 203-205.
    Sunley, Emil M., Jr.  "Employee Benefits and Transfer Payments,"
    Comprehensive Income Taxation, ed. Joseph A. Pechman.  Washington, DC:
    The Brookings Institution, 1977, pp. 90-92.
    Turner, Robert.  "Fringe Benefits,"  in The Encyclopedia of Taxation and
    Tax Policy, eds. Joseph J. Cordes, Robert O. Ebel, and Jane G. Gravelle.
    Washington, DC: Urban Institute Press, 2005.
    U.S. Congress, Joint Committee on Taxation.  General Explanation of the
    Revenue Provisions of the Deficit Reduction Act of 1984.  Committee Print,
    98th Congress, 2nd session.  December 31, 1984, pp. 858-859.

    Education, Training, Employment and Social Services:
    Employment

    EXCLUSION OF BENEFITS
    PROVIDED UNDER CAFETERIA PLANS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    27.9

    -

    27.9

    2007

    30.6

    -

    30.6

    2008

    33.4

    -

    33.4

    2009

    36.6

    -

    36.6

    2010

    40.0

    -

    40.5

    Authorization

    Section 125.

    Description

    Cafeteria plans allow employees to choose among cash and certain
    nontaxable benefits (such as health care benefits) without paying taxes if they
    select the latter.  A general rule of tax accounting is that when taxpayers have
    the option of receiving both cash and nontaxable benefits they are taxed even
    if they select the benefits since they are deemed to be in constructive receipt
    of the cash (that is, since it is within their control to receive it).  Section 125
    of the Internal Revenue Code provides an express exception to this rule when
    certain nontaxable benefits are chosen under a cafeteria plan.  The tax
    expenditure measures the loss of revenue from not including the nontaxable
    benefits in taxable income when employees have this choice.  Cafeteria plan
    benefits are also not subject to employment taxes of either the employer or
    employee.

    "Cash" includes not only cash payments but also employment benefits that
    are normally taxable, such as vacation pay.  Nontaxable benefits include any
    employment benefits that are excluded from gross income under a specific
    section of the Code, other than long-term care insurance, scholarships or
    fellowships, employer educational assistance, miscellaneous fringe benefits,
    and most forms of deferred compensation.  Nontaxable benefits typically
    included in cafeteria plans are accident and health insurance, dependent care
    assistance, group-term life insurance, and adoption assistance.  Employer
    contributions to health savings accounts are also an allowable nontaxable
    benefit.

    Most flexible spending accounts (FSAs) are governed by cafeteria plan
    provisions, as are premium conversion arrangements under which employees
    pay their share of health insurance premiums on a pretax basis.  In both cases,
    employees are choosing between cash wages (through voluntary salary-
    reduction agreements) and nontaxable benefits.

    Cafeteria plans must be in writing.  The written plan must describe the
    available benefits, eligibility rules, procedures governing benefit elections
    (usually occurring during an annual open season), employer contributions,
    and other matters.  Under IRS regulations, midyear election changes generally
    are allowed only for employee status changes (e.g., the birth of a child) or
    benefit cost changes (e.g., child care fees increase), though midyear changes
    on the basis of cost are not allowed for health benefits.

    A highly compensated participant is taxed on all benefits if the cafeteria
    plan discriminates in favor of highly compensated individuals as to eligibility,
    benefits, or contributions.  A highly compensated individual includes an
    officer, a 5-percent shareholder, someone with high earnings, or a spouse or
    dependent of any of these individuals.  In addition, if more than 25 percent of
    the total tax-favored benefits are provided to key employees, these key
    employees will be taxed on all benefits.  A key employee is an individual who
    is an officer, a 5-percent owner, a 1-percent owner earning more than
    $150,000, or one of the top 10 employee-owners.  There are some exceptions
    to these rules, including cafeteria plans maintained under collective
    bargaining agreements.

    Amounts in health care FSAs or Health Reimbursement Accounts (HRAs)
    may be rolled over into Health Savings Accounts (HSAs) under legislation
    adopted at the end of 2006 (H.R. 6111).

    Impact

    Cafeteria plans allow employees to choose among a number of nontaxable
    employment benefits without incurring a tax liability simply because they
    could have received cash.  The principal effect is to encourage employers to
    give employees some choice in the benefits they receive.

    As with other tax exclusions, the tax benefits are greater for taxpayers with
    higher incomes.  Higher income taxpayers may be more likely to choose
    nontaxable benefits (particularly health care benefits) instead of cash, which
    would be taxable.  Lower income taxpayers may be more likely to choose
    cash, which they may value more highly and for which the tax rates would be
    comparatively low.

    More employers reportedly are offering cafeteria plans, but employee
    access to them depends largely on firm size.  Consider health care flexible
    spending accounts (FSAs), one of the most common plan options, which the
    2003 Medical Expenditure Panel Survey (MEPS) found were offered by 18
    percent of private-sector firms and were available to 48 percent of private-
    sector employees.  According to this survey, 55 percent of larger firms (50 or
    more workers) offered health care FSAs but only 5 percent  of smaller firms
    did.  Similarly, 64 percent of workers in larger firms had access to health care
    FSAs, but only 8 percent did in smaller firms.

    Actual usage is considerably less.  According to a 2004 Mercer survey,
    20% of eligible employees in firms of 500 or more employees participated in
    a health care FSA, as did 36% of eligible employees in firms of 10 or more
    employees.  Reasons for low FSA participation include employee perceptions
    of complexity, concerns about end-of-year forfeitures, and limited employer
    encouragement.  For lower income employees, particularly those who do not
    use much health care, the tax savings may not be sufficient incentive to
    participate.

    FSAs were made available to federal government employees starting on
    July 1, 2003.  In 2005, approximately 163,000 federal employees (less than
    6% of the total) had an FSA.

    Rationale

    Under the Employee Retirement Income Security Act of 1974 (ERISA), an
    employer contribution made before January 1, 1977 to a cafeteria plan in
    existence on June 27, 1974 was required to be included in an employee's
    gross income only to the extent the employee actually elected taxable
    benefits.  For plans not in existence on June 27, 1974, the employer con-
    tribution was included in gross income to the extent the employee could have
    elected taxable benefits.

    The Tax Reform Act of 1976 extended these rules to employer
    contributions made before January 1, 1978.  The Foreign Earned Income Act
    of 1978 made a further extension until the effective date of the Revenue Act
    of 1978 (i.e., through 1978 for calendar-year taxpayers).

    In the Revenue Act of 1978, the current provision as outlined above was
    added to the Code to ensure that the tax exclusion was permanent, but no
    specific rationale was provided.

    The Deficit Reduction Act of 1984 limited permissible benefits and
    established additional reporting requirements.  The Tax Reform Act of 1986
    imposed stricter nondiscrimination rules (regarding favoritism  towards highly
    compensated employees) on cafeteria and other employee benefit plans.  In
    1989, the latter rules were repealed by legislation to increase the public debt
    limit (P.L. 101-140).

    By administrative rulings, federal government employees were allowed to
    start paying their health insurance premiums on a pretax basis in 2000 and to
    establish flexible spending accounts in 2003.

    Also by administrative ruling, in 2005 the Internal Revenue Service
    allowed employees an additional 2 and � months to use remaining balances
    in their health care FSAs at the end of the year.  Previously, unused balances
    at the end of the year were forfeited to employers.

    Assessment

    Cafeteria plans often are more attractive to employees than fixed benefit
    packages since they can choose the benefits best suited to their individual
    circumstances.  Usually, choice extends to both the type of benefit (health
    care, child care, etc.) as well as the amount, at least within certain limits.
    Ability to fine-tune benefits increases the efficient use of resources and may
    help some employees better balance competing demands of family and work.
    As with other employment benefits, however, the favored tax treatment of
    cafeteria plans leads to different tax burdens for individuals with the same
    economic income.  One justification for this outcome might be that it is in the
    public interest for employers to provide social benefits to workers if otherwise
    they would enroll in public programs or go without coverage.  However,
    providing social benefits through employment puts burdens on employers,
    particularly those with a small number of workers, and may impede workers'
    willingness and ability to move among jobs.

    Health care flexible spending accounts (FSAs) funded through salary
    reduction agreements allow employees to receive tax benefits for the first
    dollars of their unreimbursed medical expenditures; in contrast, other
    taxpayers get tax benefits only if they itemize deductions and their
    unreimbursed expenditures exceed 7 � percent of adjusted gross income.  It
    is possible that FSAs encourage additional consumption of health care,
    though many workers are reluctant to put large sums in their accounts since
    unused amounts cannot be carried over to later years.

    	Selected Bibliography

    Cavanaugh, Maureen B.  On the Road to Incoherence: Congress,
    Economics, and Taxation.  UCLA Law Review, v. 49 (February, 2002).
    Lyke, Bob.  Tax Benefits for Health Insurance and Expenses: Overview of
    Current Law and Legislation.  Library of Congress.  CRS Report RL33505.
    Updated periodically.
    Peterson, Chris L. and Bob Lyke.  Health Care Flexible Spending
    Accounts.  Library of Congress.  CRS Report RL32656.  Updated
    periodically.
    Roberts, Gary E.  Municipal Government Benefits Practices and Personnel
    Outcomes: Results from a National Survey.  Public Personnel Management.
    v. 33 no. 1 (Spring, 2004).
    Rubenstein, Sarah.  Buying Health Insurance, Cafeteria Style.  The Wall
    Street Journal Online (October 19, 2004).
    Ryan, Chris and Cathy Wells.  FSA Rule Change a Mixed Bag for
    Participants, Administrators.  Benefits Law Journal.  vol. 18 no. 3 (Autumn,
    2005).
    Simmons, John G.  Flexible Benefits for Small Employers.  Journal of
    Accountancy.  v. 191 no. 3 (March, 2001).
    Turner, Robert.  Fringe Benefits.  The Encyclopedia of Taxation and Tax
    Policy.  2nd edition. Washington, the Urban Institute Press, 2005.
    U.S. Congress.  Joint Committee on Taxation.  General Explanation of the
    Revenue Provisions of the Deficit Reduction Act of 1984, 98th Congress, 2nd
    session, December 31, 1984, pp. 867-872.

    Education, Training, Employment, and Social Services:
    	Employment

    EXCLUSION OF HOUSING ALLOWANCES
    FOR MINISTERS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.5

    -

    0.5

    2007

    0.5

    -

    0.5

    2008

    0.5

    -

    0.5

    2009

    0.6

    -

    0.6

    2010

    0.6

    -

    0.6

    	Authorization

    Section 107.

    	Description

    Under an exclusion available for a "minister of the gospel," gross income
    does not include

    (1) the fair rental value of a church-owned or church-rented home
    furnished as part of his or her compensation, or

    (2) a cash housing/furnishing allowance paid as part of the minister's
    compensation.

    The housing/furnishing allowance may provide funds for rental or
    purchase of a home, including down payment, mortgage payments, interest,
    taxes, repairs, furniture payments, garage costs, and utilities.

    Ministers receiving cash housing allowances also may claim deductions on
    their individual income tax returns for mortgage interest and real estate taxes
    on their residences even though such expenditures were allocable, in whole or
    in part, to tax-free receipt of the cash housing allowance.  While excluded
    from income taxes, the fair rental value or cash housing/furnishing allowance
    is subject to Social Security payroll taxes.

    Impact

    As a result of the special exclusion provided for parsonage allowances,
    ministers receiving such housing allowances pay less tax than other taxpayers
    with the same or smaller economic incomes.  The tax benefit of the exclusion
    also provides a disproportionately greater benefit to relatively better-paid
    ministers, by virtue of the higher marginal tax rates applicable to their
    incomes.

    Further, some ministers claim income tax deductions for housing costs
    allocable to the receipt of tax-free allowances.

    	Rationale

    The provision of tax-free housing allowances for ministers was first made a
    part of the Internal Revenue Code by passage of the Revenue Act of 1921
    (P.L. 98 of the 67th Congress), without any stated reason.  The original
    rationale may reflect the difficulty of placing a value on the provision of a
    church-provided rectory.  Since some churches provided rectories to their
    ministers as part of their compensation, while other churches provided a
    housing allowance, Congress may have wished to provide equal tax treatment
    to both groups.  Another suggested rationale is that originally the provision
    was provided in recognition of the clergy as an economically deprived group
    with low incomes.

    The Internal Revenue Service reversed a 1962 ruling (Ruling 62-212) in
    1983 (Revenue Ruling 83-3) providing that, to the extent of the tax-free
    housing allowance, deductions for interest and property taxes may not be
    itemized as a tax deduction.  This change was based on the belief that it was
    unfair to allow tax-free income to be used to generate individual itemized
    deductions to shelter taxable income.

    In the Tax Reform Act of 1986 (P.L. 99-514), Congress reversed the IRS
    ruling because the tax treatment had been long-standing, and some Members
    were concerned that the IRS might treat tax-free housing allowances provided
    to U.S. military personnel similarly.

    The Internal Revenue Service's position (Revenue Ruling 71-280) is that
    the exclusion may not exceed the fair rental value of the home plus the cost of
    utilities.  The Tax Court held that amounts used to provide a home are
    excludable even if the amount received exceeds the fair market rental value of
    the home (Richard D. Warren, et ux. v. Commissioner; 114 T.C. No. 23 (May
    16, 2000)).  In that case, 100 percent of compensation was designated as a
    housing allowance ($77,663 in 1993, $76,309 in 1994, and $84,278 in 1995).
     The court dismissed the IRS's argument that its position prevents unequal
    treatment between ministers for whom housing is provided and excluded and
    those ministers receiving a rental allowance.  That decision was appealed to
    the Ninth Circuit Court of Appeals, which directed parties to submit briefs on
    whether the court should address the constitutionality of the parsonage
    exclusion.

    In order to forestall action by the Ninth Circuit by making the underlying
    issue in the Warren case moot, Congress clarified the parsonage housing tax
    allowance with passage of the Clergy Housing Allowance Clarification Act of
    2002 (P.L. 107-181).  In large part Congress adopted the more conservative
    IRS position such that the "allowance does not exceed the fair rental value of
    the home, including furnishings and appurtenances such as a garage, plus the
    cost of utilities."  The Act says that it is intended to "minimize government
    intrusion into internal church operations and the relationship between a
    church and its clergy" and "recognize that clergy frequently are required to
    use their homes for purposes that would otherwise qualify for favorable tax
    treatment, but which may require more intrusive inquiries by the government
    into the relationship between clergy and their respective churches with respect
    to activities that are inherently religious."

    Assessment

    The tax-free parsonage allowances encourage some congregations to
    structure maximum amounts of tax-free housing allowances into their
    minister's pay and may thereby distort the compensation package.

    The provision is inconsistent with economic principles of horizontal and
    vertical equity.  Since all taxpayers may not exclude amounts they pay for
    housing from taxable income, the provision violates horizontal equity
    principles.  For example, a clergyman teaching in an affiliated religious
    school may exclude the value of his housing allowance whereas a teacher in
    the same school may not.  This example shows how the tax law provides
    different tax treatment to two taxpayers whose economic incomes may be
    similar.

    Ministers with higher incomes receive a greater tax subsidy than lower-
    income ministers because of their higher marginal tax rates.  Vertical equity is
    a concept which requires that tax burdens be distributed fairly among people
    with different abilities to pay.  The disproportionate benefit of the tax
    exclusion to individuals with higher incomes reduces the progressivity of the
    tax system, which is viewed as a reduction in equity.

    Ministers who have church-provided homes do not receive the same tax
    benefits as those who purchase their homes and also have the tax deductions
    for interest and property taxes available to them.  Code Section 265 disallows
    deductions for interest and expenses which relate to tax-exempt income
    except in the case of military housing allowances and the parsonage
    allowance.  As such, this result is inconsistent with the general tax policy
    principle of preventing double tax benefits.

    	Selected Bibliography

    Aprill, Ellen P.  "Parsonage and Tax Policy: Rethinking the Exclusion,"
    Tax Notes, vol. 96, (Aug. 26, 2002), pp. 1243-1257.
    Bader, Mary.  "Clergy Housing Allowances: IRS Loses Battle, Wins War,"
    The Tax Adviser, vol. 36, (Feb, 2005), pp. 82-84.
    Bednar, Phil. "After Warren: Revisiting Taxpayer Standing and the
    Constitutionality of Parsonage Allowances," Minnesota Law Review, vol. 87
    (June 2003), pp. 2101-2131.
    Dwyer, Boyd Kimball.  "Redefining 'Minister of the Gospel' To Limit
    Establishment Clause Issues," Tax Notes, vol. 95, (June 17, 2002), pp. 1809-
    1815.
    Frazer, Douglas H. "The Clergy, the Constitution, and the Unbeatable
    Double Dip: The Strange Case of the Tax Code's Parsonage Allowance," The
    Exempt Organization Tax Review, vol. 43.  (February 2004), pp. 149-152.
    Foster, Matthew W.  "The Parsonage Allowance Exclusion: Past, Present,
    and Future," Vanderbilt Law Review, vol. 44.  January 1991, pp. 149-178.
    Harris, Christine.  "House Unanimously Clears Parsonage Exclusion Bill,"
    Tax Notes, vol. 95 no. 4 (April 22, 2002), pp. 474-475.
    Hiner, Ronald R. and Darlene Pulliam Smith. "The Constitutionality of the
    Parsonage Allowance," Journal of Accountancy, vol. 194. (Nov 2002), pp.
    92-93.
    Koski, Timothy R.  "Divine Tax Opportunities for Members of the
    Clergy," Practical Tax Strategies, vol. 63 (October 1999), pp. 207-208, 241-
    246.
    Martin, Vernon M., Jr. and Sandra K. Miller.  "The Clergy's Unique Tax
    Issues," The Tax Adviser, vol. 29 (August 1998), pp. 557-561.
    McNair, Frances E., Edward E. Milam, and Deborah L. Seifert "Tax
    Planning for Servants of God," Journal of Accountancy, vol. 198, (Oct. 2004)
     pp. 65-69.
    Newman, Joel S.  "On Section 107's Worst Feature:  The Teacher-
    Preacher,"  Tax Notes, vol. 61.  December 20, 1993, pp. 1505-1508.
    O'Neill, Thomas E.  "A Constitutional Challenge to Section 107 of the
    Internal Revenue Code," Notre Dame Lawyer, vol. 57.  June 1982, pp. 853-
    867.
    Raby, Burgess J.W. and William L. Raby.  "Some Thoughts on the
    Parsonage Exemption Imbroglio," Tax Notes, vol. 96, (Sept. 9, 2002), p.
    1497.

    Rakowski, Eric.  "The Parsonage Exclusion: New Developments," Tax
    Notes, vol. 96, no. 3 (July 15, 2002), pp. 429-437.
    Schloemer, Paul G. and Ryan Wilson, "Minister Housing Allowance
    Presents New Challenge," The CPA Journal. Vol. 75, (Dec. 2005), pp. 44-49.
    Stokeld, Fred.  "No Surprises in Ninth Circuit's Decision in Parsonage
    Case," Tax Notes, vol. 96, (Sept. 2, 2002), pp. 1318-1319.
    U.S. Congress, Joint Committee on Taxation.  General Explanation of the
    Revenue Provisions of the Deficit Reduction Act of 1984, H.R. 4170, 98th
    Congress, Public Law 98-369.  Washington, DC: U.S.  Government Printing
    Office, December 31, 1984, pp. 1168-1169.
    -.  General Explanation of the Tax Reform Act of 1986, H.R. 3838, 99th
    Congress, Public Law 99-514.  Washington, DC: U.S. Government Printing
    Office, May 4, 1987, pp. 53-54.
    Zelinsky, Edward A.  "Dr. Warren, Section 107, and the Court-Appointed
    Amicus," Tax Notes, vol. 96, no. 8 (Aug. 26, 2002), pp. 1267-1272.

    Education, Training, Employment, and Social Services:
    Employment

    EXCLUSION OF MISCELLANEOUS FRINGE BENEFITS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    6.6

    -

    6.6

    2007

    6.8

    -

    6.8

    2008

    7.0

    -

    7.0

    2009

    7.2

    -

    7.2

    2010

    7.7

    -

    7.7

    Authorization

    Sections 132 and 117(D).

    Description

    Individuals do not include in income certain miscellaneous fringe benefits
    provided by employers, including services provided at no additional cost,
    employee discounts, working condition fringes, de minimis fringes, and
    certain tuition reductions.  Special rules apply with respect to certain parking
    facilities provided to employees and certain on-premises athletic facilities.

    These benefits also may be provided to spouses and dependent children of
    employees, retired and disabled former employees, and widows and widowers
    of deceased employees. Certain nondiscrimination requirements apply to
    benefits provided to highly compensated employees.

    Impact

    Exclusion from taxation of miscellaneous fringe benefits provides a
    subsidy to employment in those businesses and industries in which such
    fringe benefits are common and feasible.  Employees of retail stores, for
    example, may receive discounts on purchases of store merchandise.  Such
    benefits may not be feasible in other industries--for example, for
    manufacturers of heavy equipment.

    The subsidy provides benefits both to the employees (more are employed
    and they receive higher compensation) and to their employers (who have
    lower wage costs).

    Rationale

    This provision was enacted in 1984; the rules affecting transportation
    benefits were modified in 1992 and 1997.  The Congress recognized that in
    many industries employees receive either free or discount goods and services
    that the employer sells to the general public.  In many cases, these practices
    had been long established and generally had been treated by employers,
    employees, and the Internal Revenue Service as not giving rise to taxable
    income.

    Employees clearly receive a benefit from the availability of free or
    discounted goods or services, but the benefit may not be as great as the full
    amount of the discount.  Employers may have valid business reasons, other
    than simply providing compensation, for encouraging employees to use the
    products they sell to the public.  For example, a retail clothing business may
    want its salespersons to wear its clothing rather than clothing sold by its
    competitors.  As with other fringe benefits, placing a value on the benefit in
    these cases is difficult.

    In enacting these provisions, the Congress also wanted to establish limits
    on the use of tax-free fringe benefits.  Prior to enactment of the provisions,
    the Treasury Department had been under a congressionally imposed
    moratorium on issuance of regulations defining the treatment of these fringes.
     There was a concern that without clear boundaries on use of these fringe
    benefits, new approaches could emerge that would further erode the tax base
    and increase inequities among employees in different businesses and
    industries.

    Assessment

    The exclusion subsidizes employment in those businesses and industries in
    which fringe benefits are feasible and commonly used.  Both the employees
    and their employers benefit from the tax exclusion.  Under normal market
    circumstances, more people are employed in these businesses and industries
    than they would otherwise be, and they receive higher compensation (after
    tax).  Their employers receive their services at lower cost.  Both sides of the
    transaction benefit because the loss is imposed on the U.S. Treasury in the
    form of lower tax collections.

    Because the exclusion applies to practices which are common and may be
    feasible only in some businesses and industries, it creates inequities in tax
    treatment among different employees and employers.  For example,
    consumer-goods retail stores may be able to offer their employees discounts
    on a wide variety of goods ranging from clothing to hardware, while a
    manufacturer of aircraft engines cannot give its workers compensation in the
    form of tax-free discounts on its products.

    Selected Bibliography

    Kies, Kenneth J.  "Analysis of the New Rules Governing the Taxation of
    Fringe Benefits," Tax Notes, v. 38.  September 3, 1984, pp. 981-988.
    McKinney, James E.  "Certainty Provided as to the Treatment of Most
    Fringe Benefits by Deficit Reduction Act," Journal of Taxation.  September
    1984, pp. 134-137.
    Raby, Burgess J. W. and William L. Raby.  "Working Conditions Fringes:
    Fishing Trips to Telecommuting," Tax Notes, Vol. 101, October 27,2003, pp.
    503-507.
    Sunley, Emil M., Jr.  "Employee Benefits and Transfer Payments,"
    Comprehensive Income Taxation, ed. Joseph A. Pechman.  Washington, DC:
    The Brookings Institution, 1977, pp. 90-92.
    Turner, Robert.  "Fringe Benefits,"  in The Encyclopedia of Taxation and
    Tax Policy, eds. Joseph J. Cordes, Robert O. Ebel, and Jane G. Gravelle.
    Washington, DC: Urban Institute Press, 2005.
    U.S. Congress, Joint Committee on Taxation.  General Explanation of the
    Revenue Provisions of the Deficit Reduction Act of 1984.  Committee Print,
    98th Congress, 2nd session.  December 31, 1984, pp. 838-866.
    -, Senate Committee on Finance.  Fringe Benefits, Hearings, 98th
    Congress, 2nd session.  July 26, 27, 30, 1984.

    Education, Training, Employment and Social Services:
    	Employment

    EXCLUSION OF EMPLOYEE AWARDS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2005

    0.2

    -

    0.2

    2006

    0.2

    -

    0.2

    2007

    0.2

    -

    0.2

    2008

    0.2

    -

    0.2

    2009

    0.2

    -

    0.2

    Authorization

    Sections 74(c), 274(j).

    Description

    Generally, prizes and awards to employees that do not qualify as a de
    minimis fringe benefit under Section 132(e) are taxable to the employee.
    Section 74(c), however, provides an exclusion for certain awards of tangible
    personal property given to employees for length of service or for safety
    achievement.

    The amount of the exclusion (under subsection 74(c)) for the employee is
    the value of the property awarded, and is generally limited by the employer's
    deduction for the award (under Section 274(j)) - $400, or up to $1,600 for
    awards granted as part of qualified employee achievement award plans.
    Qualified employee achievement plans are established or written employer
    programs which do not discriminate in favor of highly compensated
    employees.  In addition, the average cost per recipient of all awards granted
    under all established plans for an employer cannot exceed $400.

    For employees of non-profit employers, the amount of the exclusion is the
    amount that would have been allowed if the employer were taxable (non-
    profit organizations are generally not subject to federal income taxes) - $400,
    and up to $1,600 if the non-profit employer has a qualified employee
    achievement award plan.

    Generally, the limitation on the exclusion for the employee is the cost to
    (and deduction for) the employer related to the award.  If however both the
    cost to the employer for the award and the fair market value of the award
    exceed the limitation, the employee must include the excess (fair market value
    minus the limitation) in gross income.

    Length of service awards which qualify for the exclusion (and the
    employer deduction of cost), cannot be awarded to an employee in the first
    five years of service, or to an employee who has received a length of service
    award (other than an award excluded as a de minimis fringe benefit under
    Section 132(e)) in that year or any of the prior four years of service.  Awards
    for safety achievement (other than an award excluded as a de minimis fringe
    benefit under Section 132(e)) which qualify for the exclusion (and the
    employer deduction of cost) cannot be awarded to a manager, administrator,
    clerical employee, or other professional employee.  In addition, awards for
    safety achievement cannot have been awarded, in that year, to more than 10%
    of employees.

    The amount of an eligible employee award which is excluded from gross
    income is also excluded under the Federal Insurance Contributions Act
    (FICA) for Social Security and Medicare taxes (Old Age, Survivors and
    Disability tax and Hospital tax).

    Impact

    Sections 74(c) and 274(j) exclude from gross income certain employee
    awards of tangible personal property for length of service and safety
    achievement that would otherwise be taxable.

    Rationale

    The exclusion for certain employee awards was adopted in the Tax Reform
    Act of 1986.  Prior to that Act, with exceptions that were complex and
    difficult to interpret, awards received by employees generally were taxable.

    Assessment

    The exclusion recognizes a traditional business practice which may have
    social benefits.  The combination of the limitation on the exclusion as to
    eligibility for qualifying awards,  and the dollar amount of the exclusion not
    being increased since 1986, keep the exclusion from becoming a vehicle for
    significant tax avoidance.  However, the lack of an increase in the exclusion
    effectively reduces the tax-free portion of some awards.

    Selected Bibliography

    U.S. Congress, Joint Committee on Taxation.  General Explanation of the
    Tax Reform Act of 1986, 100th Congress, 1st session.  May 4, 1987, pp.
    30-38.

    Education, Training, Employment, and Social Services:
    Employment

    EXCLUSION OF INCOME EARNED BY
    VOLUNTARY EMPLOYEES' BENEFICIARY ASSOCIATIONS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    3.3

    -

    3.3

    2007

    3.4

    -

    3.4

    2008

    3.5

    -

    3.5

    2009

    3.7

    -

    3.7

    2010

    3.8

    -

    3.8

    Authorization

    Sections 419, 419A, 501(a), 501(c)(9), 4976

    Description

    Voluntary Employees' Beneficiary Associations (VEBAs) provide life
    insurance, medical, disability, accident, and other welfare benefits to
    employee members and their dependents and beneficiaries.  Most  VEBAs are
    organized as trusts to be legally separate from employers.  Provided certain
    requirements are met, the income earned by a VEBA is exempt from federal
    income taxes under Sections 501(a) and 501(c)(9).  If the requirements are
    not met however, the income is subject to the unrelated business income tax
    (UBIT).  With some exceptions, income earned by a VEBA used for
    prefunding retiree health benefits is subject to this tax.

    Employer contributions to VEBAs are deductible within limits
    described below, while employee contributions are made with after-
    tax dollars.  When distributed, VEBA benefits are taxable income to
    recipients unless there is a statutory exclusion explicitly pertaining to
    those kinds of benefits.  Thus, accident and health benefits are
    excludable under Sections 104 and 105, but severance and vacation
    pay benefits are taxable.

    VEBAs must meet a number of general requirements, including:
    (1) the organization must be an association of employees who share a
    common employment-related  bond; (2) membership in the
    association must be voluntary (or, if mandatory, under conditions
    described below); (3) the association must be controlled by its
    members, by an independent trustee (such as a bank), or by trustees
    or fiduciaries at least some of whom are designated by or on behalf of
    the members; (4) substantially all of the organization's operations
    must further the provision of life, sickness, accident, and other
    welfare benefits to employees and their dependents and beneficiaries;
    (5) none of the net earnings of the organization may accrue, other
    than by payment of benefits, directly or indirectly to any shareholder
    or private individual; (6) benefit plans (other than collectively-
    bargained plans) must not discriminate in favor of highly
    compensated individuals; and (7) the organization must apply to the
    IRS for a determination of tax exempt status.

    These general requirements have been refined and limited by both
    IRS and court decisions.  For example, employee members may have
    a common employer or affiliated employers, common coverage
    under a collective bargaining agreement, or membership in a labor
    union or a specified job classification.  In addition, members may be
    employees of several employers engaged in the same line of business
    in the same geographic area.  Not all members need be employees,
    but at least 90 percent of the membership one day each calendar
    quarter must be employees.  Membership may be required if
    contributions are not mandatory or if it is pursuant to a collective
    bargaining agreement or union membership.  Permissible benefits
    generally include those that safeguard or improve members' health
    or that protect against contingencies that interrupt or impair their
    earning power including vacation benefits, recreational activities, and
    child care.  Prohibited benefits include pension and annuities payable
    at retirement and deferred compensation unless it is payable due to
    an unanticipated event such as unemployment.

    VEBA benefits may not discriminate in favor of the highly paid.  In
    addition, VEBAs used for prefunding of retiree medical or life
    insurance benefits are required to establish separate accounts for
    members who are key employees.

    In general, employer deductions for VEBA contributions are
    limited to the sum of qualified direct costs and additions to qualified
    asset accounts, minus VEBA after-tax net income.  These account
    limits are specified in Internal Revenue Code Sections 419 and
    419A.  Qualified direct costs are the amounts employers could have
    deducted for employee benefits had they used cash basis accounting
    (essentially, benefits and account expenses actually paid during the
    year).  Qualified asset accounts include: (1) reserves set aside for
    claims incurred but unpaid at the end of the year for disability,
    medical, supplemental unemployment and severance pay, and life
    insurance benefits; (2) administrative costs for paying those claims;
    and (3) additional reserves for post-retirement medical and life
    insurance benefits and for non-retirement medical benefits of bona
    fide association plans.  The reserve for post-retirement benefits must
    be funded over the working lives of covered individuals on a level
    basis, using actuarial assumptions incorporating current, not
    projected, medical costs.  For post-retirement life insurance,
    amounts in excess of $50,000 per employee may not be taken into
    account in determining the reserve.  Special limits apply to certain
    benefits.   After-tax net income consists of net interest and investment
    earnings plus employee contributions, minus any unrelated income
    tax liability.  Employer contributions are deductible only if they
    would otherwise be deductible as a trade or business expense or as an
    expense related to the production of income.  In addition, employer
    contributions are deductible only in the year actually paid.

    The prefunding limits just described do not apply to collectively
    bargained or employee pay-all plans (sometimes called 419A(f)(5)
    plans) or to multiple employer welfare plans (MEWAs) of ten or more
    employers in which no employer makes more than 10 percent of the
    contributions (sometimes called 419A(f)(6) plans).  The  latter plans
    (MEWAs) cannot have experienced rated contributions for single
    employers.

    VEBAs are subject to the UBIT to the extent they are overfunded
    because contributions exceed account limits.  However, the UBIT
    does not apply on the following sources of income: (1) income that is
    either directly or indirectly attributable to assets held by a VEBA as
    of July 18, 1984 (the date of enactment of the Deficit Reduction Act
    of 1984); (2) income on collectively bargained or employee pay-all
    VEBAs; and (3) income on VEBAs for which substantially all
    contributions came from tax-exempt employers.  Tax rates applicable
    to trusts are used to calculate the UBIT for VEBAs organized as
    trusts.

    Under Section 4976, any reversion of VEBA assets to the
    employer is subject to a 100% excise tax.

    Impact

    VEBAs have been used by employers for a variety of reasons
    including to segregate assets, earn tax free investment returns,
    reduce future contribution requirements by prefunding, create an
    offsetting asset for an employer liability and meet requirements of
    rate making bodies and regulatory agencies.  Funding a welfare
    benefit through a VEBA often offers tax advantages to the employer.
     The magnitude of the tax advantage depends on the amount of
    benefits payable and the duration of the liability.  Thus, the tax
    advantage is greater for a VEBA that funds the disabled claim reserve
    for a Long Term Disability plan than for a VEBA that funds the
    Incurred but Not Paid claim reserve for a medical plan.  The greatest
    tax advantage accrues to an employer that uses a VEBA for
    prefunding of a retiree health care plan, especially if the prefunding
    is for a collectively bargained group of employees.

    Unlike qualified defined benefit pension plans, employers are not
    legally required to prefund retiree health plans.  However, certain
    employers have found it advantageous to prefund retiree health
    benefits.  Utilities such as electric, gas, water, and telephone
    companies (prior to deregulation) were required by regulators to
    prefund retiree benefits in order to include the cost of the benefits in
    rates they charged to customers.  Similarly, companies that did
    business with the U.S. Department of Defense were required to
    prefund retiree benefits in order to include the cost of benefits as
    part of the contract charges.

    Use of VEBAs for prefunding retiree health benefits gathered
    momentum after the Financial Accounting Standards Board (FASB)
    required accrual accounting for post-retirement benefits other than
    pensions under Statement of Financial Accounting Standard 106
    (FAS 106).  This accounting standard, which was effective for
    employers' fiscal years beginning after December 15, 1992, required
    employers to calculate the net periodic postretirement health care
    cost on an accrual basis and recognize it as an expense in the
    employer's income statement.  If the employer had segregated assets
    dedicated to the payment of retiree health care benefits, the return
    on these assets reduced the net periodic postretirement health care
    cost.  With the release of FAS 106, employers were in search of the
    ideal funding vehicle that met all of the following conditions:  (1) the
    employer could make tax deductible contributions; (2) the rate of
    return on the funding vehicle compared favorably to alternate uses of
    employer funds; (3) adequate contributions could be made for
    funding  the plan obligations; and (4) assets were inaccessible to the
    employer for any purpose other than specified in the plan.  A
    collectively bargained VEBA was the one funding vehicle that met all
    of these criteria.  Although non-collectively bargained VEBAs had
    shortcomings, some employers used them nonetheless.  Investment
    strategies used to improve the after-tax rate of return for such
    VEBAs included buying life insurance within the VEBA trust so that
    the VEBA could benefit from the tax-free inside buildup of the
    insurance policy.

    Because of the more advantageous tax treatment for collectively
    bargained VEBAs, employers used VEBAs for prefunding  retiree
    health benefits more frequently for  unionized employees than for
    non-union employees.  Investment income on the funds accumulated
    tax free and there were no limits on  contributions.  Some employers
    also established employee-pay-all VEBAs for prefunding employee
    out-of-pocket health care costs in retirement.  In this type of VEBA,
    employees make all of the contributions, with no contributions made
    by employers, and the investment income on the VEBA accumulates
    tax free.  Employees can withdraw funds after retirement from the
    VEBA to pay health care costs without paying taxes on the
    withdrawals.

    Recently, there has been interest in the use of employee-pay-all
    VEBAs in order to provide medical benefits to retirees of bankrupt
    companies.  Retirees in bankrupt companies often lose some or all of
    their health care coverage.  By pooling the risk in a VEBA, retirees
    may find that the premiums are more attractive than otherwise
    available in the individual health insurance market.

    The Survey of Employer Health Benefits conducted by the Kaiser
    Family Foundation and the Health Research and Educational Trust
    indicates that in 2006, 35 percent of large firms (200 or more
    employees) offered retiree health benefits compared with 9 percent
    of small firms (3 to199 employees).  Among large firms, firms with
    union employees were much more likely to offer retiree health
    benefits (50 percent) than firms without union employees (27
    percent).

    Not all firms that offer retiree health benefits use a VEBA for
    prefunding them.  According to the 2005 Mercer National Survey of
    Employer-Sponsored Health Plans, 9 percent of employers with 500
    or more employees are currently using a VEBA for prefunding of
    retiree medical benefits and another 7 percent  are considering using
    a VEBA for this purpose.  The likelihood of funding retiree health
    benefits with a VEBA increases with the size of the employer.  While
    25 percent of employers with 20,000 or more employees are
    currently using a VEBA for prefunding of retiree health benefits, only
    5 percent of employers with 500 to 999 employees use a VEBA for
    this purpose.  Mercer also reports that the use of a VEBA for
    prefunding retiree health benefits is most common for employers in
    the communication, transportation and utility industries.

    Unlike pensions, VEBA health benefits accrue uniformly across all
    income groups.  Retiree health benefits unlike pension benefits are
    not salary related.  In fact, the benefits of VEBAs are more likely to
    accrue in favor of the lower paid employees for two reasons.  First,
    VEBAs are used more often for unionized employees who are
    typically paid less than management employees.  And secondly, when
    VEBAs are used for non-union employees, employers typically
    exclude key employees from the VEBA in order to avoid
    cumbersome administrative requirements to maintain separate
    accounts within the VEBA.

    Rationale

    VEBAs were originally granted tax-exempt status by the Revenue
    Act of 1928, which allowed  associations to provide payment of life,
    sickness, accident, or other benefits to their members and
    dependents provided: (1) no part of their net earnings accrued (other
    than through such payments) to the benefit of any private
    shareholder or individual; and (2) 85 percent or more of their
    income consisted of collections from members for the sole purpose of
    making benefit payments and paying expenses.  The House report
    noted that these associations were common and, without further
    explanation, that a specific exemption was desirable.  Presumably,
    VEBAs were seen as providing welfare benefits that served a public
    interest and normally were exempt from taxation.

    The Revenue Act of 1942 allowed employers to contribute to the
    association without violating the 85-percent-of-income requirement.
    In the Tax Reform Act of 1969, Congress completely eliminated the
    85-percent requirement, allowing a tax exclusion for VEBAs that had
    more than 15 percent of their income from investments.  However,
    the legislation imposed the UBIT on VEBA income (as well as the
    income of similar organizations) to the extent it was not used for
    exempt functions.

    While VEBAs cannot be used for deferred compensation,
    sometimes it has been difficult to distinguish such benefits.
    Particularly after 1969, VEBAs presented opportunities for
    businesses to claim tax deductions for contributions that would not be
    paid out in benefits until many years afterwards, with investment
    earnings building tax-free.  In many cases, the benefits were
    disproportionately available to corporate officers and higher-income
    employees.  After passage of the Tax Equity and Fiscal Responsibility
    Act of 1982 (TEFRA), there was increased marketing of plans
    providing readily available deferred benefits (for severance pay, for
    example) to owners of small businesses that appeared to circumvent
    restrictions the Act had placed on qualified pensions.

    In response, the Deficit Reduction Act of 1984 (DEFRA) placed
    tight restrictions on employer contributions (Section 419 of the
    Code) and limitations on accounts (Section 419A).  In addition,
    tighter nondiscrimination rules were adopted with respect to highly
    compensated individuals.  These changes applied to welfare benefit
    funds generally, not just VEBAs.  The nondiscrimination rules were
    further modified by the Tax Reform Act of 1986.  The Tax Reform
    Act of 1986 also exempted collectively bargained  welfare benefit
    funds and employee pay-all plans from account limits, thereby
    exempting the investment income on such VEBA trusts from the
    UBIT.

    DEFRA did not apply these restrictions to collectively bargained
    plans or the  multiple employer welfare plans (MEWAs) described
    above.  In practice, both exemptions allowed arrangements that the
    IRS and others criticized as tax shelters.  In 2003, the IRS stated its
    intention to issue regulations disallowing employer deductions for
    arrangements set up through sham labor negotiations (by October,
    2006 they had not yet been issued).  It also issued final regulations
    defining experienced-rating arrangements that preclude employer
    deductions for MEWAs.

    The Pension Protection Act of 2006 authorized an additional
    reserve for non-retirement medical benefits of bona fide association
    plans.

    Assessment

    Although there appears to be some abuse of VEBAs by small
    employers for estate planning purposes, VEBAs have usually been
    used in ways that further social goals.  When VEBAs are used for
    prefunding of retiree health benefits, they increase the likelihood of
    employees receiving such benefits.  Particularly in case of
    bankruptcy, the presence of a VEBA with accumulated assets for
    payment of retiree health benefits offers retirees a measure of
    protection.  Under current law, VEBAs offer an attractive way to
    prefund retiree health benefits for union employees, but not for non-
    union employees.

    When an employer provides retiree health benefits, retirees
    typically have significant out-of-pocket payments for premiums,
    deductibles, and copayments.  An employee-pay-all VEBA could be
    used to allow employees to accumulate funds during their working
    years for payment of out-of-pocket health care costs during
    retirement.  However, current law poses some problems in the use of
    an employee-pay-all VEBA for this purpose.  Amounts contributed by
    an active employee cannot be refunded to the employee or his family
    upon job termination or premature death. In addition, although
    investment income on funds in an employee-pay-all VEBA is not
    subject to the UBIT, if employee and employer contributions are
    commingled in the same VEBA, all investment income is subject to
    that tax.  As concerns mount about the future of retiree health
    benefits, Congress might reconsider some of these restrictions.

    With the addition of prescription drug coverage to Medicare, it is
    possible that some employers that are currently providing retiree
    health benefits will eliminate or reduce prescription drug coverage.
    To the extent that these employers have been prefunding retiree
    health benefits through VEBAs, the new provision would reduce their
    deductions for such prefunding.

    	Selected Bibliography

    Elswick, Jill.  VEBAs Gain Currency for Retiree Medical Benefits.
    Employee Benefit News. (June 1, 2003).
    Geisel, Jerry.  Making Retiree Health Care Affordable.  Business
    Insurance.  v. 40 no. 4 (January 23, 2006).
    Joint Committee on Taxation.  Welfare Benefit Plans.  General
    Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984.
    JCS-41-84 (December, 1984), p. 774-806.
    Kehoe, Danea M.  419A: A Legislative Odyssey.  Journal of Financial
    Service Professionals.  v. 56 no. 2 (March, 2002).

    Koresko, John J. and Jennifer S. Martin: VEBAs, Welfare Plans, and
    Section 419(f)(6): Is the IRS Trying to Regulate or Spread Propaganda?
    Southwestern University Law Review, v. 32 (2003)
    Macey, Scott J. and George F. O'Donnell: Retiree Health Benefits - The
    Divergent Paths. New York University Review of Employee Benefits and
    Executive Compensation (2003)
    Moran, Anne E.  VEBAs: Possibilities for Employee Benefit Funding.
    Employee Relations Law Journal. v. 29 no 1 (summer, 2003)
    Ross, Allen F.  Are VEBAs Worth Another Look?  Journal of
    Accountancy.  v. 187 no. 5 (May, 1999).

    	Education, Training, Employment, and Social Services:
    	Employment

    	SPECIAL TAX PROVISIONS
    	FOR EMPLOYEE STOCK OWNERSHIP PLANS (ESOPs)

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.3

    0.8

    1.1

    2007

    0.3

    0.9

    1.2

    2008

    0.3

    0.9

    1.2

    2009

    0.3

    1.0

    1.3

    2010

    0.3

    1.1

    1.4

    	Authorization

    Sections 133, 401(a)(28), 404(a)(9), 404(k), 415(c)(6), 1042, 4975(e)(7),
    4978, 4979A

    	Description

    An employee stock ownership plan (ESOP) is a defined-contribution plan
    that is required to invest primarily in the stock of the sponsoring employer.
    ESOPs are unique among employee benefit plans in their ability to borrow
    money to buy stock.  An ESOP that has borrowed money to buy stock is a
    leveraged ESOP.  An ESOP that acquires stock through direct employer
    contributions of cash or stock is a nonleveraged ESOP.

    ESOPs are provided with various tax advantages.  Employer contributions
    to an ESOP may be deducted by the employer as a business expense.
    Contributions to a leveraged ESOP are subject to less restrictive limits than
    contributions to other qualified employee benefit plans.

    An employer may deduct dividends paid on stock held by an ESOP if the
    dividends are paid to plan participants, if the dividends are used to repay a
    loan that was used to buy the stock, or for dividends paid on stock in a
    retirement plan.  The deduction for dividends used to repay a loan is limited
    to dividends paid on stock acquired with that loan.  Employees are not taxed
    on employer contributions to an ESOP or the earnings on invested funds until
    they are distributed.

    A stockholder in a closely held company may defer recognition of the gain
    from the sale of stock to an ESOP if, after the sale, the ESOP owns at least 30
    percent of the company's stock and the seller reinvests the proceeds from the
    sale of the stock in a U.S. company.

    To qualify for these tax advantages, an ESOP must meet the minimum
    requirements established in the Internal Revenue Code.  Many of these
    requirements are general requirements that apply to all qualified employee
    benefit plans.  Other requirements apply specifically to ESOPs.

    In particular, ESOP participants must be allowed voting rights on stock
    allocated to their accounts.  In the case of publicly traded stock, full voting
    rights must be passed through to participants.  For stock in closely held
    companies, voting rights must be passed through on all major corporate
    issues.

    Closely held companies must give employees the right to sell distributions
    of stock to the employer (a put option), at a share price determined by an
    independent appraiser.  An ESOP must allow participants who are
    approaching retirement to diversify the investment of funds in their accounts.

    	Impact

    The various ESOP tax incentives encourage employee ownership of stock
    through a qualified employee benefit plan and provide employers with a tax-
    favored means of financing.  The deferral of recognition of the gain from the
    sale of stock to an ESOP encourages the owners of closely held companies to
    sell stock to the company's employees.  The deduction for dividends paid to
    ESOP participants encourages the current distribution of dividends.

    Various incentives encourage the creation of leveraged ESOPs.  Compared
    to conventional debt financing, both the interest and principal on an ESOP
    loan are tax-deductible.  The deduction for dividends used to make payments
    on an ESOP loan and the unrestricted deduction for contributions to pay
    interest encourage employers to repay an ESOP loan more quickly.

    According to an analysis of information returns filed with the Internal
    Revenue Service, most ESOPs are in private companies, and most ESOPs
    have fewer than 100 participants.  But most ESOP participants are employed
    by public companies and belong to plans with 100 or more participants.
    Likewise, most ESOP assets are held by plans in public companies and by
    plans with 100 or more participants.

    	Rationale

    The tax incentives for ESOPs are intended to broaden stock ownership,
    provide employees with a source of retirement income, and grant employers a
    tax-favored means of financing.

    The Employee Retirement Income Security Act of 1974 (P.L. 93-406)
    allowed employers to form leveraged ESOPs.  The Tax Reduction Act of
    1975 established a tax-credit ESOP (called a TRASOP) that allowed
    employers an additional investment tax credit of one percentage point if they
    contributed an amount equal to the credit to an ESOP.

    The Tax Reform Act of 1976 allowed employers an increased investment
    tax credit of one-half a percentage point if they contributed an equal amount
    to an ESOP and the additional contribution was matched by employee
    contributions.

    The Revenue Act of 1978 required ESOPs in publicly traded corporations
    to provide participants with full voting rights, and required closely held
    companies to provide employees with voting rights on major corporate issues.
     The Act required closely held companies to give workers a put option on
    distributions of stock.

    The Economic Recovery Tax Act of 1981 (P.L. 97-34) replaced the
    investment-based tax credit ESOP with a tax credit based on payroll (called a
    PAYSOP).  The  1981 Act also allowed employers to deduct contributions of
    up to 25 percent of compensation to pay the principal on an ESOP loan.
    Contributions used to pay interest on an ESOP loan were excluded from the
    25-percent limit.

    The Deficit Reduction Act of 1984 (P.L. 98-369) allowed corporations a
    deduction for dividends on stock held by an ESOP if the dividends were paid
    to participants.  The Act also allowed lenders to exclude from their income 50
    percent of the interest they received on loans to an ESOP.

    The Act allowed a stockholder in a closely held company to defer
    recognition of the gain from the sale of stock to an ESOP if the ESOP held at
    least 30 percent of the company's stock and the owner reinvested the proceeds
    from the sale in a U.S. company.  The Act permitted an ESOP to assume a
    decedent's estate tax in return for employer stock of equal value.

    The Tax Reform Act of 1986 repealed the tax credit ESOP.  The Act also
    extended the deduction for dividends to include dividends used to repay an
    ESOP loan.  The Act permitted an estate to exclude from taxation up to 50
    percent of the proceeds from the sale of stock to an ESOP.  The Act allowed
    persons approaching retirement to diversify the investment of assets in their
    accounts.

    The Omnibus Budget Reconciliation Act of 1989 limited the 50-percent
    interest exclusion to loans made to ESOPs that hold more than 50 percent of a
    company's stock.  The deduction for dividends used to repay an ESOP loan
    was restricted to dividends paid on shares acquired with that loan.  The Act
    repealed both estate tax provisions: the exclusion allowed an estate for the
    sale of stock to an ESOP and the provision allowing an ESOP to assume a
    decedent's estate tax.  The Small Business Job Protection Act of 1996
    eliminated the provision that allowed a 50% interest income exclusion for
    bank loans to ESOPs.  The Economic Growth and Recovery Tax Act of 2001
    allowed firms to deduct dividends on stock held in retirement plans.

    	Assessment

    One of the major objectives of ESOPs is to expand employee stock
    ownership.  These plans are believed to motivate employees by more closely
    aligned their financial interests with the financial interests of their employers.
     The distribution of stock ownership in ESOP firms is broader than the
    distribution of stock ownership in the general population.

    Some evidence suggests that among firms with ESOPs there is a greater
    increase in productivity if employees are involved in corporate decision-
    making.  But employee ownership of stock is not a prerequisite for employee
    participation in decision-making.

    ESOPs do not provide participants with the traditional rights of stock
    ownership.  Full vesting depends on a participant's length of service and
    distributions are generally deferred until a participant separates from service.
    To provide participants with the full rights of ownership would be consistent
    with the goal of broader stock ownership, but employees would be able to use
    employer contributions for reasons other than retirement.

    The requirement that ESOPs invest primarily in the stock of the sponsoring
    employer is consistent with the goal of corporate financing, but it may not be
    consistent with the goal of providing employees with retirement income.  The
    cost of such a lack of diversification was demonstrated with the failure of
    Enron and other firms whose employees' retirement plans were heavily
    invested in company stock.  If a firm experiences financial difficulties, the
    value of its stock and its dividend payments will fall.  Because an ESOP is a
    defined-contribution plan, participants bear the burden of this risk.  The
    partial diversification requirement for employees approaching retirement was
    enacted in response to this issue.

    A leveraged ESOP allows an employer to raise capital to invest in new
    plant and equipment.  But evidence suggests that the majority of leveraged
    ESOPs involve a change in ownership of a company's stock, and not a net
    increase in investment.

    Although the deduction for dividends used to repay an ESOP loan may
    encourage an employer to repay a loan more quickly, it may also encourage
    an employer to substitute dividends for other loan payments.

    Because a leveraged ESOP allows an employer to place a large block of
    stock in friendly hands, leveraged ESOPs have been used to prevent hostile
    takeovers.  In these cases, the main objective is not to broaden employee stock
    ownership.

    ESOPs have been used in combination with other employee benefit plans.
    A number of employers have adopted plans that combine an ESOP with a
    401(k) salary reduction plan.  Some employers have combined an ESOP with
    a 401(h) plan to fund retiree medical benefits.

    	Selected Bibliography

    Blasi, Joseph R.  Employee Ownership: Revolution or Ripoff? Cambridge,
    MA: Ballinger, 1988.
    Blinder, Alan S., ed.  Paying for Productivity: A Look at the Evidence.
    Washington, DC:  The Brookings Institution, 1990.
    Conte, Michael A., and Helen H. Lawrence.  "Trends in ESOPs," Trends
    in Pensions 1992, eds. John A. Turner and Daniel J. Beller.  Washington,
    DC: U.S. Government Printing Office, 1992, pp. 135-148.
    Gamble, John E. "ESOPs: Financial Performance and Federal Tax
    Incentives," Journal of Labor Research, v. 19, Summer 1998, pp. 529-541.
    Gravelle, Jane G.,  Employer Stock in Pension Plans: Economic and Tax
    Issues, Library of Congress, Congressional Research Service Report
    RL31551,Washongton, DC:  September 4, 2002.
    -.  "The Enron Debate: Lessons for Tax Policy," Urban-Brookings Tax
    Policy Center Discussion Paper 6, Washington, DC: The Urban Institute,
    February 2003.
    Kruse, Douglas, Richard Freeman, Joseph Blasi, Robert Buchele, and
    Adria Scharf, "Motivating Employee-Owners in ESOP Firms: Human
    Resource Policies and Company Performance," in Employee Participation,
    Firm Performance and Survival, Advances in the Economic Analysis of
    Participatory and Labor-Managed Firms, v. 8, Virginie Perotin and Andrew
    Robinson, eds., Amsterdam: Elsevier, 2004.

    Mayer, Gerald.  Employee Stock Ownership Plans: Background and
    Policy Issues.  Library of Congress, Congressional Research Service Report
    RL30038.  Washington, DC: January 20, 1999.
    -.  "Employee Stock Ownership Plans," in The Encyclopedia of Taxation
    and Tax Policy, eds. Joseph J. Cordes, Robert O. Ebel, and Jane G. Gravelle.
     Washington, DC: Urban Institute Press, 2005.
    Shorter, Gary W.  ESOPs and Corporate Productivity.  Library of
    Congress, Congressional Research Service Report 91-557 E.  Washington,
    DC: July 12, 1991.
    Snyder, Todd S.,  Employee Stock Ownership Plans (ESOPs):
    Legislative History.   Library of Congress, Congressional Research
    Service Report RS21526, Washington, DC: May 20, 2003.
    U.S. General Accounting Office.  Employee Stock Ownership Plans:
    Benefits and Costs of ESOP Tax Incentives for Broadening Stock Ownership,
    PEMD-87-8.  Washington, DC: General Accounting Office, December 29,
    1986.
    -.  Employee Stock Ownership Plans: Little Evidence of Effects on
    Corporate Performance,  PEMD-88-1.  Washington, DC: General
    Accounting Office, October 29, 1987.

    	Education, Training, Employment, and Social Services:
    	Employment

    	WORK OPPORTUNITY TAX CREDIT

    Estimated Revenue Loss*

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    (1)

    0.2

    0.2

    2007

    (1)

    0.1

    0.1

    2008

    (1)

    0.1

    0.1

    2009

    (1)

    (1)

    (1)

    2010

    (1)

    (1)

    (1)

    *The tax credit is effective through December 31, 2007; H.R.
    6111 (December 2006) increases the loss for FY2007 to FY2010 by
    $0.4, $0.3, $0.2, and $0.1 for the combined work opportunity and
    welfare to work credit.
    (1)Less than $50 million.

    	Authorization

    Sections 51 and 52.

    	Description

    The Work Opportunity Tax Credit (WOTC) (to be combined with the
    welfare to work credit in 2007) is available on a nonrefundable basis to for-
    profit employers who hire individuals from the following groups:

    (1) members of families receiving benefits under the Temporary Assistance
    for Needy Families (TANF) program for a total of any 9 months during the
    18-month period ending on the hiring date;

    (2) qualified veterans who are members of families receiving benefits
    under the Food Stamp program for at least a 3-month period ending during
    the 15-month period ending on the hiring date;
    (3) 18-24 year olds who are members of families receiving Food Stamp
    benefits for the 6-month period ending on the hiring date, or receiving
    benefits for at least 3 months of the 5-month period ending on the hiring date
    in the case of family members no longer eligible for assistance under section
    6(o) of the Food Stamp Act of 1977;
    (4) high-risk youth (i.e., 18-24 year olds whose principal place of abode is
    in an empowerment zone, renewal community, or an enterprise community);
    (5) summer youth (i.e., 16-17 year olds hired for any 90-day period
    between May 1 and September 15 whose principal place of abode is in an
    empowerment zone, renewal community, or an enterprise community);
    (6) economically disadvantaged ex-felons with hiring dates within 1 year of
    the last date of conviction or release from prison;
    (7) vocational rehabilitation referrals (i.e., individuals with physical or
    mental disabilities that result in substantial handicaps to employment who
    have been referred to employers by state vocational rehabilitation agencies or
    employment networks upon completion of or while receiving rehabilitative
    services under the Rehabilitation Act of 1973 or through a program carried
    out under chapter 31 of title 38, United States Code); and
    (8) Supplemental Security Income recipients who have received benefits
    under Title XVI of the Social Security Act for any month ending within the
    60-day period ending on the hiring date.

    During the first year in which a WOTC-eligible person is hired, the
    employer can claim an income tax credit of 40% of the first $6,000 earned if
    the worker is retained for at least 400 hours.  If the WOTC-eligible hire is
    retained for 120-399 hours, the subsidy rate is 25%.  For summer youth
    employees, the 25% or 40% subsidy rate is applied against the first $3,000
    earned.  No credit can be claimed unless the eligible employee remains on the
    employer's payroll for a minimum of 120 hours.

    The maximum amount of the credit to the employer would be $1,500 or
    $2,400 per worker ($750 or $1,200 per summer-youth hire) for persons
    retained 120-399 hours or at least 400 hours, respectively.  The actual value
    could be less than these amounts, depending on the employer's tax bracket.
    An employer's usual deduction for wages must be reduced by the amount of
    the credit as well.  The credit also cannot exceed 90% of an employer's
    annual income tax liability, although the excess can be carried back 1 year or
    carried forward 20 years for workers hired on or after January 1, 1998.

    	Impact

    An employer completes a "pre-screening" notice by the date a job offer is
    made to an applicant thought to belong to the WOTC-eligible population.
    The IRS form must be mailed to the state's Employment Service (ES) agency
    within 21 days after the new hire starts working.  The ES then certifies
    whether the new hire belongs to one of the WOTC's eligible groups.

    The ES issued 598,101 certifications to employers for FY2005.   In that
    year, 36% of all certifications were for members of the 18-24 year old Food
    Stamp group and 32% were for members of the TANF group.  Another 12%
    of certifications were issued to employers for hiring WOTC-eligible high-risk
    youth ; 7% for economically disadvantaged ex-felons; and 6% for eligible SSI
    recipients.  Certifications will exceed the number of credits claimed unless all
    WOTC-eligible hires remain on firms' payrolls for the minimum employment
    period (i.e., certifications reflect eligibility determinations rather than credits
    claimed).

    	Rationale

    The temporary credit was authorized by the Small Business Job Protection
    Act of 1996 effective through September 30, 1997.  It subsequently was
    extended several times, often after the provision had expired .  Most recently,
    it was extended (retroactive to its expiration date after having lapsed on
    January 1, 2004) through December 31, 2005 by the Working Families Tax
    Relief Act of 2004.

    WOTC primarily is intended to help individuals, who have difficulty
    obtaining employment in both good and bad economic times, get jobs in the
    private sector.  The credit is designed to reduce the relative cost of hiring
    these low-skilled individuals by subsidizing their wages, and hence to
    increase employers' willingness to give them jobs despite their presumed low
    productivity.  In recent years, eligible groups temporarily have been added in
    response to disasters (i.e., New York Liberty Zone business employees after
    the 2001 terrorist attack and Hurricane Katrina employees after the 2005
    hurricane).

    A prior tax credit aimed at encouraging firms to hire hard-to-employ
    individuals, the Targeted Jobs Tax Credit (TJTC), was effective from 1978
    through 1994.  The TJTC was subject to criticism, but Congress, after making
    some revisions, retained this approach to increasing employment of
    disadvantaged workers.  H.R. 6111(December (2006) extended the credit
    through 2006 t and combined it with the welfare to work credit for 2007.

    	Assessment

    Based upon a survey of employers in two states conducted by the General
    Accounting Office (GAO) in 2001, the agency speculated that employers
    were not displacing employees in order to replace them with individuals for
    whom they could claim the credit.  According to the GAO, the cost of
    recruiting, hiring, and training WOTC-eligible workers appears to be higher
    than the amount of the credit that employers could  claim.  As employees
    certified for the credit were not terminated any more frequently than others
    when their earnings reached about $6,000 (the credit-maximizing level), the
    GAO surmised that employers were not churning their workforces to
    maximize credit receipt.

    Another limited analysis, released in 2001, yielded a fairly unfavorable
    assessment of the credit's performance.  Based on interviews with 16 firms in
    5 states that claimed the credit, researchers found that the WOTC had little or
    no influence on the employers' hiring decisions.

    A third study looked specifically at the "take-up" rate among two WOTC-
    eligible groups, namely, TANF recipients and food stamp youth.  It estimated
    that during the late 1990s relatively few newly employed members of either
    group had the credit claimed for them.

    	Selected Bibliography

    Hamersma, Sarah.  "The Work Opportunity Tax Credit: Participation Rates
    Among Eligible Workers."  National Tax Journal, vol. 56, no. 4 (December
    2003), pp. 725-738.
    Hamersma, Sarah.  The Work Opportunity and Welfare-to-Work Tax
    Credits.  Urban-Brookings Tax Policy Center, No. 15.  Washington, DC:
    October 2005.
    Howard, Christopher.  The Hidden Welfare State:  Tax Expenditures and
    Social Policy in the United States.  Princeton: Princeton University Press,
    1997.
    Levine, Linda.  The Work Opportunity Tax Credit (WOTC) and the
    Welfare-to-Work Tax Credit.   Congressional Research Service Report
    RL30089.  Washington, DC: updated August 2, 2006.
    -.  Targeted Jobs Tax Credit, 1978-1994, Congressional Research Service
    Report 95-981.  Washington, DC: September 19, 1995.
    U.S. General Accounting Office.  Work Opportunity Credit: Employers Do
    Not Appear to Dismiss Employees to Increase Tax Credits, GAO-01-329.
    Washington, DC: March 2001.
    Westat and Decision Information Resources, Inc.  Employers' Use and
    Assessment of the WOTC and Welfare-to-Work Tax Credits Program.
    Washington, DC: March 2001.

    	Education, Training, Employment, and Social Services:
    	Employment

    	WELFARE-TO-WORK TAX CREDIT

    Estimated Revenue Loss*

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    (1)

    (1)

    (1)

    2006

    (1)

    (1)

    (1)

    2008

    (1)

    (1)

    (1)

    2009

    (1)

    (1)

    (1)

    2010

    (1)

    (1)

    (1)

    *The tax credit is effective through December 31, 2007; H.R. 6111
    (December 2006) increases the loss for FY2007 to FY2010 by $0.4, $0.3,
    $0.2, and $0.1 for the combined work opportunity and welfare to work credit.

    (1)Less than $50 million.

    	Authorization

    Sections 51 and 52.

    	Description

    The Welfare to Work (WtW) Credit  is available on a nonrefundable basis
    to for-profit employers who hire long-term recipients of Temporary
    Assistance for Needy Families (TANF) benefits.  For 2007 it is combined
    with the Work Opportunity Tax Credit (WOTC).  The eligible group is
    defined as:  (1) members of families that have received TANF benefits for at
    least 18 consecutive months ending on the hiring date; (2) members of
    families that have received TANF benefits for any 18 months beginning after
    the credit's enactment  (August 5, 1997), if they are hired within 2 years after
    the date the 18-month total is reached; or (3) members of families that no
    longer are eligible for TANF assistance after August 5, 1997 because of any
    federal- or state-imposed time limit, if they are hired within 2 years after the
    date of benefit cessation.

    During the first year in which credit-eligible persons are hired,  employers
    can claim an income tax credit of 35% of the first $10,000 earned.  During
    the second year of their employment,  employers can claim an income credit
    of 50% of the first $10,000 earned.  Earnings against which the subsidy rate
    can be applied include, in addition to gross wages, certain tax-exempt
    amounts received under accident and health plans as well as under
    educational or dependent assistance programs.  An eligible-hire must remain
    on an employer's payroll for a minimum of 400 hours or 180 days in order for
    the credit to be claimed.

    The maximum amount of the credit to the employer would be $3,500 per
    worker in the first year of employment and $5,000 in the second year of
    employment.  The actual value could be less than these amounts depending
    on the employer's tax bracket.  An employer's usual deduction for wages
    must be reduced by the amount of the credit as well.  The credit also cannot
    exceed 90% of an employer's annual income tax liability, although the excess
    can be carried back 1 years or carried forward 20 years.  Employers cannot
    claim both the WOTC and WtW credit for the same individuals.

    In 2007, the maximum credit will be $4,000 in the first year.

    	Impact

    An employer completes a "pre-screening notice" by the date a job offer is
    made to an applicant thought to belong to the credit-eligible population.  The
    IRS form must be mailed to the state's Employment Service (ES) agency
    within 21 days after the new hire starts working (28 days in 2007).  The ES
    then certifies whether the new hire is part of the eligible group.  The employer
    uses the certification of eligibility to claim the WtW credit.

    According to the ES, the number of certifications issued to employers has
    varied greatly over time.  (Certifications will exceed the number of credits
    claimed unless all eligible-hires remain on firms' payrolls for the minimum
    employment period.  Thus, certifications reflect eligibility determinations
    rather than credits claimed.)  In its first full year of operation (FY1999),
    employers were issued 104,998 certifications.  After certifications rose to
    154,608 in FY2000, they declined steadily and markedly thereafter.  The
    2001 recession and subsequent slow recovery likely affected the figures
    during the early years of the decade, with 33,068 certifications issued in
    FY2003.  The low number of certifications in more recent years (e.g., 15,601
    in FY2004) likely reflects the expiration of the credit during much of the
    period.  In FY2005, ES agencies issued 32,817certifications to employers.

    	Rationale

    The WtW credit is one of the initiatives meant to help welfare recipients
    comply with the work requirements contained in welfare reform legislation
    (P.L. 104-193).  The credit is designed to lower the relative cost of hiring
    long-term family assistance beneficiaries by subsidizing their wages, and
    hence to increase private sector employers' willingness to hire them despite
    their presumed low productivity.

    Earlier tax credits aimed at encouraging firms to hire welfare recipients
    were little used according to empirical studies.  Despite this and other
    criticisms,  Congress opted to retain this approach to job creation for long-
    term family assistance recipients.

    H.R. 6111 (December 2006), extended the credit through 2006.  That
    legislation also combined it with the Work Opportunity Credit e to Work
    credit for 2007.

    	Assessment

    Since its inception, no funds have been included in legislation to conduct
    an assessment of the WtW's effectiveness.  With a target group very similar
    to one of the Work Opportunity Tax Credit's eligible groups, its availability
    has increased the complexity of the Code.

    	Selected Bibliography

    Hamersma, Sarah.  The Work Opportunity and Welfare-to-Work Tax
    Credits.  Urban-Brookings Tax Policy Center, No. 15.  Washington, DC:
    October 2005.
    Levine, Linda.  The Work Opportunity Tax Credit (WOTC) and the
    Welfare-to-Work Tax Credit.   Congressional Research Service Report
    RL30089.  Washington, DC: updated August 2, 2006.
    -.  Welfare Recipients and Employer Wage Subsidies, Library of Congress,
    Congressional Research Service Report 96-738E.  Washington, DC:
    September 3, 1996.
    Westat and Decision Information Resources, Inc.  Employers' Use and
    Assessment of the WOTC and Welfare-to-Work Tax Credits Program.
    Washington, DC: March 2001.

    Education, Training, Employment, and Social Services:
    Employment

    DEFERRAL OF TAXATION ON  SPREAD ON ACQUISITION
    OF STOCK UNDER INCENTIVE STOCK OPTION PLANS
    AND EMPLOYEE STOCK PURCHASE PLANS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.4

    -

    0.4

    2007

    0.4

    -

    0.4

    2008

    0.4

    -

    0.4

    2009

    0.2

    -

    0.2

    2010

    0.1

    -

    0.1

    	Authorization

    Sections 422-423.

    	Description

    Qualified (or "statutory") options include "incentive stock options," which
    are limited to $100,000 a year for any one employee, and "employee stock
    purchase plans," which are limited to $25,000 a year for any employee.
    Employee stock purchase plans must be offered to all full-time employees
    with at least two years of service; incentive stock options may be confined to
    officers and highly paid employees.  Qualified options are not taxed to the
    employee when granted or exercised (under the regular tax); tax is imposed
    only when the stock is sold.  If the stock is held one year from purchase and
    two years from the granting of the option, the gain is taxed as long-term
    capital gain.  The employer is not allowed a deduction for these options.
    However, if the stock is not held the required time, the employee is taxed at
    ordinary income tax rates and the employer is allowed a deduction.  The value
    of incentive stock options is included in minimum taxable income in the year
    of exercise.

    	Impact

    Both types of qualified stock options receive some tax benefit under
    current law.  The employee recognizes no income (for regular tax purposes)
    when the options are granted or when they are exercised.  Taxes (under the
    regular tax) are not imposed until the stock purchased by the employee is
    sold.  If the stock is sold after it has been held for at least two years from the
    date the option was granted and one year from the date it was exercised, the
    difference between the market price of the stock when the option was
    exercised and the price for which it was sold is taxed at long-term capital
    gains rates.  If the option price was less than 100% of the fair market value of
    the stock when it was granted, the difference between the exercise price and
    the market price (the discount) is taxed as ordinary income (when the stock is
    sold).  Taxpayers with above average or high incomes are the primary
    beneficiaries of these tax advantages.

    	Rationale

    The Revenue Act of 1964 (P.L. 88-272) enacted special rules for qualified
    stock options, which excluded these options from income when they were
    granted or exercised and instead included the gains as income at the time of
    sale of the stock.  The Tax Reform Act of 1976 (P.L. 94-455) repealed these
    special provisions and thus subjected qualified stock options to the same rules
    as applied to nonqualified options.  Therefore, if an employee receives an
    option, which has a readily ascertainable fair market value at the time it is
    granted, this value (less the option price paid for the option, if any)
    constituted ordinary income to the employee at that time.  But, if the option
    did not have a readily ascertainable fair market value at the time it was
    granted, the value of the option did not constitute ordinary income to the
    employee at that time.  However, when the option was exercised, the spread
    between the option price and the value of the stock constituted ordinary
    income to the employee.  The Economic Recovery Tax Act of 1981 (P.L. 97-
    34) reinstituted special rules for qualified stock options with the justification
    that encouraging the management of a business to have a proprietary interest
    in its successful operation would provide an important incentive to expand
    and improve the profit position of the companies involved.

    	Assessment

    Tax advantages for qualified stock options encourage companies to
    provide them to employees rather than other forms of compensation that are
    not tax favored.  Paying for the services of employees, officers, and directors
    by the use of stock options has several advantages for the companies.  Start-
    up companies often use the method because it does not involve the immediate
    cash outlays that paying salaries involves; in effect, a stock option is a
    promise of a future payment, contingent on increases in the value of the
    company's stock.  It also makes the employees' pay dependent on the
    performance of the company's stock, giving them extra incentive to try to
    improve the company's (or at least the stock's) performance.  Ownership of
    company stock is thought by many to assure that the company's employees,
    officers, and directors share the interests of the company's stockholders.
    Lastly, receiving pay in the form of stock options serves as a form of forced
    savings, since the money cannot be spent until the restrictions expire.

    Critics of the stock options, however, argue that there is no real evidence
    that the use of stock options instead of cash compensation improves corporate
    performance.  (Many of the leading users of stock options were among the
    companies suffering substantial recent stock losses.)  Furthermore, stock
    options are a risky form of pay, since the market value of the company's stock
    may decline rather than increase.  Some employees may not want to make the
    outlays required to buy the stock, especially if the stock is subject to
    restrictions and cannot be sold immediately.  And some simply may not want
    to invest their pay in their employer's stock.

    	Selected Bibliography

    Bickley, James M.  Employee Stock Options: Tax Treatment and Tax
    Issues.  Library of Congress, Congressional Research Service Report
    RL31458.  Washington, DC: updated September 1, 2006.
    Gravelle, Jane G.  Taxes and Incentive Stock Options.  Library of
    Congress, Congressional Research Service Report RS20874.  Washington,
    DC: January 30, 2003.
    Johnson, Shane A. and Yisong S. Tian.  "The Value and Incentive Effects
    of Nontraditional Executive Stock Option Plans."  Journal of Financial
    Economics, vol. 57 (2000), pp. 3-34.
    Biggs, John H.  Testimony before the U.S. Senate Finance Committee.
    April 18, 2002.

    Education, Training, Employment, and Social Services:
    Social Services

    TAX CREDIT FOR CHILDREN UNDER AGE 17

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    46.0

    -

    46.0

    2007

    45.9

    -

    45.9

    2008

    46.1

    -

    46.1

    2009

    46.0

    -

    46.0

    2010

    46.0

    -

    46.0

    	Authorization

    Section 24.

    	Description

    Families with qualifying children are allowed a credit against their federal
    individual income tax of $1,000 per qualifying child.

    To qualify for the credit the child must be an individual for whom the
    taxpayer can claim a dependency exemption.  That means the child must be
    the son, daughter, grandson, granddaughter, stepson, stepdaughter or an
    eligible foster child of the taxpayer.  The child must be under the age of 17 at
    the close of the calendar year in which the taxable year of the taxpayer begins.

    The child tax credit is phased out for taxpayers whose adjusted gross
    incomes (AGIs) exceed certain thresholds.  For married taxpayers filing joint
    returns, the phaseout begins at AGI levels in excess of $110,000, for married
    couples filing separately the phaseout begins at AGI levels in excess of
    $55,000, and for single individuals filing as either heads of households or as
    singles the phaseout begins at AGI levels in excess of $75,000.  The child tax
    credit is phased out by $50 for each $1000 (or fraction thereof) by which the
    taxpayer's AGI exceeds the threshold amounts.  Neither the child tax credit
    amount nor the phaseout thresholds are indexed for inflation.

    The child tax credit is refundable.  For families with less than three
    qualifying children, the maximum refundable credit cannot exceed 15% of a
    taxpayer's earned income in excess of a given income threshold.  For 2006,
    the income threshold is $11,300.  The threshold is indexed annually for
    inflation.  For families with three or more children, the maximum refundable
    credit is limited to the extent that the taxpayer's Social Security taxes and
    income taxes exceed the taxpayer's earned income tax credit or to the extent
    of 15% of their earned income in excess of income threshold.  In these cases,
    the taxpayer can use whichever method results in the largest refundable
    credit.

    The child tax credit can be applied against both a taxpayer's regular
    income tax and his or her alternative minimum tax.

    	Impact

    The child tax credit will benefit all families with qualifying children whose
    incomes fall below the AGI phaseout ranges.

    Distribution by Income Class of the
    Tax Credit for Children Under Age
    17, 2005

    Income Class
    (in thousands of $)

    Percentage
    of Amount

    Below $10

    0.4

    $10 to $20

    4.0

    $20 to $30

    11.5

    $30 to $40

    13.9

    $40 to $50

    12.6

    $50 to $75

    23.7

    $75 to $100

    17.2

    $100 to $200

    16.5

    $200 and over

    0.0

    	Rationale

    The child tax credit was enacted as part of the Taxpayer Relief Act of
    1997.  Initially, for tax year 1998, families with qualifying children were
    allowed a credit against their federal income tax of $400 for each qualifying
    child.  For tax years after 1998, the credit increased to $500 for each
    qualifying child.  For families with three or more children, the credit was
    refundable.

    Congress indicated that the tax structure at that time did not adequately
    reflect a family's reduced ability to pay as family size increased.  The decline
    in the real value of the personal exemption over time was cited as evidence of
    the tax system's failure to reflect a family's ability to pay.  Congress further
    believed that the child tax credit would reduce a family's tax liabilities, would
    better recognize the financial responsibilities of child rearing, and promote
    family values.

    The amount and coverage of the child tax credit was substantially
    increased by the Economic Growth and Tax Relief Reconciliation Act of
    2001.  Proponents of this increase argued that a $500 child tax credit was
    inadequate.   It was argued that the credit needed to be increased in order to
    better reflect the reduced ability to pay taxes of families with children.
    Furthermore, it was felt that the credit should be refundable for all families
    with children.

    The 2001 Act increased the child tax credit to $1,000 with the increase
    scheduled to be phased in between 2001and 2010.  It also made the credit
    refundable for families with less than three children.  The Jobs and Growth
    Tax Relief Reconciliation Act of 2003 increased the child tax credit to $1,000
    for tax years 2003 and 2004.  The Working Families Tax Relief Act of 2004
    effectively extended the $1,000 child tax credit through 2010.  The 2004 act
    also included combat pay, which is not subject to income taxes, in earned
    income for purposes of calculating the refundable portion of the credit.

    The Katrina Emergency Tax Relief Act of 2005 allowed taxpayers affected
    by hurricanes Katrina, Rita, and Wilma to use their prior year's (2004) earned
    income to compute the amount of their 2005 refundable  child credit.

    Under current law, the changes made by the 2001 act will sunset at the end
    of 2010.  For tax years beyond 2010, the child tax credit will revert to its pre-
    2001 law levels and refundability rules.

    Assessment

    Historically, the federal income tax has differentiated among families of
    different size through the combined use of personal exemptions, child care
    credits, standard deductions, and the earned income tax credit.  These
    provisions were modified over time so that families of differing size would
    not be subject to federal income tax if their incomes fell below the poverty
    level.

    The child tax credit enacted as part of the Taxpayer Relief Act of 1997,
    and expanded upon in the 2001, 2003, and 2004 tax Acts, represents a
    departure from past policy practices because it is not designed primarily as a
    means of differentiating between low-income families of different size, but
    rather is designed to provide general tax reductions to middle income
    families.  The empirical evidence, however, suggests that for families in the
    middle and higher income ranges, the federal tax burden has remained
    relatively constant over the past 15 years.

    	Selected Bibliography

    Esenwein, Gregg.  "Child Tax Credit,"  Encyclopedia of Taxation and Tax
    Policy, Ed. Joseph J. Cordes, Robert D. Ebel and Jane G. Gravelle.   The
    Urban Institute, Washington D.C.  2005.
    Gravelle, Jane G. and Jennifer Gravelle.  "Horizontal Equity and Family
    Tax Treatment: The Orphan Child of Tax Policy".  National Tax Journal,
    September 2006.
    Burman, Leonard E. and Laura Wheaton.  "Who Gets the Child Tax
    Credit?"  Tax Notes, October 17, 2005.
    Esenwein, Gregg.  The Child Tax Credit.  Library of Congress.
    Congressional Research Service Report RS21860.  2006.
    Esenwein, Gregg A.  The Child Tax Credit After the Economic Growth
    and Tax Relief  Reconciliation Act of 2001 .  Library of Congress,
    Congressional Research Service Report RS20988.   2002.
    U.S. Department of the Treasury.  Internal Revenue Service.  Child Tax
    Credit.  Publication 972.   2005.
    U.S. Congress, Joint Committee on Taxation.  Technical Explanation of
    H.R. 3768, The "Katrina Emergency Tax Relief Act of 2005."  JCX-69-05.
    September 2005.
    -, Joint Committee on Taxation.  General Explanation of Tax Legislation
    Enacted in the 107th Congress.  January 2003.
    -,  Joint Committee on Taxation.  Summary of the Provisions Contained in
    the Conference Agreement for H.R. 1836, The Economic Growth and Tax
    Relief Reconciliation Act of 2001.  May 2001.
    -, House of Representatives.  Ticket to Work and Work Incentives
    Improvement Act of 1999.  Conference Report 106-478, November 1999.
    -, Joint Committee on Taxation.  General Explanation of Tax Legislation
    Enacted in 1997.  December 1997.

    	Education, Training, Employment, and Social Services:
    Social Services

    TAX CREDIT FOR CHILD
    AND DEPENDENT CARE AND EXCLUSION OF EMPLOYER-
    PROVIDED CHILD CARE

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    3.1

     -

    3.1

    2007

    2.7

     -

    2.7

    2008

    2.7

     -

    2.7

    2009

    2.6

     -

    2.6

    2010

    2.5

     -

    2.5

    	Authorization

    Sections 21 and 129.

    	Description

    A taxpayer may claim a nonrefundable tax credit (Section 21) for
    employment-related expenses incurred for the care of a dependent child (or a
    disabled dependent or spouse).  The maximum dependent care tax credit is 35
    percent of expenses up to $3,000, if there is one qualifying individual, and up
    to $6,000 for two or more qualifying individuals.  The credit rate is reduced
    by one percentage point for each $2,000 of adjusted gross income (AGI), or
    fraction thereof, above $15,000, until the credit rate of 20 percent is reached
    for taxpayers with AGI incomes above $43,000.  Married couples must file a
    joint return in order to be eligible for the credit.

     In addition, payments by an employer, under a dependent care assistance
    program, for qualified dependent care assistance provided to an employee are
    excluded from the employee's income and, thus, not subject to federal
    individual income tax (Section 129).  The qualified expenditures are not
    counted as wages, and therefore, are also not subject to employment taxes.
    The maximum exclusion amount is $5,000, and  may not exceed the lesser of
    the earned income of the employee or the employee's spouse if married.  For
    each dollar a taxpayer receives through an employer dependent care
    assistance program, a reduction of one dollar is made in the maximum
    qualified expenses for the dependent care tax credit.

    To qualify, the employer assistance must be provided under a plan which
    meets certain conditions, including eligibility conditions which do not
    discriminate in favor of principal shareholders, owners, officers, highly
    compensated individuals or their dependents, and the program must be
    available to a broad class of employees.  The law provides that reasonable
    notification of the availability and terms of the program must be made to
    eligible employees.

    Qualified expenses (for both the tax credit and the income exclusion)
    include expenses for household services, day care centers, and other similar
    types of noninstitutional care which are incurred in order to permit the
    taxpayer to be gainfully employed.  Qualified expenses are eligible if they are
    for a dependent under 13, or for a physically or mentally incapacitated spouse
    or dependent who lives with the taxpayer for more than half of the tax year.
    Dependent care centers must comply with state and local laws and regulations
    to qualify.  Payments may be made to relatives who are not dependents of the
    taxpayer or a child of the taxpayer under age 19.

    Impact

    The credit benefits qualified taxpayers with sufficient tax liability to take
    advantage of it, without regard to whether they itemize their deductions.  It
    operates by reducing tax liability, but not to less than zero because the credit
    is nonrefundable.  Thus, the credit does not benefit persons with incomes so
    low that they have no tax liability.

    Distribution by Income Class of the
    Tax Expenditure for
    Child and Dependent Care Services, 2005

    Income Class
    (in thousands of $)

    Percentage
    Distribution

    Below $10

    0.0

    $10 to $20

    0.6

    $20 to $30

    5.2

    $30 to $40

    11.7

    $40 to $50

    11.2

    $50 to $75

     21.0

    $75 to $100

    17.9

    $100 to $200

    27.2

    $200 and over

    5.2

    The credit rate phases down from 35 to 20 percent as income rises from
    $15,000 to $43,000, providing the largest monetary benefit to parents with
    incomes of $43,000 or less.  In the past, the absence of an inflation
    adjustment has affected the ability of moderate-income taxpayers to receive
    the maximum benefits under the credit.

    The tax exclusion provides an incentive for employers to provide, and
    employees to receive, compensation in the form of dependent-care assistance
    rather than cash.  The assistance is free from income and employment taxes,
    while the cash is not.  As is the case with all deductions and exclusions, this
    benefit is related to the taxpayer's marginal tax rate and, thus, provides a
    greater benefit to taxpayers in high tax brackets than those in low tax
    brackets.  To the extent employers provide dependent care assistance rather
    than increases in salaries or wages, the Social Security Trust Fund and the
    Hospital Insurance Trust Fund (for Medicare) lose receipts.  Because of the
    lower amounts of earnings reported to Social Security the employee may
    receive a lower Social Security benefit during retirement years.

    Rationale

    The deduction for child and dependent care services was first enacted in
    1954.  The allowance was limited to $600 per year and was phased out for
    families with income between $4,500 and $5,100.  Single parents and
    widow(er)s did not have an income limitation for the deduction.  The
    provision was intended to recognize the similarity of child care expenses to
    employee business expenses and provide a limited benefit.  Some believe
    compassion and the desire to reduce welfare costs contributed to the
    enactment of this allowance.

    The provision was made more generous in 1964, and was revised and
    broadened in 1971.  Several new justifications in 1971 included encouraging
    the hiring of domestic workers, encouraging the care of incapacitated persons
    at home rather than in institutions, providing relief to middle-income
    taxpayers as well as low-income taxpayers, and providing relief for
    employment-related expenses of household services as well as for dependent
    care.

    The Tax Reduction Act of 1975 substantially increased the income limits
    ($18,000 to $35,000) for taxpayers who could claim the deduction.

    The deduction was replaced by a nonrefundable credit with enactment of
    the Tax Reform Act of 1976.  Congress believed that such expenses were a
    cost of earning income for all taxpayers and that it was wrong to deny the
    benefits to those taking the standard deduction.  Also, the tax credit provided
    relatively more benefit than the deduction to taxpayers in the lower tax
    brackets.

    The Revenue Act of 1978 provided that the child care credit was available
    for payments made to relatives.  The stated rationale was that, in general,
    relatives provide better attention and the allowance would help strengthen
    family ties.

    The tax exclusion was enacted in the Economic Recovery Tax Act of 1981
    (P.L. 97-34), and was intended to provide an incentive for employers to
    become more involved in the provision of dependent care services for their
    employees. Also in 1981, the tax credit was converted into the current sliding-
    scale credit and increased.  The congressional rationale for increasing the
    maximum amounts was due to substantial increases in costs for child care.
    The purpose of switching to a sliding-scale credit was to target the increases
    in the credit toward low- and middle-income taxpayers because Congress felt
    that group was in greatest need of relief.

    The Family Support Act of 1988 modified the dependent care tax credit.
    First, the credit became available for care of children under 13 rather than 15.
     Second, a dollar-for-dollar offset was provided against the amount of
    expenses eligible for the dependent care credit for amounts excluded under an
    employer-provided dependent care assistance program.  Finally, the act
    provided that the taxpayer must report on his or her tax return the name,
    address, and taxpayer identification number of the dependent care provider.

    With passage of the Economic Growth and Tax Relief Reconciliation Act
    of 2001, the sliding-scale credit was increased 5 percent while the maximum
    expenditure amounts for care were raised from $2,400 to $3,000 for one
    qualifying individual and from $4,800 to $6,000 in the case of two or more
    qualified individuals.  It seems likely that these changes were made because
    these provisions are not subject to an automatic inflation provision.

    The provision was further amended by the Job Creation and Worker
    Assistance Act of 2002 which determined that the amount of "deemed earned
    income" in the case of a nonworking spouse incapable of self-care or a
    student is increased to $250 if there is one qualifying child or dependent, or
    $500 if there are two or more children.

    In 2004, the Working Families Tax Relief Act was passed which made two
    changes for dependent care expenses.  The bill imposed a requirement that a
    disabled dependent (or spouse), who is not a qualifying child under age 13,
    live with the taxpayer for more than half the tax year.  It also eliminated the
    requirement that the taxpayer maintain a household in which the qualifying
    dependent resides.

    Assessment

    An argument for the child and dependent care tax credit is that child care is
    a cost of earning income; if this is the rationale, however, it can also be
    argued that the amount should be a deductible expense that is available to all
    taxpayers.

    The issue of whether the tax credit is progressive or regressive lingers
    because an examination of distribution tables shows that the greatest federal
    revenue losses occur at higher rather than lower income levels.  The
    distribution table appearing earlier in this section shows that taxpayers whose
    adjusted gross  incomes were under $20,000 are estimated to claim 0.6
    percent of the total value of the tax credit in 2005, while taxpayers in the $50-
    $75,000 income class are estimated to claim 21.0 percent.  However, the
    determination of the dependent care tax credit progressivity cannot be made
    simply by comparing an estimate of the federal tax expenditure.  A more
    appropriate measure is the credit amount relative to the taxpayer's income.

    It is generally observed that the credit is regressive at lower income levels
    primarily because the credit is non-refundable.  Thus, the structure of the
    credit (albeit, except at low-income levels) has been found to be progressive.

    This is not meant to imply that if the credit were made refundable it would
    solve all of the problems associated with child care for low-income workers.
    For example, the earned income tax credit is refundable and designed so that
    payments can be made to the provision's beneficiaries during the tax year.  In
    practice, few elect to receive advance payments, and wait to claim the credit
    when their annual tax returns are filed the following year.  This experience
    illustrates the potential problems encountered in designing a transfer
    mechanism for payment of a refundable child care credit.  The truly poor
    would need such payments in order to make payments to caregivers.

    The child and dependent care tax credit still lacks an automatic adjustment
    for inflation, while other code provisions are adjusted yearly.  In the past, this
    absence of an automatic yearly adjustment has affected the ability of low-
    income taxpayers to use the credit.

    Prior to tax year 2003, the qualifying expenditure amount had not been
    increased since 1982.  The current $3,000 and $6,000 limits for qualified
    expenses, which expire in 2010, are equivalent to $58 per week for one
    qualifying individual and $115 for two or more qualifying individuals.  This
    amount is equivalent to $1.45 per hour per individual (using a standard 40
    hour work-week), which is far below the federal minimum wage level, and
    below the median weekly cost of paid child care in 1999 ($69 a child).

    In order to properly administer the dependent care tax credit, the Internal
    Revenue Service requires submission of a tax identification number for the
    provider of care.  To claim the credit complicates income tax filing, although
    the complexity aids in compliance by reducing fraudulent claims.  To the
    extent that payments are made to individuals, the taxpayer may also be
    responsible for employment taxes on the payments.

    The debate over the income exclusion for dependent care expenses turns
    on whether the expenses are viewed as personal consumption or business
    expenses (costs of producing income).  Some have noted that the $5,000 limit
    for the exclusion may be an attempt to restrict the personal consumption
    element for middle and upper income taxpayers.

    Since all employers will not provide a dependent care assistance program,
    the tax exclusion violates the economic principle of horizontal equity, in that
    all taxpayers with similar incomes are not treated equally.  Since upper-
    income taxpayers will receive a greater subsidy than lower-income taxpayers
    because of their higher tax rate, the tax subsidy is inverse to need.  If
    employers substitute benefits for wage or salary increases, the benefits are not
    subject to employment taxes, impacting the Social Security and Hospital
    Insurance Trust Funds.

    On the positive side, it is generally believed that the availability of
    dependent care can reduce employee absenteeism and unproductive work
    time.  The tax exclusion may also encourage full participation of  women in
    the work force as the lower after-tax cost of child care may not only affect
    labor force participation but hours of work.  Further, it can be expected that
    the provision affects the mode of child care by reducing home care and
    encouraging more formal care such as child care centers.  Those employers
    that may gain most by the provision of dependent-care services are those
    whose employees are predominantly female, younger, and whose industries
    have high personnel turnover.

    	Selected Bibliography

    Altshuler, Rosanne. and Amy Ellen Schwartz.  "On the Progressivity of
    the Child Care Tax Credit: Snapshot Versus Time-Exposure Incidence,"
    National Tax Journal, v. 49 (March 1996), pp. 55-71.
    Averett, Susan L.; H. Elizabeth Peters, and Donald M. Waldman. "Tax
    Credits, Labor Supply, and Child Care," The Review of Economics and
    Statistics, v. 79 (February 1997), pp. 125-135.
    Benson, Joseph E. and Arthur A. Whatley.  "Pros and Cons of Employer-
    Sponsored Child Care," Journal of Compensation and Benefits, v. 9
    (January/February 1994), pp. 16-20.
    Connelly, Rachel, Deborah S. Degraff, and Rachel Willis. "The Value of
    Employer-Sponsored Child Care to Employees," Industrial Relations, v. 43,
    issue 4, October 2004, pp. 759-793.
    Dickert-Conlin, Stacy, Katie Fitzpatrick, and Andrew Hanson, "Utilization
    of Income Tax Credits by Low-Income Individuals, " National Tax Journal
    v.58, no. 4, December 2005.
    Dunbar, Amy E.  "Child Care Expenses: The Child Care Credit," in The
    Encyclopedia of Taxation and Tax Policy, eds. Joseph J. Cordes, Robert D.
    Ebel, and Jane G. Gravelle.  Washington, DC: Urban Institute Press, 2005,
    pp. 53-55.
    Fischer, Efrem Z.  "Child Care:  The Forgotten Tax Deduction,"  Cardozo
    Women's Law Journal, v. 3, no. 1 (1996), pp. 113-134.
    Gentry, William M. and Alison P. Hagy.  "The Distributional Effects of
    the Tax Treatment of Child Care Expenses."  Cambridge, Mass., National
    Bureau of Economic Research, 1995.  43 p.  (Working Paper no. 5088).
    Gravelle, Jane G.  Federal Income Tax Treatment of the Family, Library of
    Congress, Congressional Research Service Report 91-694 RCO. Washington,
    DC (Available from the author).
    Heen, Mary L.  "Welfare Reform, Child Care Costs, and Taxes:
    Delivering Increased Work-Related Child Care Benefits to Low-Income
    Families.  Yale Law and Policy Review, v. 13 (January 1996), pp. 173-217.
    Hollingsworth, Joel S.  "Save the Cleavers: Taxation of the Traditional
    Family," Regents University Law Review, v. 13, no. 1, (2000/2001), pp. 29-
    64.
    Kelly, Erin L. "The Strange History of Employer-Sponsored Child Care:
    Interested Actors, Uncertainty, and the Transformation of Law in
    Organizational Fields," The American Journal of Sociology, v. 109, no. 3,
    November 2003, pp. 606-649.
    Koniak, Jaime. "Should the Street Take Care? The Impact of Corporate-
    Sponsored Day Care on Business in the New Millenium." Columbia Business
    Law Review, 2002, pp. 193-222.
    McIntyre, Lee.  "The Growth of Work-Site Daycare," Federal Reserve
    Bank of Boston Regional Review, v. 10, no. 3, (2000) pp. 8-15.
    National Women's Law Center, "Indexing the DCTC is Necessary to
    Prevent Further Erosion of the Credit's Value to Low-Income Families,"
    working paper, April 2003, pp. 1-4.

    Rosenberg, Lee Fletcher.  "Child Care Benefits May Get Boost From Tax
    Credit," Business Insurance, v. 35, no. 31 (July 2001), pp. 3, 34.
    Rothausen, Teresa J.,  Jorge A. Gonzalez and Nicole E. Clarke.  "Family-
    Friendly Backlash - Fact or Fiction?  The Case of Organizations' On-Site
    Child Care Centers," Personnel Psychology, v. 51, no. 3 (Autumn 1998), pp.
    685-706.
    Scott, Christine. Dependent Care: Current Tax Benefits and Legislative
    Issues, Library of Congress, Congressional Research Service Report
    RS21466, Washington, DC.
    Seetharaman, Ananth and Govind S. Iyer.  "A Comparison of Alternative
    Measures of Tax Progressivity:  The Case of the Child and Dependent Care
    Credit,"  Journal of the American Taxation Association, v. 17 (Spring 1995),
    pp. 42-70.
    Sprang, Ginny, Mary Secret and Judith Bradford.  "Blending Work and
    Family: A Case Study," Affilia, v. 14, no. 1 (Spring 1999), pp. 98-116.
    Steuerle, C. Eugene.  "Systemic Thinking About Subsidies for Child
    Care," Tax Notes 78 (1998): 749.
    Stoltzfus, Emily. Citizen, Mother, Worker, University of North Carolina
    Press, 2003.
    Thomas, Ann F. and Alison P. Hagy.  "Forum on Married Women and the
    Income Tax: Marriage Penalties and Marriage Bonuses of the 105th Congress.
     Panel III: Child Care and Federal Tax Policy," New York Law School
    Journal of Human Rights, v. 16, pt. 1 (Symposium 1999), pp. 203-216.
    U.S. Congress, Congressional Budget Office.  Budget Options.  "Eliminate
    the Tax Exclusion for Employer-Sponsored Dependent Care."  Washington,
    DC: February 2001, p. 406.
    U.S.  Congress, House Committee on Ways and Means.  2004 Green
    Book; Background Material and Data on Programs Within the Jurisdiction
    of the Committee on Ways and Means, Committee Print, 108th Congress, 2d
    Session.  March 2004, pp. 13-49.
    U.S. Congress, Joint Committee.  General Explanation of the Economic
    Recovery Tax Act of 1981 (H.R. 4242, 97th Congress; Public Law 97-34).
    Washington, DC: U.S. Government Printing Office, December 31, 1981, pp.
    53-56.
    Wiley, Michael J. and Anthony P. Curatola.  "Dependent Care Assistance
    Programs," Strategic Finance Magazine, v. 83, no. 9 (March 2002), pp. 17-
    18.
    Woodward, Nancy Hatch.  "Child Care to the Rescue," HR Magazine, v.
    44, no. 8 (August 1999) pp. 82-84.

    	Education, Training, Employment, and Social Services:
    Social Services

    TAX CREDIT FOR EMPLOYER-PROVIDED CHILD CARE

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    (1)

    (1)

    (1)

    2007

    (1)

    (1)

    (1)

    2008

    (1)

    (1)

    (1)

    2009

    (1)

    (1)

    (1)

    2010

    (1)

    (1)

    (1)

    (1)Less than $50 million.

    	Authorization

    Section 45F.

    	Description

    Employers are allowed a tax credit equal to 25 percent of qualified
    expenses for employee child care and 10 percent of qualified expenses for
    child care resource and referral services.  Qualified child care expenses
    include the cost of acquiring, constructing, rehabilitating or expanding
    property used for a qualified child care facility, costs for the operation of the
    facility (including training costs and certain compensation for employees, and
    scholarship programs), or for contracting with a qualified child care facility to
    provide child care.

    A qualified child care facility must have child care as its principal purpose
    and must meet all applicable state and local laws and regulations.  A facility
    operated by a taxpayer is not a qualified child care facility unless, in addition
    to these requirements, the facility is open to all employees and, if qualified
    child care is the principal trade or business of the taxpayer, at least 30 percent
    of the enrollees at the facility are dependents of employees of the taxpayer.
    Use of a qualified child care facility and use of child care resource and
    referral services cannot discriminate in favor of highly paid employees.

      The maximum total credit that may be claimed by a taxpayer cannot
    exceed $150,000 per taxable year.  The credit is reduced by the amounts of
    any tax deduction claimed for the same expenditures.  Any credit claimed for
    acquiring, constructing, rehabilitating, or expanding property is recaptured if
    the facility ceases to operate as a qualified child care facility, or for certain
    ownership transfers within the first 10 years. The credit recapture is a
    percentage, based on the year when the cessation as a qualified child care
    facility or transfer occurs.

    	Impact

    A 25 percent credit is a very large tax subsidy which should significantly
    decrease the cost of on-site facilities for employers and encourage some firms
    to develop on-site facilities.  Firms have to be large enough to make the
    facility viable, i.e. have enough employees with children in need of child care.
     Thus, large firms will be those that provide on-site child care.

    This nonrefundable tax credit has the potential to violate the principle of
    horizontal equity, which requires that similarly situated taxpayers should bear
    similar tax burdens.  Mid- and small-sized firms may not have sufficient tax
    liability to be able to take advantage of the credit.  Even for those firms that
    are able to claim the credit, they may not be able to claim the full amount
    because of limited tax liability.

    Although the credit is contingent on non-discrimination in favor of more
    highly compensated employees, this provision, unlike child care tax benefits
    in general, may provide greater benefits to middle and upper income
    individuals because its relative cost effect is dependent on the size of the firm
    and not the income of the employees.   Indeed, lower income employees may
    not be able to afford the higher quality child care facilities offered by some
    firms (although some employers subsidize costs for lower income workers).

    	Rationale

    This provision was adopted as part of the Economic Growth and Tax
    Relief Reconciliation Act of 2001 (P.L. 107-16) and was designed to
    encourage on-site employer child care facilities.

     	Assessment

    Specific subsidies for on-site employer-provided child care would be
    economically justified if there were a market failure that prevented firms from
    providing this service.  Few firms offer such facilities, although small firms
    may not have enough potential clients to allow the center to be economically
    viable. The limit on the subsidy amount is intended to  target smaller firms,
    but it is not clear why such activities are under-supplied by the market.  Some
    research has suggested that on-site care produces benefits that firms may not
    take into account, such as reduced absenteeism and increased productivity,
    but not all evidence is consistent with that view. In addition, employers may
    be reluctant to commit to on-site child care because of uncertainties regarding
    costs and return.  There is also some concern that employer-provided child
    care centers may create resentment among employees who are either childless
    or on a waiting list for admittance of their children to the center.

    Some firms have also begun offering emergency or back-up care, which is
    a more limited proposition that may be more likely to reduce absenteeism.
    The credits may encourage more firms of larger size to provide these benefits,
    which may increase productivity because parents are not forced to stay home
    with a sick child or a child whose care giver is temporarily not available.

    	Selected Bibliography

    "Deciding How to Provide Dependent Care Isn't Child's Play." Personnel
    Journal, v. 74, October 1995, p. 92.
    Fitzpatrick, Christina Smith and Nancy Duff Campbell. "The Little Engine
    that Hasn't: The Poor Performance of Employer Tax Credits for Child Care."
    National Women's Law Center, November 2002.
    Koniak, Jaime. "Should the Street Take Care? The Impact of Corporate-
    Sponsored Day Care on Business in the New Millenium." Columbia Business
    Law Review, 2002, pp. 193-222.
    McIntyre, Lee.  "The Growth of Work-Site Daycare."  Federal Reserve
    Bank of Boston Regional Review, Vol. 10, No. 3, 2000, pp. 8-15.
    Rosenberg, Lee Fletcher.  "Child Care Benefits May Get Boost from Tax
    Credit."  Business Insurance, Vol. 35, July 30, 2001, pp. 3, 34.
    Rothausen, Teresa J, et al.  "Family-Friendly Backlash - Fact or Fiction?
    The Case of Organizations' On-Site Child Care Centers."  Personnel
    Psychology, v. 51 (Autumn 1998), pp. 685-706.
    Woodward, Nancy Hatch. "Child Care to the Rescue."  HRMagazine, Vol.
    44, August 1999, pp. 82-84.

    Education, Training, Employment, and Social Services:
    	Social Services

    EXCLUSION OF CERTAIN FOSTER CARE PAYMENTS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.6

     -

    0.6

    2007

    0.6

     -

    0.6

    2008

    0.7

     -

    0.7

    2009

    0.7

     -

    0.7

    2010

    0.8

     -

    0.8

    	Authorization

    Section 131.

    	Description

    Qualified foster care payments are excluded from the foster care provider's
    gross income.  Qualified foster care payments are those payments made in
    carrying out a state or local government foster care program.  The payments
    must be made by a state or local governmental agency or any qualified foster
    care placement agency for either of two purposes: (1) for caring for a
    qualified individual in the foster care provider's home.  A "qualified foster
    individual" is defined as an individual placed by a qualified foster care
    placement agency, regardless of the individual's age at the time of
    placement.; or (2) additional compensation for additional care, provided in the
    foster care provider's home that is necessitated by an individual's physical,
    mental, or emotional handicap for which the state has determined that
    additional compensation is needed (referred to as a difficulty of care
    payment).

    The exclusion for foster care payments is limited. Foster care payments,
    other than difficulty of care payments, are limited based on the number of
    foster care individuals in the provider's home over age 18. Foster care
    payments made for more than five qualified foster care individuals aged 19 or
    older are not excluded from gross income.

    For difficulty of care payments, there are two limitations.  The first
    limitation is based on the number of foster care individuals under age 19.
    Difficulty of care payments made for more than 10 qualified foster care
    individuals under age 19 in the provider's home are not excluded from gross
    income. The second limitation is based on the number of foster care
    individuals in the provider's home over age 18. Difficulty of care payments
    made for more than five qualified foster care individuals aged 19 or older are
    not excluded from gross income.

    The Internal Revenue Service has ruled that foster care payments excluded
    from income are not "earned income" for purposes of the Earned Income Tax
    Credit (EITC).

    Impact

    Both foster care and difficulty of care payments qualify for a tax exclusion.
     Since these payments are not counted as part of gross income, the tax savings
    reflect the marginal tax bracket of the foster care provider.  Thus, the
    exclusion has greater value for taxpayers with higher incomes (and higher
    marginal tax rates) than for those with lower incomes (and lower marginal tax
    rates).  In general, foster care providers who have other income, would
    receive a larger tax benefit than foster care providers without other income.

    	Rationale

    In 1977, the Internal Revenue Service, in Revenue Ruling 77-280, 1977-2
    CB 14, held that payments made by charitable child-placing agencies or
    governments (such as child welfare agencies) were reimbursements or
    advances for expenses incurred on behalf of the agencies or governments by
    the foster parents and therefore not taxable.

    In the case of payments made to providers which exceed reimbursed
    expenses, the Internal Revenue Service ruled that the foster care providers
    were engaged in a trade or business with a profit motive and dollar amounts
    which exceed reimbursements were taxable income to the foster care
    provider.

    The exclusion of foster care payments entered the tax law officially with
    the passage of the Periodic Payments Settlement Tax Act of 1982 (P.L. 97-
    473).  That act codified the tax treatment of foster care payments and
    provided a tax exclusion for difficulty of care payments made to foster parents
    who provide additional services in their homes for physically, mentally, or
    emotionally handicapped children.

    In the Tax Reform Act of 1986 (P.L. 99-514), the provision was modified
    to exempt all qualified foster care payments from taxation.  This change was
    made to relieve foster care providers from the detailed record-keeping
    requirements of prior law.  Congress feared that detailed and complex record-
    keeping requirements might deter families from accepting foster children or
    from claiming the full tax exclusion to which they were entitled.  This act also
    extended the exclusion of foster care payments to adults placed in a taxpayer's
    home by a government agency.

    Under a provision included in the Job Creation and Worker Assistance Act
    of 2002 (P.L. 107-147), the definition of "qualified foster care payments" was
    expanded to include for-profit agencies contracting with State and local
    governments to provide foster home placements.  The change was made in
    recognition that States often contract services out to for-profit firms and that
    the tax code had not recognized the role of private agencies in helping the
    States provide foster care services for placement and delivery of payments.
    The provisions are thought to reduce complexity with the hope that simpler
    rules may encourage more families to provide foster care services.

    Assessment

    It is generally conceded that the tax law treatment of foster care payments
    provides administrative convenience for the Internal Revenue Service, and
    prevents unnecessary accounting and record-keeping burdens for foster care
    providers.  The trade-off is that to the extent foster care providers receive
    payments over actual expenses incurred, monies which should be taxable as
    income are provided an exemption from individual income and payroll
    taxation.

    Both the General Accounting Office (1989) and James Bell Associates
    (1993; under contract from the Department of Health and Human Services)
    have reported a shortage of foster parents.  Included among the reasons for
    this shortage are the low reimbursement rates paid to foster care providers,
    with some providers dropping out of the program because the low payment
    rates do not cover actual costs.  Thus, to the extent that the exclusion
    promotes participation in the program, it is beneficial from a public policy
    viewpoint.

    	Selected Bibliography

    U. S. Congress, Joint Committee on Taxation.  General Explanation of the
    Tax Reform Act of 1986, H.R. 3838, 99th Congress, Public Law 99-514.
    Washington, DC: U.S. Government Printing Office, May 4, 1987, pp. 1346-
    1347.
    U.S. General Accounting Office, Child and Family Services Reviews:
    Better Use of Data and Improved Guidance Could Enhance HHS's Oversight
    of State Performance, GAO Report GAO-04-333 (Washington: April 2004),
    pp. 1-55.
    - , Foster Care: States Focusing on Finding Permanent Homes for
    Children, but Long-Standing Barriers Remain, GAO Report GAO-03-626T
    (Washington: April 8, 2003), pp. 1-24.

    	Education, Training, Employment, and Social Services:
    	Social Services

    	ADOPTION CREDIT AND
    	EMPLOYEE ADOPTION BENEFITS EXCLUSION

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.4

    -

    0.4

    2007

    0.4

    -

    0.4

     2008

    0.4

    -

     0.4

    2009

    0.4

    -

    0.4

    2010

    0.5

    -

    0.5

    Authorization

    Section 23, 137.

    	Description

    The tax code provides a dollar-for-dollar adoption tax credit for qualified
    adoption expenses and an income tax exclusion of benefits received under
    employer-sponsored adoption assistance programs.  Both have a limitation on
    qualified expenses ($10,960 in tax year 2006) that is indexed for inflation.
    The adoption tax credit is nonrefundable, but may be carried forward five
    years.  Employer-provided adoption assistance benefits must be received
    under a written plan for an employer-sponsored adoption assistance program.
     Both the tax credit and income tax exclusion amounts are phased-out
    (allowable qualified adoption expenses are reduced) for taxpayers with high
    adjusted gross incomes.  For tax year 2006, a taxpayer with modified adjusted
    gross income over $164,410 has qualified adoption expenses reduced.  For a
    modified adjusted gross income of $204,410 or more, the qualified adoption
    expenses are reduced to zero.  The phase-out range is adjusted for inflation.
    The adoption credit is allowed against the alternative minimum tax.  Unlike
    some other tax exclusions, the exclusion for employer-provided adoption
    assistance is only for the income tax.  Benefits provided through an employer-
    provided adoption assistance program are subject to employment taxes.

    Qualified adoption expenses include reasonable and necessary adoption
    fees, court costs, attorney fees, and other expenses directly related to a legal
    adoption of a qualified child. A qualified child is under age 18; or an
    individual of any age who is physically or mentally incapable of caring for
    themself.  In the case of special needs adoptions, state required expenses such
    as construction, renovations, alterations, or other purchases may qualify as
    adoption expenditures.  In the case of a special needs adoption, the maximum
    tax credit is allowed regardless of actual qualified adoption expenses.  For
    domestic adoptions, qualified adoption expenses are eligible for the tax credit
    and income tax exclusion when incurred.  For intercountry (foreign)
    adoptions, qualified adoption expenses are not eligible for the tax credit or
    income tax exclusion until after the adoption is finalized.

    The provisions are unavailable for expenses related to surrogate parenting
    arrangements, or the adoption of a spouse's child.  The provisions are also
    unavailable for expenditures contrary to state or federal law.

    The code prohibits double benefits.  Qualified adoption expenses cannot be
    used for both the adoption tax credit and the income tax exclusion.  If a
    deduction or credit is taken for the qualified adoption expenses under other
    Internal Revenue Code sections, the adoption tax credit and income tax
    exclusion would not be available for any adoption expenses used for the other
    deduction of credit.  The adoption tax credit or income tax exclusion is also
    not available for expenses paid by a grant received under a federal, state, or
    local program.

    Married couples are generally required to file a joint tax return to be
    eligible for the credit.  The Secretary of the Treasury is permitted to establish,
    by regulation, procedures to ensure that unmarried taxpayers who adopt a
    single child and who have qualified adoption expenses have the same dollar
    limitation as a married couple.  The taxpayer is required to furnish the name,
    age, and Social Security number for each adopted child.

    	Impact

    Both the tax credit and employer exclusion may reduce the costs associated
    with adoptions through lower income taxes for taxpayers whose incomes fall
    below the adjusted gross income level where qualified expenses are zero
    ($204,410 in tax year 2006).  The tax credit is claimed by only a small
    proportion of taxpayers.  For tax year 2003, less than .05% of tax returns
    claimed the adoption tax credit, with an average credit of $5,452.  One factor
    limiting the use of the credit is the nonrefundable nature of the credit.  The
    adoption tax credit is taken against tax liability after certain other
    nonrefundable tax credits such as the child tax credit and the education
    credits.

    Distribution by Income Class of the Adoption Credit
    in Tax Year 2003

    Adjusted Gross Income Class
    (in thousands of $)

    Percentage
    Distribution

    Below $25

    0.0

    $25 to $50

    15.6

    $50 to $75

    27.6

    $75 to $100

    27.4

    $100 to $200

    29.4

    $200 and over

    0.0

    Source: Data compiled from IRS, Individual Complete Report, Publication
    		1304, Table 3.3.

    	Rationale

    An itemized deduction was provided by the Economic Recovery Tax Act
    of 1981 (P.L. 97-34) to encourage, through the reduction of  financial
    burdens, taxpayers who legally adopt children with special needs.  The
    deduction was repealed with passage of the Tax Reform Act of 1986 (P.L. 99-
    514).  The rationale for repeal was the belief that the deduction provided the
    greatest benefit to higher-income taxpayers and that budgetary control over
    assistance payments could best be handled by agencies with responsibility and
    expertise in the placement of special needs children.

    The tax credit and income tax exclusion provisions for qualified adoption
    expenses were enacted by Congress as part of the Small Business Job
    Protection Act of 1996 (P.L. 104-188).  The credit was enacted because of the
    belief that the financial costs associated with the adoption process should not
    be a barrier to adoptions.

    The Economic Growth and Tax Relief Reconciliation Act of 2001 (P.L.
    107-16) increased the maximum qualified adoption expenses for the tax credit
    and income exclusion to $10,000 per eligible child, including special needs
    children. The act also extended the exclusion from income for employer
    provided adoption assistance and increased the beginning point of the income
    phase-out range to $150,000.  Congressional reports noted that both the
    credit and exclusion had been successful in reducing the after-tax
    cost of adoption to affected taxpayers.  It was felt that increasing the
    size of both the credit and exclusion and expanding the number of
    taxpayers who qualify for the tax benefit would encourage more
    adoptions and allow more families to afford adoption.  The legislation
    intended to make portions of the law permanent which were
    previously only temporary (those provisions will sunset after
    December 31, 2010).

    Changes made by the Job Creation and Worker Assistance Act of 2002
    (P.L. 107-147) were designed to clarify the provisions contained in the
    Economic Growth and Tax Relief Reconciliation Act of 2001.

    Assessment

    While federal tax assistance has been provided in the past for the
    placement of special needs children, both the current law tax credit and
    exclusion are more broadly based.  The provisions apply to the vast majority
    of adoptions (that are not by family members), and are not targeted only to the
    adoptions of special needs children.

    It appears that the credit and income tax exclusion are designed to provide
    tax relief to moderate income families for the costs associated with adoptions
    and to encourage families to seek adoptable children.  Taxpayers with
    adjusted gross incomes of less than $164,410 (in tax year 2006) can receive
    the full tax exclusion or tax credit as long as they owe sufficient before-credit
    taxes.  The phase-out applies only to those taxpayers whose adjusted gross
    incomes exceed $164,410 (in tax year 2006).  It would appear that the
    rationale for the cap is that taxpayers whose incomes exceed $164,410 (in tax
    year 2006) have the resources for adoption so that the federal government
    does not need to provide special tax benefits for adoption to be affordable.
    The phase-out also reduces the revenue loss associated with these provisions.

    The tax credit and income tax exclusion are in addition to a direct
    expenditure program which was first undertaken in 1986 to replace the tax
    deduction of that time.  However, especially with regard to the carryforward
    feature of the tax credit, the need for a direct federal assistance program for
    adopting children with special needs may warrant re-examination.  Under the
    tax provision's "double benefit" prohibition, the receipt of a grant will offset
    the tax credit or exclusion.  The offset applies in all cases-including those
    for special needs children.  Thus, it can be said that only in special needs
    adoption cases where a low or moderate income individual receives a grant
    greater than $5,000 could the benefit from receiving the grant exceed that of
    the tax credit for the same amount of out-of-pocket expenses.

    Some have assumed that tax credits and direct government grants are
    similar, since both may provide benefits at specific dollar levels.  However,
    some argue that tax credits are often preferable to direct government grants,
    because they provide greater freedom of choice to the taxpayer.  Such
    freedoms include, for example, the timing of expenditures or the amount to
    spend, while government programs typically have more definitive rules and
    regulations.  Additionally, in the case of grants, absent a specific tax
    exemption, a grant may result in taxable income to the recipient.

    Use of a tax mechanism does, however, add complexity to the tax system,
    since the availability of the credit and tax exclusion must be made known to
    all taxpayers, and space on the tax form must be provided (with
    accompanying instructions).  The enactment of these provisions added to the
    administrative burdens of the Internal Revenue Service.  A criticism of the tax
    deduction available under prior law was that the Internal Revenue Service had
    no expertise in adoptions and was therefore not the proper agency to
    administer a program of federal assistance for adoptions.

    	Selected Bibliography

    Brazelton, Julia K.  "Tax Implications of New Legislation Designed to
    Provide Adoption Incentives."  Taxes, v. 75 (August 1997), pp. 426-436.
    Cvach, Gary Q. and Martha Priddy Patterson.  "Adoption Credit and
    Assistance Exclusion," The Tax Adviser, v. 28 (June 1997), pp. 359-360.
    Foster, Sheila and Cynthia Bolt-Lee.  "Changes in Tax Law Benefit
    Adopting Parents," The CPA Journal, v. 67 (October 1997), pp. 52-54.
    Greenfield, Richard.  "Tax Credits that are Not Child's Play," The CPA
    Journal, v. 69 (September 1999), pp. 61-62.
    Henney, Susan M.  "Adoption From Foster Care in a Sociocultural
    Context: An Analysis of Adoption Policies, Programs, and Legislation,"
    Dissertation from The University of Texas at Austin, DAI, 62, no. 02A,
    (2000), 774 p.
    Hollingsworth, Leslie Doty.  "Adoption Policy in the United States: A
    Word of Caution," Social Work, v.45, no. 2 (Mar 2000), pp. 183-186.
    Manewitz, Marilyn.  "Employers Foster Assistance for Adoptive Parents,"
    HRMagazine, v. 42 (May 1997), pp. 96-99.
    Mickelson, Emily Maureen, and Christine Scott, Tax Benefits for Families:
    Adoption, Library of Congress, Congressional Research Service Report 95-
    928.  Washington, DC: August 31, 2006.
    O'Connor, M. "Federal Tax Benefits for Foster and Adoptive Parents and
    Kinship Caregivers: 2001 Tax Year," Seattle: Casey Family Programs, 2001,
    19 p.
    Smith, Sheldon R.  "Tax Benefits for Adoption," Tax Notes, v. 95 (May
    13, 2002), pp. 1065-1071.
    -, Adoption Tax Benefits: Policy Considerations," Tax Notes, v. 91 (May
    14, 2001), pp. 1159-1164.
    Smith, Sheldon R. and Glade K. Tew. "The Adoption Exclusion:
    Complications for Employees," Tax Notes, v. 90 (Jan. 29, 2001), pp. 659-
    664.

    U.S. Congress, House Committee on Ways and Means.  2004 Green Book;
    Background Material and Data on Programs Within the Jurisdiction of the
    Committee on Ways and Means,"  Committee Print, 108th Congress, 2d
    Session, March 2004, pp. 11-33 to 11-66.
    U.S. Congress, House Committee on Ways and Means.  Adoption
    Promotion and Stability Act of 1996.  House Report 104-542, Part 2, 104th
    Congress, 2d session.  Washington, DC:  U.S. Government Printing Office,
    May 3, 1996.
    U.S. General Accounting Office, Child and Family Services Reviews:
    Better Use of Data and Improved Guidance Could Enhance HHS's Oversight
    of State Performance, GAO Report GAO-04-333 (Washington: April 2004),
    pp. 1-55.
    - , Foster Care: States Focusing on Finding Permanent Homes for
    Children, but Long-Standing Barriers Remain, GAO Testimony GAO-03-
    626T (Washington: April 8, 2003), pp. 1-24.
    U.S. Treasury Department, Office of Tax Policy.  Report to The Congress
    on Tax Benefits for Adoption, October 2000,  pp. 1-69.

    Education, Training, Employment, and Social Services:
    Social Services

    DEDUCTION FOR CHARITABLE CONTRIBUTIONS,
    OTHER THAN FOR EDUCATION AND HEALTH

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    29.1

    1.7

    29.8

    2007

    31.9

    1.7

    32.6

    2008

    34.2

    1.7

    34.9

    2009

    36.8

    1.8

    38.6

    2010

    38.4

    1.8

    40.2

    	Authorization

    Section 170 and 642(c).

    	Description

    Subject to certain limitations, charitable contributions may be deducted by
    individuals, corporations, and estates and trusts.  The contributions must be
    made to specific types of organizations: charitable, religious, educational, and
    scientific organizations, non-profit hospitals, public charities, and federal,
    state, and local governments.

    Individuals who itemize may deduct qualified contributions of up to 50
    percent of their adjusted gross income (AGI) (30 percent for gifts of capital
    gain property).  For contributions to non-operating foundations and
    organizations, deductibility is limited to the lesser of 30 percent of the
    taxpayer's contribution base, or the excess of 50 percent of the contribution
    base for the tax year over the amount of contributions which qualified for the
    50 percent deduction ceiling (including carryovers from previous years).
    Gifts of capital gain property to these organizations are limited to 20 percent
    of AGI.

    If a contribution is made in the form of property, the deduction depends on
    the type of taxpayer (i.e., individual, corporate, etc.), recipient, and purpose.

    The maximum amount deductible by a corporation is 10 percent of its
    adjusted taxable income.  Adjusted taxable income is defined to mean taxable
    income with regard to the charitable contribution deduction, dividends-
    received deduction, any net operating loss carryback, and any capital loss
    carryback.  Excess contributions may be carried forward for five years.
    Amounts carried forward are used on a first-in, first-out basis after the
    deduction for the current year's charitable gifts have been taken.  Typically, a
    deduction is allowed only in the year in which the contribution occurs.
    However, an accrual-basis corporation is allowed to claim a deduction in the
    year preceding payment if its board of directors authorizes a charitable gift
    during the year and payment is scheduled by the 15th day of the third month of
    the next tax year.

    As a result of the enactment of the American Jobs Creation Act of 2004,
    P.L. 108-357, donors of noncash charitable contributions face increased
    reporting requirements.  For charitable donations of property valued at $5,000
    or more, donors must obtain a qualified appraisal of the donated property.
    For donated  property valued in excess of $500,000, the appraisal must be
    attached to the donor's tax return.  Deductions for donations of patents and
    other intellectual property are limited to the lesser of the taxpayer's basis in
    the donated property or the property's fair market value.  Taxpayers can claim
    additional deductions in years following the donation based on the income the
    donated property provides to the donee.  The 2004 act also mandates
    additional reporting requirements for charitable organizations receiving
    vehicle donations from individuals claiming a tax deduction for the
    contribution, if it is valued in excess of $500.

    Taxpayers are required to obtain written substantiation from a donee
    organization for contributions which exceed $250.  This substantiation must
    be received no later than the date the donor-taxpayer filed the required
    income tax return.  Donee organizations are obligated to furnish the written
    acknowledgment when requested with sufficient information to substantiate
    the taxpayer's deductible contribution.

    The Pension Protection Act of 2006 (P.L. 109-280) included several
    provisions that temporarily expand charitable giving incentives.  The
    provisions, effective after December 31, 2005 and before January 1, 2008,
    include enhancements to laws governing non-cash gifts and tax-free
    distributions from individual retirement  plans for charitable purposes.  The
    2006 law also tightened rules governing charitable giving in certain areas,
    including gifts of taxidermy, contributions of clothing and household items,
    contributions of fractional interests in tangible personal property, and record-
    keeping and substantiation requirements for certain charitable contributions.

    Impact

    The deduction for charitable contributions reduces the net cost of
    contributing.  In effect, the Federal Government provides the donor with a
    corresponding grant that increases in value with the donor's marginal tax
    bracket.  Those individuals who use the standard deduction or who pay no
    taxes receive no benefit from the provision.

    A limitation applies to the itemized deductions of high-income taxpayers.
    Under this provision, in 2006, otherwise allowable deductions are reduced by
    3 percent of the amount by which a taxpayer's adjusted gross income (AGI)
    exceeds $150,500 (adjusted for inflation in future years).  The table below
    provides the distribution of all charitable contributions.

    Distribution by Income Class of the Tax Expenditure
    for Charitable Contributions, 2005

    Income Class
    (in thousands of $)

    Percentage
    Distribution

    Below $10

    0.0

    $10 to $20

    0.1

    $20 to $30

    0.5

    $30 to $40

    1.1

    $40 to $50

    2.0

    $50 to $75

    8.3

    $75 to $100

     9.6

    $100 to $200

    28.7

    $200 and over

    49.7

    	Rationale

    This deduction was added by passage of the War Revenue Act of October
    3, 1917.  Senator Hollis, the sponsor, argued that high wartime tax rates
    would absorb the surplus funds of wealthy taxpayers, which were generally
    contributed to charitable organizations.

    The provisions enacted in 2004 resulted from Internal Revenue Service and
    congressional concerns that taxpayers were claiming inflated charitable
    deductions, causing the loss of federal revenue.  In the case of vehicle
    donations, concern was expressed about the inflation of deductions.  GAO
    reports published in 2003 indicated that the value of benefit to charitable
    organizations from donated vehicles was significantly less than the value
    claimed as deductions by taxpayers.  The 2006 enactments were, in part, a
    result of continued concerns from 2004.

    Assessment

    Supporters note that contributions finance socially desirable activities.
    Further, the federal government would be forced to step in to assume some
    activities currently provided by charitable, nonprofit organizations if the
    deduction were eliminated.  However, public spending might not be available
    to make up all of the difference.  In addition, many believe that the best
    method of allocating general welfare resources is through a dual system of
    private philanthropic giving and governmental allocation.

    Economists have generally held that the deductibility of charitable
    contributions provides an incentive effect which varies with the marginal tax
    rate of the giver.  There are a number of studies which find significant
    behavioral responses, although a study by Randolph suggests that such
    measured responses may largely reflect transitory timing effects.

    Types of contributions may vary substantially among income classes.
    Contributions to religious organizations are far more concentrated at the lower
    end of the income scale than contributions to hospitals, the arts, and
    educational institutions, with contributions to other types of organizations
    falling between these levels.  However, the volume of donations to religious
    organizations is greater than to all other organizations as a group.  For
    example, the American Association of Fund-Raising Counsel Trust for
    Philanthropy, Inc. estimated that giving to religious institutions amounted to
    45 percent of all contributions ($93.2 billion) in calendar year 2005.  This
    was in comparison to the next largest component of charitable giving
    recipients, educational institutions, at 14.8 percent ($38.56 billion).

    Those who support eliminating this deduction note that deductible
    contributions are made partly with dollars which are public funds.  They feel
    that helping out private charities may not be the optimal way to spend
    government money.

    Opponents further claim that the present system allows wealthy taxpayers
    to indulge special interests and hobbies.  To the extent that charitable giving
    is independent of tax considerations, federal revenues are lost without having
    provided any additional incentive for charitable gifts.  It is generally argued
    that the charitable contributions deduction is difficult to administer and adds
    complexity to the tax code.

    	Selected Bibliography

    Aprill, Ellen P.  "Churches, Politics, and the Charitable Contribution
    Deduction," Boston College Law Review, v. 42 (July 2001), pp. 843-873.
    Boatsman, James R. and Sanjay Gupta.  "Taxes and Corporate Charity:
    Empirical Evidence From Micro-Level Panel Data,"  National Tax Journal, v.
    49 (June 1996), pp. 193-213.
    Broman, Amy J.  "Statutory Tax Rate Reform and Charitable
    Contributions: Evidence from a Recent Period of Reform," Journal of the
    American Taxation Association.  Fall 1989, pp. 7-21.
    Brown, Melissa S., Managing Editor  Giving USA 2004, The Annual
    Report on Philanthropy for the Year 2003, American Association of Fund-
    Raising Counsel Trust for Philanthropy.  Indiana University-Purdue
    University Indianapolis:  2004.
    Buckles, Johnny Rex. "The Case for the Taxpaying Good Samaritan:
    Deducting Earmarked Transfers to Charity under Federal Income Tax Law,
    Theory and Policy," Fordham Law Review, v. 70 (March 2002), pp. 1243-
    1339.
    Cain, James E., and Sue A. Cain.  "An Economic Analysis of Accounting
    Decision Variables Used to Determine the Nature of Corporate Giving,"
    Quarterly Journal of Business and Economics, v. 24 (Autumn 1985), pp. 15-
    28.
    Clotfelter, Charles T.  "The Impact of Tax Reform on Charitable Giving:
    A 1989 Perspective."  In Do Taxes Matter?  The Impact of the Tax Reform
    Act of 1986, edited by Joel Slemrod, Cambridge, Mass.:  MIT Press, 1990.
    -."The Impact of Fundamental Tax Reform on Non Profit Organizations."
    In Economic Effects of Fundamental Tax Reform, Eds. Henry J. Aaron and
    William G. Gale.  Washington, DC:  Brookings Institution, 1996.
    Colombo, John D.  "The Marketing of Philanthropy and the Charitable
    Contributions Deduction:  Integrating Theories for the Deduction and Tax
    Exemption," Wake Forest Law Review, v. 36 (Fall 2001), pp. 657-703.
    Crimm, Nina J.  "An Explanation of the Federal Income Tax Exemption
    for Charitable Organizations: A Theory of Risk Compensation," Florida Law
    Review, v. 50 (July 1998),  pp. 419-462.
    Cromer, Mary Varson. "Don't Give Me That!: Tax Valuation of Gifts to
    Art Museums," Washington and Lee Law Review, v. 6,  Spring 2006, pp.
    777-809.
    Eason, Pat, Raymond Zimmermann, and Tim Krumwiede.  "A Changing
    Environment in the Substantiation and Valuation of Charitable
    Contributions," Taxes, v. 74 (April 1996), pp. 251-259.
    Feenberg, Daniel.  "Are Tax Price Models Really Identified: The Case of
    Charitable Giving," National Tax Journal, v. 40, (December 1987), pp. 629-
    633.
    Feldman, Naomi and James Hines, Jr. "Tax Credits and Charitable
    Contributions in Michigan," University of Michigan, Working Paper, October
    2003.

    Fisher, Linda A.  "Donor-Advised Funds: The Alternative to Private
    Foundations," Cleveland Bar Journal, v. 72 (July/August 2001), pp. 16-17.
    Fullerton, Don.  Tax Policy Toward Art Museums.  Cambridge, MA:
    National Bureau of Economic Research, 1990 (Working Paper no. 3379).
    Gergen, Mark P.  "The Case for a Charitable Contributions Deduction,"
    Virginia Law Review, v. 74 (November 1988), pp. 1393-1450.
    Gravelle, Jane. Economic Analysis of the Charitable Contribution
    Deduction for Nonitemizers, Library of Congress, Congressional Research
    Service Report RL31108, April 29, 2005.
    Green, Pamela and Robert McClelland. "Taxes and Charitable Giving,"
    National Tax Journal, v. 54 (Sept. 2001), pp. 433-450.
    Gruber, Jonathan.  "Pay or Pray? The Impact of Charitable Subsidies on
    Religious Attendance," National Bureau of Economic Research Working
    Paper, 10374, March, 2004, pp. 1-40.
    Izzo, Todd.  "A Full Spectrum of Light: Rethinking the Charitable
    Contribution Deduction," University of Pennsylvania Law Review, v. 141
    (June 1993), pp. 2371-2402.
    Jacobson, Rachel. "The Car Donation Program: Regulating Charities and
    For-Profits," The Exempt Organization Tax Review, v. 45, August 2004, pp.
    213-229.
    Jones, Darryll K.  "When Charity Aids Tax Shelters," Florida Tax Review,
    v. 4 (2001), pp. 770-830.
    Joulfaian, David and Mark Rider. "Errors-In-Variables and Estimated
    Income and Price Elasticities of Charitable Giving,"  National Tax Journal, v.
    57 (March 2004), pp. 25-43.
    Kahn, Jefferey H.  "Personal Deductions: A Tax "Ideal" or Just Another
    "Deal"?," Law Review of Michigan State University, v. 2002 (Spring 2002),
    pp. 1-55.
    Krumwiede, Tim, David Beausejour, and Raymond Zimmerman.
    "Reporting and Substantiation Requirements for Charitable Contributions,"
    Taxes, v. 72 (January 1994), pp. 14-18.
    Omer, Thomas C. "Near Zero Taxable Income Reporting by Nonprofit
    Organizations," Journal of American Taxation Association, v. 25, Fall 2003,
    pp. 19-34.
    O'Neil, Cherie J., Richard S. Steinberg, and G. Rodney Thompson.
    "Reassessing the Tax-Favored Status of the Charitable Deduction for Gifts of
    Appreciated Assets,"  National Tax Journal, v. 49 (June 1996), pp. 215-233.
    Randolph, William C.  "Charitable Deductions," in The Encyclopedia of
    Taxation and Tax Policy, eds. Joseph J. Cordes, Robert D. Ebel, and Jane G.
    Gravelle.  Washington, DC: Urban Institute Press, 2005.
    -.  "Dynamic Income, Progressive Taxes, and the Timing of Charitable
    Contributions,"  Journal of Political Economy, v. 103 (August 1995), pp.
    709-738.
    Robinson, John R.  "Estimates of the Price Elasticity of Charitable Giving:
    A Reappraisal Using 1985 Itemizer and Nonitemizer Charitable Deduction
    Data," Journal of the American Taxation Association.  Fall 1990, pp. 39-59.

    Smith, Bernard.  "Charitable Contributions: A Tax Primer," Cleveland Bar
    Journal, v. 72 (Nov. 2000), pp. 8-11.
    Stokeld, Fred, "ETI Repeal Bill Would Tighten Rules on Vehicle, Patent
    Donations," Tax Notes, October 18, 2004, pp. 293-294.
    Teitell, Conrad.  "Tax Primer on Charitable Giving," Trust & Estates, v.
    139, (June 2000), pp. 7-16.
    Tiehen, Laura. "Tax Policy and Charitable Contributions of Money,"
    National Tax Journal, v. 54 (Dec 2001), pp. 707-723.
    Tobin, Philip T.  "Donor Advised Funds: A Value-Added Tool for
    Financial Advisors," Journal of Practical Estate Planning, v. 3
    (October/November 2001), pp. 26-35, 52.
    U.S. Congress, Congressional Budget Office.  Budget Options.  See
    Rev-12, Limit Deductions for Charitable Giving to the Amount Exceeding 2
    Percent of Adjusted Gross Income.  Washington, DC:  Government Printing
    Office (February 2005), p 281.
    U.S. Congress, Government Accountability Office.  Vehicle Donations:
    Benefits to Charities and Donors, but Limited Program Oversight, GAO
    Report GAO-04-73, Washington, DC: U.S. Government Printing Office,
    November 2003, pp. 1-44.
    - . Vehicle Donations: Taxpayer Considerations When Donating Vehicles
    to Charities, GAO Report GAO-03-608T, Washington, DC: U.S.
    Government Printing Office, April 2003, pp. 1-15.
    U.S. Congress, Joint Committee on Taxation, Technical Explanation Of
    H.R. 4, The "Pension Protection Act Of 2006," as Passed by the House on
    July 28, 2006, and as Considered by the Senate on August 3, 2006,
    JCX-38-06, Washington, DC: U.S. Government Printing Office, August3,
    2006, pp. 1-386.
    - , Senate Committee on Finance.  Staff Discussion Draft: Proposals for
    Reforms and Best Practices in the Area of Tax-Exempt Organizations,
    Washington, DC: U.S. Government Printing Office, June 22, 2004, pp. 1-19.
    Wittenbach, James L. and Ken Milani.  "Charting the Interacting
    Provisions of the Charitable Contributions Deductions for Individuals,"
    Taxation of Exempts, v. 13 (July/August 2001), pp. 9-22.
    U.S. Department of Treasury.  "Charitable Giving Problems and Best
    Practices," testimony given by Mark Everson, Commissioner of Internal
    Revenue, Internal Revenue Service, IR-2004-81, Washington, DC: U.S.
    Government Printing Office, June 22, 2004, pp. 1-17.
    Yetman, Michelle H. and Robert J. Yetman. "The Effect of Nonprofits'
    Taxable Activities on the Supply of Private Donations," National Tax
    Journal, v. 56, March 2003, pp. 243-258.
    -.  "Dynamic Income, Progressive Taxes, and the Timing of Charitable
    Contributions,"  Journal of Political Economy, v. 103 (August 1995), pp.
    709-738.

    Education, Training, Employment, and Social Services:
    Social Services

    TAX CREDIT FOR DISABLED ACCESS EXPENDITURES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.1

    (1)

    0.1

    2007

    0.1

    (1)

    0.1

    2008

    0.1

    (1)

    0.1

    2009

    0.1

    (1)

    0.1

    2010

    0.1

    (1)

    0.1

    (1)Less than $50 million.

    	Authorization

    Section 44.

    	Description

    A nonrefundable tax credit equal to 50 percent of eligible access
    expenditures is provided to small businesses, defined as those with gross
    receipts of less than $1 million or those with no more than 30 full-time
    employees.  Eligible access expenditures must exceed $250 in costs to be
    eligible but expenditures which exceed $10,250 are not eligible for the credit.
     The expenditures must be incurred to make a business accessible to disabled
    individuals.

    The credit is included as a general business credit and subject to present
    law limits.  No further deduction or credit is permitted for amounts allowable
    as a disabled-access credit.  No increase in the property's adjusted basis is
    allowable to the extent of the credit.  The credit may not be carried back to tax
    years before the date of enactment.

    In 2002, the Internal Revenue Service (IRS) issued an alert (Internal
    Revenue News Release 2002-17) to taxpayers concerning a fraudulent
    disabled access credit scheme.  That scheme involves the sale of coin-
    operated pay telephones to individual investors.  Investors were advised
    incorrectly that they were entitled to claim the disabled access credit of up to
    $5,000 on their individual income tax returns because the telephone is
    equipped with a volume control.  The IRS disallows this credit if claimed by a
    taxpayer who is not operating as a business or who does not qualify as an
    eligible small business and if the purchase does not make a business
    accessible to disabled individuals.  The IRS has continued to issue the alert,
    including a notice in March 2006 (Internal Revenue News Release
    IR-2006-45).

    Impact

    The provision lessens the after-tax cost to small businesses for
    expenditures to remove architectural, communication, physical, or
    transportation access barriers for persons with disabilities by providing a tax
    credit for expenditures (which exceed $250 but are less than $10,250).  The
    tax credit allows taxpayers to  reduce tax liability by the cost of qualified
    expenditures.

    The value of this tax treatment is twofold.  First, a 50-percent credit is
    greater than the tax rate of small businesses.  Thus, a greater reduction in
    taxes is provided by the credit than through immediate expensing of access
    expenditures.  Second, the value to small businesses is increased by the
    amount to which the present value of the tax credit exceeds the present value
    of periodic deductions which typically could be taken over the useful life of
    the capital expenditure.  The direct beneficiaries of this provision are small
    businesses that make access expenditures.

    	Rationale

    This tax credit was added to the Code with the passage of the Revenue
    Reconciliation Act of 1990 (P.L. 101-508).  The purpose was to provide
    financial assistance to small businesses for compliance with the Americans
    With Disabilities Act of 1990 (ADA; P.L. 101-336).  For example, that act
    requires restaurants, hotels, and department stores that are either newly
    constructed or renovated to provide facilities that are accessible to persons
    with disabilities, and calls for removal of existing barriers when readily
    achievable in facilities previously built.

    While the provision encourages compliance with ADA, subsequent access
    improvements are not covered by the provision.  A 2004 IRS ruling (Internal
    Revenue Service Memorandum 200411042) clarified that eligible small
    businesses already in compliance with the ADA may not claim the disabled
    access credit for expenditures paid or incurred for the purpose of upgrading or
    improving disabled access.

    Assessment

    A firm's ability to benefit from the credit is dependent on its income tax
    liability.  Some firms may not have sufficient tax liability to be able to take
    advantage of the credit, and for those firms that are able to claim the credit,
    some may not be able to claim the full amount.

    The tax credit may not be the most efficient method for accomplishing the
    objective because some of the tax benefit will go for expenditures the small
    business would have made absent the tax benefit and because there is
    arguably no general economic justification for special treatment of small
    businesses over large businesses.

    Alternatively, the requirements of the Americans with Disabilities Act
    placed capital expenditure burdens that may be a hardship to small
    businesses.  These rules are designed primarily for social objectives, i.e. to
    accommodate persons with disabilities; thus proponents assert that the
    subsidy is justified in this instance.

    	Selected Bibliography

    Bullock, Reginald Jr.  "Tax Provisions of the Americans with Disabilities
    Act," The CPA Journal, v. 63, no. 2, (February 1993), pp. 58-59.
    Cook, Ellen D., Anne K. Judice, and J. David Lofton.  "Tax Aspects of
    Complying with the Americans with Disabilities Act," The CPA Journal, v.
    66 (May 1996), pp. 38-42.
    Cook, Ellen D. and Anita C. Hazelwood.  "Tax Breaks Cut the Cost of
    Americans With Disabilities Act Compliance," Practical Tax Strategies, v.
    69 (Sept 2002), pp. 145-155.
    Eisenstadt, Deborah E.  "Current Tax Planning for Rehabilitation
    Expenses, Low-Income Housing, and Barrier Removal Costs," Taxation for
    Accountants, v. 34 (April 1985), pp. 234-238.
    Ellentuck, Albert B.  "Credit for Compliance," Nation's Business, v. 79,
    (April 1991), p. 60.
    Jackson, Pamela J.  Business Tax Provisions that Benefit Persons with
    Disabilities, Library of Congress, Congressional Research Service Report
    RS21006,  Washington, DC: June 28, 2005.
    Lebow, Marc I., Wayne M. Schell, and P. Michael McLain.  "Not All
    Expenditures to Aid the Disabled Qualify for Credit," The Tax Adviser, v. 32,
    (December 2001), pp. 810-811.

    Health

    EXCLUSION OF EMPLOYER CONTRIBUTIONS
    FOR HEALTH CARE, HEALTH INSURANCE PREMIUMS, AND
    LONG-TERM CARE INSURANCE PREMIUMS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    90.6

    -

    90.6

    2007

    99.7

    -

    99.7

    2008

    107.0

    -

    107.0

    2009

    114.5

    -

    114.5

    2010

    122.2

    -

    122.2

    Authorization

    Sections 105, 106, and 125.

    Description

    Employees pay no income or payroll taxes on employer contributions for
    coverage under accident or health plans.  This exclusion also applies to
    certain health benefits received by employees who participate in so-called
    cafeteria plans established by their employers.  In general, employees covered
    by these plans may exclude from taxable income their payments for employer-
    provided health insurance.  In addition, many employers offer health benefits
    to employees through flexible spending accounts (FSAs).  Under such an
    account, an employee chooses a benefit amount at the start of a calendar year
    and draws on the account to pay for medical expenses not covered by an
    employer's health plans.  FSAs are funded either through wage and salary
    reductions or employer contributions, both of which are exempt from income
    and payroll taxes.

    The exclusion for employer contributions to health and accident plans is
    available regardless of whether an employer self-insures or enters into
    contracts with third-party insurers to provide group and individual health
    plans.  Unlike some fringe benefits, there are no limits on the amount of
    employer contributions that may be excluded, with one notable exception.
    The exception is so-called "excess reimbursements" paid to highly
    compensated employees under self-insured medical plans that fail to satisfy
    specified non-discrimination requirements; these reimbursements must be
    included in an affected employee's taxable income.

    Impact

    The tax exclusion for employer contributions to employee health plans
    benefits only those taxpayers who participate in employer-subsidized plans.
    Beneficiaries consist of present employees and their spouses and dependents,
    as well as retirees.  In 2005, about 64 percent of the U.S. population received
    health insurance coverage through employers, according to figures published
    by the U.S. Census Bureau.

    Although the tax exclusion benefits a majority of working Americans, it
    provides greater benefits to higher-income taxpayers than to lower-income
    ones.  Such an outcome is to be expected for two reasons.  First, highly paid
    employees typically receive larger amounts of employer-paid health
    insurance.  Second, they naturally end up in higher tax brackets.  The value of
    an exclusion depends in part on a taxpayer's marginal tax rate.

    As noted earlier, non-discrimination rules apply to health and accident
    plans offered by self-insured employers. Under these rules, benefits paid to
    highly compensated employees must be included in their taxable incomes if a
    self-insured medical reimbursement plan discriminates in favor of these
    employees.  However, the same rules do not apply to plans purchased from
    third-party insurers that offer more generous benefits to highly compensated
    employees.  In this case, these employees may exclude the benefits from
    taxable income.

    While the tax code encourages the provision of health insurance through
    the workplace, not all workers receive health insurance coverage from their
    employers.  Those at greatest risk of being uninsured include workers under
    age 25, workers in firms with fewer than 25 employees, part-time workers,
    workers earning relatively low wages, and workers in the construction,
    business and personal service, entertainment, and wholesale and retail trade
    industries.

    The following table presents data for 2005 on health insurance coverage by
    income group for the entire non-institutionalized, non-elderly population of
    the United States.  Income is expressed as a percentage of the Federal poverty
    income level for that year.

    Health Insurance Coverage From Specified Sources, by Family Income Relative to the Federal
    Poverty Level, 2005
    (Percent of U.S. Civilian, Non-institutionalized Population
    Under Age 65)

    Type of Insurance

    Income Relative to
    the Poverty Levela

    Population (in
    millions)

    Employment-basedb

    Publicc

    Otherd

    Uninsured

    Less than 100%

    	 33.3

    	18.6

    46.6

    673

    34.0

    100% to 149%

    	 21.3

    34.0

    33.0

    	8.0

    31.9

    150% to 199%

     23.1

    48.3

    21.4

    	9.6

    28.3

    200% and above

    179.8

    78.6

    	 6.0

    10.6

    11.8

    Total

    258.3

    64.3%

    	15.0%

    	9.8%

    17.9.%

    People may have more than one source of health insurance; thus row percentages may total to more
    than 100.
    a The weighted average poverty threshold for a family with two adults and two children in 2005
    was $19,806.  Excluded from the poverty analysis of the data on health insurance coverage were
    roughly 700,000 children who lived with families to which they were unrelated.  Most of them were
    foster children.  As a result, the total size of the under-65 population is 0.6 million larger than the size
    of the total population covered by the poverty analysis.
    b Group health insurance through employer or union.
    C Medicare, Medicaid, the State Children's Health Insurance Program, or other state programs
    for low-income individuals.
     	d Private nongroup health insurance, veterans coverage, or military health care.

    Note: Based on Congressional Research Service analysis of data from the March 2006 Current
    Population Survey (CPS).  Source:  Peterson, Chris L.  Health Insurance Coverage: Characteristics
    of the Insured and Uninsured Populations in 2005.  Library of Congress, Congressional Research
    Service Report No. 96-891 EPW.  Washington, DC:  updated August 30, 2006.  Table 2, p. 3.

    It is clear from the data that the likelihood of being insured through an
    employer increased substantially with household income.  The percentage of
    those covered by employment-based health insurance (column 3) in 2005
    climbed from 18.8 percent for people whose income is less than the poverty-
    income level to 78.6 percent for people whose family income is two or more
    times that level.

    At the same time, the likelihood of receiving public health insurance rose
    as household income dropped.  The percentage of those covered by public
    insurance (column 4) declined in 2005 from 46.6 percent in the lowest
    income group to 6.0 percent in the highest income group.  A similar pattern
    prevailed among the uninsured:  the percentage of uninsured declined from
    34.0 percent for those whose income was below the poverty level to 11.8
    percent for those whose income was two or more times above the poverty
    level.

    	Rationale

    The exclusion of compensation received by individuals in the form of
    employer-provided accident or health plans originated with the Revenue Act
    of 1918.  But it was not until 1943 that the Internal Revenue Service (IRS)
    ruled that employer contributions to group health insurance policies were not
    considered part of taxable income.  But this ruling did not address all
    outstanding concerns about the tax treatment of employer-provided health
    benefits.  For instance, it did not apply to employer contributions to individual
    health insurance policies.  The tax status of those contributions remained
    unclear until the IRS ruled in 1953 that they were subject to taxation.  This
    ruling had but a brief existence, as the enactment of IRC section 106 in 1954
    reversed it.  Henceforth, employer contributions to all accident and health
    plans were considered deductible expenses for employers and non-taxable
    compensation for employees.  The legislative history of section 106 indicates
    that its principal purpose was to eliminate differences in the tax treatment of
    employer contributions to group and individual health insurance plans.

    The Revenue Act of 1978 added the non-discrimination provisions of
    section 105(h).  These provisions specified that the benefits paid to highly
    compensated employees under self-insured medical reimbursement plans
    were taxable if the plan discriminated in favor of these employees.  The Tax
    Reform Act of 1986 repealed section 105(h) and replaced it with a new
    section 89 of the Internal Revenue Code, which extended non-discrimination
    rules to group health insurance plans.  In 1989, P.L. 101-140 repealed section
    89 and reinstated the pre-1986 Act rules under section 105(h).

    Under the Health Insurance Portability and Accountability Act of 1996
    (P.L. 104-191), employer contributions to the cost of qualified long-term care
    insurance may be excluded from employees' taxable income.  But this
    exclusion does not apply to long-term care benefits received under a cafeteria
    plan or flexible spending account (FSA).

    Assessment

    The exclusion for employer-provided health insurance is thought to exert a
    strong influence on health insurance coverage for a large share of the non-
    elderly working population.  Because of the subsidy, employees have a robust
    incentive to prefer compensation in the form of health benefits rather than
    taxable wages.  On average, $1 in added health benefits is worth only $0.70
    in added wages.

    Such a preference,  however, has a notable drawback:  it may lead
    employees to purchase more health insurance coverage then they need.  Most
    health economists think the unlimited exclusion for employer-provided health
    benefits has led to excessive use of health care services, which in turn has put
    upward pressure on health care costs.

    This is not to suggest there are no social benefits from the exclusion.
    Owing to the risk pooling that occurs in employment-based group health
    insurance, it can be argued that the exclusion enables many employees to
    purchase health insurance plans with few or no coverage exclusions at a lower
    cost than they would be able to in the individual market.

    Measured as a percentage of total wages and salaries, employer
    contributions for group health insurance rose from 0.8 percent in 1955, to 1.6
    percent in 1965, 3.1 percent in 1975, 5.4 percent in 1985, and 8.1 percent in
    1993.  The percentage dropped to 7.5 percent in 1995, to 7.3 percent in 1996,
    and to 7.0 percent in 1997, where it remained in 1998 and 1999.  In 2001, the
    percentage stood at 6.6 percent.

    Workers and their dependents who are covered by employer-provided
    health insurance receive a much more generous tax subsidy than individuals
    who purchase health insurance in the individual market or who have no health
    insurance, pay out of pocket for their medical expenses, and claim the
    medical-expense itemized income tax deduction.  The cost of employer-paid
    health care is completely excluded from the taxable income of those who
    receive such care.  By contrast, relatively few taxpayers can take advantage of
    the medical expense deduction.  To do so, they must itemize on their tax
    returns, and their out-of-pocket spending on medical care (including health
    insurance premiums) must exceed 7.5 percent of their adjusted gross income.
     In addition to the tax exclusion, employer-paid health insurance is exempt
    from payroll taxation.

    Proposals to limit the tax exclusion for employer-provided health benefits
    periodically attract serious consideration.  Generally, their principal aim is to
    retain the main social benefit of the exclusion - expanded access to health
    insurance - while curbing its main social cost - an incentive to purchase
    excessive insurance coverage.  One way to achieve this goal would be to cap
    the exclusion at or somewhat below the average cost of group health
    insurance in major regions.  A case in point is a proposal by the tax reform
    panel created by President George W. Bush in January 2005.  In its final
    report issued in November 2005, the panel recommended capping the
    exclusion at the average U.S. premiums for individual and family health
    insurance coverage.  But not all analysts favor such an approach. Critics of
    limiting the exclusion say that it would be difficult to determine in an
    equitable manner where to draw the line between reasonable and excessive
    health insurance coverage.  They also note that any limit on the exclusion
    would have to reflect the key factors determining health insurance premiums,
    including a firm's geographic location, size of its risk pool, and the risk
    profile of its employees.

    	Selected Bibliography

    Arnet, Grace-Marie, ed.  Empowering Health Care Consumers Through
    Tax Reform.  Ann Arbor, MI, University of Michigan Press, 1999.
    Burman, Leonard E., and Jack Rodgers.  "Tax Preferences and
    Employment-Based Health Insurance," National Tax Journal, v. 45, no. 3.
    September 1992, pp. 331-46.
    Burman, Leonard E., and Roberton Williams.  Tax Caps on Employment-
    Based Health Insurance.  National Tax Journal, v. 47, no. 3.  September
    1994, pp. 529-45.
    Carasso, Adam.  "Growth in the Exclusion of Employer Health
    Premiums."  Tax Notes.  June 27, 2005, p. 1697.
    Feldstein, Martin, and Bernard Friedman.  "Tax Subsidies, the Rational
    Demand for Insurance and the Health Care Crisis," Journal of Public
    Economics, v. 7.  April 1977, pp. 155-78.
    Fronstin, Paul.  "Employment-Based Health Benefits: Trends in Access
    and Coverage."  Issue Brief.  no. 284.  Employee Benefit Research Institute.
    Washington, DC: August 2005.
    Gruber, Jonathan.  Taxes and Health Insurance, Working Paper 8657.
    Cambridge, MA:  National Bureau of Economic Research, December 2001.
    Gruber, Jonathan, and James M. Poterba.  "Tax Subsidies to Employer-
    Provided Health Insurance," in Martin Feldstein and James Poterba, eds.,
    Empirical Foundations of Household Taxation.  National Bureau of
    Economic Research.  Chicago and London: Univ. of Chicago Press, 1996.
    -. "Fundamental Tax Reform and Employer-Provided Health Insurance,"
    in Economic Effects of Fundamental Tax Reform, eds. Henry H. Aaron and
    William G. Gale.  Washington, DC: Brookings Institution Press, 1996, pp.
    125-170.
    Lyke, Bob.  Tax Benefits for Health Insurance: Current Legislation.
    Library of Congress Congressional Research Service Issue Brief IB 98037.
    Washington, DC: updated regularly.
    Marquis, Susan, and Joan Buchanan.  "How Will Changes in Health
    Insurance Tax Policy and Employer Health Plan Contributions Affect Access
    to Health Care and Health Care Costs?"  Journal of the American Medical
    Association, v. 271, no. 12.  March 23/30, 1994, pp. 939-44.
    Pauly, Mark V.  "Taxation, Health Insurance, and Market Failure in the
    Medical Economy," Journal of Economic Literature, v. 24, no. 2. June 1986,
    pp. 629-75.
    Pauly, Mark V., and John C. Goodman.  "Using Tax Credits for Health
    Insurance and Medical Savings Accounts," in Henry J. Aaron, The Problem
    That Won't Go Away.  Washington, DC: Brookings Institution, 1996.
    President's Advisory Panel on Federal Tax Reform.  Simple, Fair, and
    Pro-Growth: Proposals to Fix America's Tax System.  Washington, DC:
    November 2005.

    Smart, Michael and Mark Stabile.  Tax Credits and the Use of Medical
    Care, Working Paper 9855.  Cambridge, MA:  National Bureau of Economic
    Research, July 2003.
    U.S. Congress, Congressional Budget Office.  Tax Subsidies for Medical
    Care: Current Policies and Possible Alternatives.  Washington, DC: 1980.
    -.  The Tax Treatment of Employment-Based Health Insurance.
    Washington, DC: March 1994.
    -, House Committee on the Budget, Subcommittee on Oversight, Task
    Force on Tax Expenditures and Tax Policy.  Tax Expenditures for Health
    Care, Hearings, 96th Congress, 1st session.  July 9-10, 1979.
    -, House Committee on Ways and Means.  1994 Green Book. Background
    Material and Data on Programs within the Jurisdiction of the Committee on
    Ways and Means.  Overview of Entitlement Programs, Committee Print
    WMCP 103-27, 103rd Congress, 2nd session.  Washington, DC: U.S.
    Government Printing Office, July 15, 1994, pp. 689-92, 943-50.
    -, Joint Committee on Taxation.  Overview of Administration Proposal to
    Cap Exclusion for Employer Provided Medical Care and Tax Treatment of
    Other Fringe Benefits.  Committee Print, 98th Congress, 1st session.  June
    21, 1983.
    Wilensky, Gail R.  "Government and the Financing of Health Care,"
    American Economic Review, v. 72, no. 2.  May 1982, pp. 202-07.
    -, and Amy K. Taylor.  "Tax Expenditures and Health Insurance: Limiting
    Employer-Paid Premiums," Public Health Reports, v. 97. September-October
    1982, pp. 438-44.

    Health

    EXCLUSION OF MEDICAL CARE AND CHAMPUS/TRICARE
    MEDICAL INSURANCE FOR MILITARY DEPENDENTS,
    RETIREES, AND RETIREE DEPENDENTS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    1.9

    -

    1.9

    2007

    2.0

    -

    2.0

    2008

    2.1

    -

    2.1

    2009

    2.3

    -

    2.3

    2010

    2.5

    -

    2.5

    	Authorization

    Sections 112 and 134 and certain court decisions [see specifically Jones v.
    United States, 60 Ct. Cl. 552 (1925)].

    	Description

    Active-duty military personnel are provided with a variety of benefits (or
    cash payments in lieu of such benefits) that are not subject to taxation.
    Among such benefits are medical and dental care.  Dependents of active-duty
    personnel, retired military personnel and their dependents, survivors of
    deceased members, and reservists who have served on active duty since
    September 11, 2001 and join in the Selected Reserve are also eligible for
    these benefits.

    Military dependents and retirees are permitted to receive some of their
    medical care in military facilities and from military doctors, provided there is
    adequate capacity.  These individuals also have the option of being treated by
    civilian health-care providers working under contract with the Department of
    Defense (DOD).  DOD currently relies on a program known as TriCare to
    coordinate the medical care provided by military and civilian providers.
    TriCare gives most beneficiaries three choices for receiving medical care:
    TriCare Prime, a DOD-managed health maintenance organization (HMO);
    TriCare Extra, a preferred-provider organization (PPO); or TriCare Standard
    (formerly known as CHAMPUS), a fee-for-service option.  In addition,
    TriCare For Life is available for beneficiaries who are age 65 or over and thus
    are eligible for Medicare. TriCare Extra and TriCare Standard reimburse
    beneficiaries for a portion of their spending on civilian health care.

    The FY2001 Defense Authorization Act included a provision allowing
    military retirees and their dependents who are eligible for Medicare A and
    participate in Medicare Part B to retain their TriCare coverage as a secondary
    payer to Medicare.  To be eligible, an individual must have served at least 20
    years in the military.  Under the plan, TriCare pays most of the cost of
    treatments not covered by Medicare.

    Impact

    As with the exclusion for employer-provided health insurance, the benefits
    from the tax exclusion for health care received by military personnel
    dependents, retirees, and other eligible individuals depend on a recipient's tax
    bracket.  The higher the tax bracket, the greater the tax savings.  For example,
    an individual in the 10-percent tax bracket (the lowest Federal income tax
    bracket) avoids $10 in tax liability for every $100 of health benefits he or she
    may exclude; the tax savings rises to $35 for someone in the 35-percent tax
    bracket.

    The larger tax saving for higher-income military personnel may be partly
    offset by higher deductibles under the TriCare Extra plan and higher co-
    payments for outpatient visits under the TriCare Prime plan required of
    dependents of higher-ranked personnel (E-5 and above).  Retirees under age
    65 and their dependents pay an enrollment fee for TriCare Prime and tend to
    pay higher deductibles and co-payments than the dependents of active-duty
    personnel.  The FY2001 Defense Authorization Act eliminated these co-
    payments and deductibles for retirees and their dependents over age 64 who
    pay the Medicare Part B monthly premium.

    	Rationale

    The tax exclusion for health care received by the dependents of active-duty
    military personnel, retirees and their dependents, and other eligible
    individuals has evolved over time.  The main forces driving this evolution
    have been  legal precedent, legislative action by Congress, a series of
    regulatory rulings by the Treasury Department, and long-standing
    administrative practices.

    In 1925, the United States Court of Claims, in its ruling in Jones v. United
    States, 60 Ct. Cl. 552 (1925), drew a sharp distinction between the pay and
    the allowances received by military personnel.  The court ruled that housing
    and housing allowances for these individuals were reimbursements similar to
    other tax-exempt benefits received by employees in the executive and
    legislative branches.

    Before this decision, the Treasury Department maintained that the rental
    value of living quarters, the value of subsistence allowances, and
    reimbursements should be included in the taxable income of military
    personnel.  This view rested on an earlier federal statute, the Act of August
    27, 1894 (which was found to unconstitutional by the courts), which imposed
    a two-percent tax "on all salaries of officers, or payments to persons in the
    civil, military, naval, or other employment of the United States."

    Under the Dependent Medical Care Act of 1956, the dependents of active-
    duty military personnel and retired military personnel and their dependents
    were allowed to receive medical care at military medical facilities on a
    "space-available" basis.  Military personnel and their dependents gained
    access to civilian health care providers through the Military Medical Benefits
    Amendments Act of 1966, which created the Civilian Health and Medical
    Program of the Uniformed Services (CHAMPUS), the precursor of the
    Tricare system.

    The Tax Reform Act of 1986 consolidated these rules into a new section
    134 of the Internal Revenue Code.  A principal aim of Congress in taking this
    step was to make the tax treatment of military fringe benefits more transparent
    and consistent with the tax treatment of fringe benefits under the Deficit
    Reduction Act of 1984.

    Even if there was no specific statutory exclusion for the health benefits
    received by military personnel and their dependents, a case for excluding
    them from taxation could be made on the basis of sections 105 and 106 of the
    Internal Revenue Code.  These sections make it possible to exclude from the
    taxable income of employees any employer-provided health benefits they
    receive.

    Assessment

    Some military fringe benefits mirror those offered by private employers,
    such as allowances for housing, subsistence, moving and storage expenses,
    higher living costs abroad, and uniforms.  Others are similar to employer-
    provided medical and dental benefits, education assistance, group term life
    insurance, and disability and retirement benefits.  While it can be argued that
    health benefits for active-duty personnel are critical to the military's mission
    and thus should not be taxed, health care for dependents of active-duty
    personnel and retirees and their dependents has more in common with an
    employer-provided fringe benefit.

    Most of the economic issues raised by the tax treatment of military health
    benefits are similar to those associated with the tax treatment of civilian and
    employer-provided health benefits.  A central issue is that a tax exclusion for
    health benefits encourages individuals to purchase excessive health insurance
    coverage.  Another issue is that such coverage may lead covered individuals
    to consume inefficient amounts of health care.  For health economists, health
    care is inefficient when its marginal cost exceeds its marginal benefit.

    Nonetheless, some of the issues raised by military health benefits have no
    counterpart in the civilian sector.  Direct care provided in military facilities
    may at times be difficult to value for tax purposes.  At the same time, such
    care may be the only feasible option for dependents living with service
    members who have been assigned to geographic areas where adequate civilian
    medical facilities are lacking.

    Proposals to make the tax treatment of health care received by dependents
    of active-duty personnel less generous may have important implications for
    rates of enlistment in the military.  It is conceivable that a reduction in the tax
    exclusion for health care received by these dependents would need to be
    coupled with an increase in military pay so that remaining in the military
    would continue to be an appealing career choice for military personnel with
    dependents and incomes high enough to incur tax liabilities.

    	Selected Bibliography

    Best, Richard.  Military Medical Care Services: Questions and Answers.
    Library of Congress, Congressional Research Service Issue Brief IB93103,
    updated periodically.
    Binkin, Martin.  The Military Pay Muddle.  Washington, DC: The
    Brookings Institution, April 1975.
    Hanson, Marshall.  "Is TRICARE Standard or TRICARE Extra the Right
    Option?"  The Officer, April 2004, p. 39.
    Owens, William L.  "Exclusions From, and Adjustments to, Gross
    Income,"  Air Force Law Review, v. 19 (Spring 1977), pp. 90-99.
    U.S. Congress, Congressional Budget Office.  The Tax Treatment of
    Employment Based Health Insurance.  Washington, DC: March 1994.
    -, House.  Joint Committee on Taxation.  General Explanation of the Tax
    Reform Act of 1986, H.R. 3838, 99th Congress, Public Law 99-514.
    Washington, DC: U.S. Government Printing Office, 1987, pp. 828-830.
    Winkenwerder, William Jr.  "Tricare: Your Military Health Plan," Soldiers
    Magazine, February 1, 2004, p. S1.

    	Health

    DEDUCTION FOR HEALTH INSURANCE PREMIUMS
    AND LONG-TERM CARE INSURANCE PREMIUMS
    PAID BY THE SELF-EMPLOYED

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    3.8

    -

    3.8

    2007

    4.2

    -

    4.2

    2008

    4.5

    -

    4.5

    2009

    4.9

    -

    4.9

    2010

    5.2

    -

    5.2

    Authorization

    Section 162(l).

    	Description

    Generally, a self-employed individual may deduct the entire amount he or
    she pays for health insurance (with some restrictions, which are discussed
    below) or long-term care insurance for himself or herself and his or her
    immediate family.  The deductible share of eligible insurance expenses rose
    from 25 percent in 1987 to 100 percent in 2003 and thereafter.  For the
    purpose of this deduction only, self-employed individuals are defined as sole
    proprietors, working partners in a partnership, and employees of an S
    corporation who own more than 2 percent of the corporation's stock.  The
    deduction is taken above-the-line, which is to say that it may be claimed
    regardless of whether or not a self-employed individual itemizes on his or her
    tax return.

    Use of the deduction for health insurance expenditures by the self-
    employed is subject to several limitations.  First, the deduction cannot exceed
    a taxpayer's net earned income from the trade or business in which the health
    insurance plan was established, minus the deductions for 50 percent of the
    self-employment tax and any contributions to qualified pension plans.
    Second, the deduction is not available for any month when a self-employed
    individual is eligible to participate in a health plan maintained by his or her
    employer or his or by her spouse's employer.  Third, if a self-employed
    individual claims an itemized deduction for medical expenses under IRC
    section 213, any deduction for health insurance premiums claimed under
    section 162 must be subtracted from the medical expenses eligible for the
    itemized deduction.  Whatever health insurance premiums cannot be deducted
    under section 162(1) may be included with these medical expenses, subject to
    the statutory threshold of 7.5 percent of adjusted gross income (AGI).  And
    fourth, the self-employed must include their deductible health insurance
    expenditures in computing their self-employment taxes.

    	Impact

    In 2004, the most recent year for which data are available, claims for the
    health insurance deduction for the self-employed totaled nearly 3.7 million,
    (down from 3.8 million in 2003), and the total amount claimed came to $17.3
    billion (up from $16.4 billion in 2003).  It is not clear from available data how
    many self-employed claimed the deduction for long-term care insurance
    spending or what the total value of those claims came to.

    The deduction under section 162(l) reduces the out-of-pocket cost of health
    insurance or long-term care insurance for self-employed individuals and their
    immediate families by an amount that hinges on marginal tax rates.  As a
    result, higher-income individuals benefit more from the deduction than do
    lower-income individuals.  Moreover, given that there is no statutory limit on
    the amount of eligible health or long-term care insurance expenditures that
    can be deducted, the deduction has the potential to encourage self-employed
    individuals in higher tax brackets to purchase overly generous health
    insurance coverage.

    The bond between the size of the subsidy and income is illustrated in the
    following table.  It shows the percentage distribution by AGI of the total
    deduction for health insurance expenditures by the self-employed claimed for
    2004, and the average amount claimed per tax return for each income class.
    On the whole, individuals with AGIs of less than $50,000 accounted for 38
    percent of the total amount claimed.  More telling was the distribution of the
    average amount claimed per tax return for each AGI class.  Not surprisingly,
    the average claim increased with income to the extent that for individuals
    with an AGI of $200,000 and above, it was more than double the average
    claim for individuals with an AGI below $30,000.  If the deductions were
    translated by the application of weighted marginal tax rates into tax savings
    by income class, the resulting tax expenditure values would be even more
    heavily distributed among the higher-income groups.

    Distribution of the Deduction for Medical Insurance
    Premiums by the Self-employed by Adjusted Gross
    Income Class in 2004

    Adjusted Gross
    Income Class
    (in thousands of $)

    Percentage
    Distribution
    of
    Deductions
    (%)

    Average
    Amount of
    the
    Deduction
    Claimed per
    Tax Return
    ($)

    Below $15

    11

     3,224

    $15 to under $30

    13

    3,646

    $30 to under $50

    14

    4,005

    $50 to under $100

    23

    4,495

    $100 to under $200

     18

    5,757

    $200 and over

    21

    7,822

    Total

    100

    4,669

    Note: This is not a distribution of tax expenditure values.  Derived from
    data taken from the following publication:  Internal Revenue Service.
    SOI Bulletin, Winter 2005-2006, table 1, p.15.  Covers taxable and non-
    taxable returns.

    	Rationale

    The health insurance deduction for the self-employed first entered the tax
    code as a temporary provision of the Tax Reform Act of 1986.  Under the act,
    the deduction was equal to 25 percent of qualified health insurance
    expenditures and was set to expire on December 31, 1989.  The Technical
    and Miscellaneous Revenue Act of 19.8 made a few technical corrections to
    the provision.

    A series of laws extended the deduction for brief periods during the early
    1990s:  the Omnibus Budget Reconciliation Act of 1989 extended the
    deduction for 9 months (through September 30, 1990) and made it available
    to subchapter S corporation shareholders; the Omnibus Budget Reconciliation
    Act of 1990 extended the deduction through December 31, 1991; the Tax
    Extension Act of 1991 extended the deduction through June 30, 1992; and
    the Omnibus Budget Reconciliation Act of 1993 extended it through
    December 31, 1993.  Throughout this period, the deductible share of eligible
    health insurance expenditures remained at 25 percent.

    Congress allowed the deduction to expire at the end of 1993, and it took no
    action to extend it during 1994.  A law enacted in April 1995, P.L. 104-7,
    reinstated the deduction, retroactive to January 1, 1994, and made it a
    permanent provision of the Internal Revenue Code.  Under the act, the
    deductible share of eligible health insurance expenditures was to remain at 25
    percent for 1994 and then rise to 30 percent in 1995 and beyond.

    The Health Insurance Portability and Accountability Act of 1996 (HIPAA,
    P.L. 104-191) increased the deductible share of health insurance expenditures
    by the self-employed from to 30 percent in 1995 and 1996 to 40 percent in
    1997 and gradually to 80 percent by 2006 and thereafter.  HIPAA also
    allowed self-employed persons to include in the expenditures eligible for the
    deduction their payments for qualified long-term care insurance, beginning
    January 1, 1997.  The act imposed dollar limits on the amount of long-term
    care premiums that could be deducted in a single tax year and indexed these
    limits for inflation.  In 2006, these limits range from $280 for individuals age
    40 and under to $3,530 for individuals over age 70.

    The Omnibus Consolidated and Emergency Supplemental Appropriations
    Act for FY1999 (P.L. 105-277) increased the deduction to its present level: it
    rose to 70 percent of eligible expenditures in 2002, and to 100 percent in
    2003 and thereafter.

    Assessment

    In enacting the deduction for spending on health insurance and long-term
    care insurance by the self-employed, Congress seemed to be motivated by two
    policy objectives.  One was to provide those individuals with a tax benefit
    comparable to the exclusion from the taxable income of employees of any
    employer-provided health benefits they receive.  A second objective was to
    improve access to health care by the self-employed.

    The deduction has the effect of lowering the after-tax cost of health
    insurance purchased by the self-employed by a factor equal to a self-employed
    individual's marginal income tax rate.  Individuals who purchase health
    insurance coverage in the non-group market but are not self-employed receive
    no such tax benefit.  There is some evidence that the deduction has fostered a
    significant increase in health insurance coverage among the self-employed
    and their immediate families.  As one would expect, the gains appear to have
    been concentrated in higher-income households.

    Proponents of allowing the self-employed to deduct 100 percent of health
    insurance expenditures cited equity as the main justification for such tax
    treatment.  In their view, simple fairness required that the self-employed
    receive the same tax subsidy for those health insurance expenditures as
    employees who receive health insurance through their employers.  While the
    section 162(l) a deduction greatly narrowed the gap between the self-
    employed and the employed, it does not achieve strict equality in the tax
    treatment of health insurance coverage for the two groups.  Recipients of
    employer-provided health insurance (including shareholder-employees of S
    corporations who own more than 2 percent of stock) are permitted to exclude
    employer contributions from the wage base used to determine their Social
    Security and Medicare tax contributions.  By contrast, the self-employed must
    include their spending on health insurance in the wage base used to calculate
    their self-employment taxes under the Self-Employment Contributions Act.

    The deduction also raises some concern about its efficiency effects.  Critics
    of the current tax subsidies for health insurance contend that a 100-percent
    deduction is likely to encourage self-employed individuals to purchase health
    insurance coverage that contributes to wasteful or inefficient use of health
    care.  To reduce this likelihood, some favor capping the deduction at an
    amount commensurate with a standardized health benefits package.

    In addition, there is some evidence that health insurance may not be critical
    to the utilization of health care by the self-employed.  A 2001 study by
    Harvey Rosen and Craig William Perry using data on health care spending in
    1996 examined the use of health care by the self-employed.  It found that
    there were no significant differences in utilization rates between employees
    and the self-employed in hospital admissions, hospital stays, dental checkups,
    and optometrist visits, and that the self-employed had higher utilization rates
    for alternative care and chiropractor visits - even though the self-employed
    had a lower health insurance coverage rate than the employees.  These
    findings call into question one rationale for expanding health insurance
    coverage through the use of tax subsidies:  that access to adequate health care
    hinges on having health insurance.

    	Selected Bibliography

    Conly, Sonia.  Self-Employment Health Insurance and Tax Incentives.
    Proceedings of the Eighty-Eighth Annual Conference on Taxation, 1995.
    Columbus, OH:  National Tax Association, 1996, pp. 138-44.
    Gruber, Jonathan and James Poterba.  "Tax Incentives and the Decision to
    Purchase Health Insurance: Evidence from the Self-Employed,"  The
    Quarterly Journal of Economics, v. 109, issue 3. August 1994, pp. 701-33.
    Guenther, Gary.  Federal Tax Treatment of Health Insurance Expenditures
    by the Self-Employed: Current Law and Issues for Congress.  Library of
    Congress, Congressional Research Service Report RL33311.  Washington,
    DC: March 13, 2006.

    Gurley-Calvez, Tami.  Health Insurance Deductibility and Entrepreneurial
    Survival.  Small Business Administration, Office of Advocacy.  Washington,
    DC: April 2006.
    Lyke, Bob. Tax Benefits for Health Insurance and Expenses: Overview of
    Current Law and Legislation.  Library of Congress, Congressional Research
    Service Report RL33505.  Washington, DC: June 30, 2006.
    Perry, William Craig and Harvey S. Rosen.  Insurance and the Utilization
    of Medical Services Among the Self-Employed.  Working Paper 8490.
    National Bureau of Economic Research.  Cambridge, MA: September 2001.
    U.S. Congress, House Committee on Ways and Means, Subcommittee on
    Health.  Health Insurance Premium Tax Deductions for the Self-Employed.
    Hearing, Serial 104-36, 104th Cong., 1st Sess., January 27, 1995.
    Washington, U.S. Govt. Print. Off., 1996.
    -, Joint Committee on Taxation.  General Explanation of the Tax Reform
    Act of 1986, H.R. 3838, 99th Congress, P.L. 99-514,  Joint Committee Print
    JCS-10-87. Washington, DC: U.S. Government Printing Office, May 4, 1987,
    pp. 815-17.
    Wellington, Alison J.  "Health Insurance Coverage and Entrepreneurship,"
    Journal of Contemporary Economic Policy, v. 19, no. 4, October 2001, pp.
    465-478.

    Health

    DEDUCTION  FOR MEDICAL EXPENSES
    AND LONG-TERM CARE EXPENSES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    7.3

    -

    7.3

    2007

    8.2

    -

    8.2

    2008

    9.5

    -

    9.5

    2009

    10.7

    -

    10.7

    2010

    12.1

    -

    12.1

    Authorization

    Section 213.

    	Description

    Most medical expenses that are paid for by an individual but not
    reimbursed by an employer or insurance company may be deducted from
    taxable income if they exceed 7.5 percent of his or her adjusted gross income
    (AGI).  In order to claim this deduction, individuals must itemize on their tax
    returns.  If an individual receives reimbursements for medical expenses
    deducted in a previous tax year, the reimbursements must be included in
    taxable income for the year when they are received.  But any reimbursement
    received for medical expenses incurred in a previous year for which no
    deduction was claimed may be excluded from an individual's taxable income.

    A complicated set of rules governs the expenses eligible for the deduction.
      These expenses include amounts paid by the taxpayer on behalf of himself
    or herself, his or her spouse, and eligible dependents for the following
    purposes:

    (1) health insurance premiums, including a variable portion of premiums
    for long-term care insurance, employee payments for employer-sponsored
    health plans, Medicare Part B premiums, and other self-paid premiums;

    (2) diagnosis, treatment, mitigation, or prevention of disease, or for the
    purpose of affecting any structure or function of the body, including dental
    care;

    (3) prescription drugs and insulin (but not over-the-counter medicines);

    (4) transportation primarily for and essential to medical care; and

    (5) lodging away from home primarily for and essential to medical care, up
    to $50 per night for each individual.

    In general, the cost of programs entered by an individual on his or her own
    initiative to improve general health or alleviate physical or mental discomfort
    unrelated to a specific disease or illness may not be deducted.  But the cost of
    similar programs prescribed by a physician to treat a particular disease are
    deductible.  The same distinction applies to procedures mainly intended to
    improve an individual's appearance.  For instance, the IRS does not consider
    the cost of whitening teeth discolored by aging to be a deductible medical
    expense, but the cost of breast reconstruction after a mastectomy and vision
    correction through laser surgery are deductible expenses.

    	Impact

    For individual taxpayers who itemize, the deduction can ease the financial
    burden imposed by costly medical expenses.  For the most part, the federal
    tax code regards these expenses as involuntary expenses that reduce a
    taxpayer's ability to pay taxes by absorbing a substantial part of income.

    But the deduction is not limited to strictly involuntary expenses.  It also
    covers some costs of preventive care, rest cures, and other discretionary
    expenses.  A significant share of deductible medical expenses relate to
    procedures and care not covered by many insurance policies (such as
    orthodontia).

    Like all deductions, the medical expense deduction yields the largest tax
    savings per dollar of expense for taxpayers in the highest income tax brackets.
     Nonetheless, relative to other itemized deductions, a larger percentage of the
    tax benefits from the medical expense deduction goes to taxpayers in the
    lower-to-middle income brackets.  As the figures in the table below show, 61
    percent of the deduction in 2004 was claimed by taxpayers with AGIs below
    $50,000.  There are several reasons why such an outcome is not as unlikely or
    anomalous as it may seem.  Lower-income taxpayers have relatively low rates
    of health insurance coverage, either because of they cannot afford health
    insurance coverage or it is not offered by their employers.  As a result, many
    of these taxpayers are forced to pay out of packet for the health care they and
    their immediate families receive.  In addition, medical spending represents a
    larger fraction of household budgets among low-income taxpayers than it
    does among high-income taxpayers, making it easier for low-income
    taxpayers to exceed the 7.5-percent AGI threshold in a given tax year.
    Finally, low-income households are more likely to suffer significant declines
    in their incomes than high-income households when serious medical problems
    cause working adults to lose time from work.

    Distribution by Income Class of the Deduction for
    Medical Expenses in 2004

    Adjusted Gross Income
    (in thousands of $)

    Percentage
    Distribution

    Below $15

    16

    $15 to below $30

    23

    $30 to below $50

    22

    $50 to below $100

    28

    $100 to below $200

    8

    $200 and over

    3

    Source:  Internal Revenue Service.  "Individual Income Tax Returns,
    Preliminary Data, 2004."  Statistics of Income Bulletin.  Washington, DC:
    Winter 2005-2006.  Table 1, p. 16.

    	Rationale

    Since the early 1940s, numerous changes have been made in the rules
    governing the deduction of medical expenses.  For the most part, these
    changes have focused on where to set the income threshold, whether to cap
    the deduction and at what amount, the maximum deductible amount for
    taxpayers who are 65 and over and disabled, whether to carve out a separate
    income thresholds for spending on medicines and drugs and for health
    insurance expenditures, and the medical expenses that qualify for the
    deduction.

    Taxpayers were first allowed to deduct health care expenses above a
    specific income threshold in 1942.  The deduction was a provision of the
    Revenue Act of 1942.  In adopting such a rule, Congress was trying to
    encourage improved standards of public health and to ease the burden of high
    tax rates during World War II.  The original deduction covered medical ex-
    penses (including spending on health insurance) above 5 percent of AGI and
    was capped at $2,500 for a married couple filing jointly and $1,250 for a
    single filer.

    Under the Revenue Act of 1948, the 5-percent income threshold remained
    intact, but the maximum deduction was changed so that it equaled the product
    of the then personal exemption of $1,250 and the number of exemptions
    claimed.  The deduction could not exceed $5,000 for joint returns and $2,500
    for all other returns.

    The Revenue Act of 1951 repealed the 5-percent floor for taxpayers and
    spouses who were age 65 and over.  No changes were made in the maximum
    deduction available to other taxpayers.

    Congress passed legislation that substantially revised the Internal Revenue
    Code in 1954.  One of its provisions reduced the AGI threshold to 3 percent
    and created a 1-percent floor for spending on drugs and medicines.  In
    addition, the maximum deduction was increased to $2,500 per exemption,
    with a ceiling of $5,000 for an individual return and $10,000 for a joint or
    head-of-household return.

    In 1959, the maximum deduction was increased to $15,000 for taxpayers
    who were 65 and over and disabled, and to $30,000 if their spouses also met
    both criteria.

    The threshold was removed on deductions for dependents age 65 and over
    the following year.

    In 1962, the maximum deduction was increased to $5,000 per exemption,
    with a limit of $10,000 for individual returns, $20,000 for joint and head of
    household returns, and $40,000 for joint returns filed by taxpayers and their
    spouses who were 65 or over and disabled.

    Congress eliminated the 1-percent floor on medicine and drug expenses for
    those age 65 or older (taxpayer, spouse, or dependent) in 1964.  In the
    following year, a 3-percent floor for medical expenses and a 1-percent floor
    for drugs and medicines were reinstated for taxpayers and dependents aged 65
    and over.  The limitations on maximum deductions were abolished, and a
    separate deduction not to exceed $150 was established for health insurance
    payments.

    The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) made a
    number of significant changes in the section 213 deduction.  First, it raised
    the floor from 3 percent to 5 percent of AGI.  Second, it eliminated the
    separate deduction for health insurance payments and allowed taxpayers to
    add them to other qualified medical expenses in computing the section 213
    deduction.  Finally, TEFRA removed the separate 1-percent floor for drug
    costs, excluded non-prescription or over-the-counter drugs from the
    deduction, and merged the deduction for prescription drugs and insulin with
    the deduction for other medical expenses.

    Under the Tax Reform Act of 1986 (TRA86), the income threshold for the
    medical expenses deduction increased from 5 percent of AGI to its present
    level of 7.5 percent.

    The Omnibus Budget Reconciliation Act of 1990 disallowed deductions
    for the cost of cosmetic surgery, with certain exceptions.  It also exempted the
    medical expense deduction from the overall limit on itemized deductions for
    high-income taxpayers.

    Under the Health Insurance Portability and Accountability Act of 1996
    (HIPAA, P.L. 104-191), spending on long-term care and long-term care
    insurance was granted the same tax treatment as spending on health insurance
    and medical expenses.  This meant that as of January 1, 1997, taxpayers were
    allowed to include expenditures for long-term care (including premium costs)
    in the medical expenses eligible for the deduction.  The act also imposed
    annual dollar limits, indexed for inflation, on the of long-term care insurance
    payments a taxpayer may deduct, subject to the 7.5 percent of AGI threshold.
     The limits depend on the age of the insured person:  in 2006, they range from
    $280 for individuals age 40 and under to $3,530 for individuals over age 70.
    HIPAA also specified that periodic reimbursements received under a
    qualified long-term care insurance plan were considered payments for
    personal injuries and sickness and could be excluded from gross income,
    subject to a cap which was indexed for inflation.  These payments could not
    be claimed as part of the section 213 deduction because they were considered
    reimbursement for health care received under a long-term care contract.
    Insurance payments above the cap that did not offset the actual costs incurred
    for long-term care services had to be included in taxable income.

    Assessment

    Changes in the tax laws during the 1980s substantially reduced the number
    of tax returns claiming the itemized deduction for medical and dental
    expenses.   In 1980, 19.5 million returns, or 67 percent of itemized returns
    and 21 percent of all returns, claimed the deduction.  But in 1983, the first
    full tax year reflecting the changes made by TEFRA, 9.7 million returns,
    representing 28 percent of itemized returns and 10 percent of all returns,
    claimed the deduction.  The modifications made by TRA86 led to a further
    decline in the number of individuals claiming the deduction.  In 1990, for
    instance, 5.1 million returns, or 16 percent of itemized returns and 4 percent
    of all returns, claimed the deduction.  Since then, however, the number of
    individuals claiming the deduction has been steadily rising.  For example, 9.5
    million returns claimed the deduction for 2004, or 20 percent of all itemized
    returns and 7 percent of all returns.

    The deduction is intended to assist taxpayers with relatively high medical
    expenses paid out of pocket relative to their taxable income.  Taxpayers are
    more likely to use the deduction if they can fit several large medical
    expenditures into a single tax year.  Unlike the itemized deduction for
    casualty losses, a taxpayer cannot carry medical expenses that cannot be
    deducted in the current tax year over to previous or future tax years.

    Some argue that the deduction serves the public interest by expanding
    health insurance coverage.  In theory, it could have this effect, as it lowers the
    after-tax cost of such coverage.  This reduction can be as large as 35% for
    someone in the highest tax bracket.  Yet there appears to be a tenuous link, at
    best, between the deduction and health insurance coverage.  So few taxpayers
    can claim the deduction that it is unlikely to have much impact on the
    decision to purchase health insurance, especially among individuals whose
    only option for coverage is to buy health insurance the non-group market,
    where premiums tend to be higher and exclusions in benefits more numerous
    than in the group market.  What is more, few among those who itemize and
    have health insurance coverage are likely to qualify for the deduction because
    much of their use of medical care is covered by insurance.

    Current tax law is inequitable in its treatment of health insurance
    expenditures.  Taxpayers who receive health benefits from their employers
    receive a larger tax subsidy, at the margin, than taxpayers who purchase
    health insurance on their own or self-insure.  Employer-paid health care is
    excluded from income and payroll taxes, whereas the cost of health insurance
    bought in the non-group market can be deducted from taxable income only to
    the extent that it exceeds 7.5 percent of AGI.  Lowering or abolishing the
    AGI threshold for the deduction would narrow the narrow gap between the
    tax benefits for health insurance available to the two groups.

    	Selected Bibliography

    Goldsberry, Edward, Ashley Tenney and David Luke.  "Deductibility of
    Tuition and Related Fees as Medical Expenses," The Tax Adviser, November
    2002, pp. 701-702.
    Guenther, Gary.  Tax Subsidies for Expanding Health Insurance
    Coverage:  Selected Policy Issues for the 108th Congress.  Library of
    Congress, Congressional Research Service Report RL30762, Washington,
    DC: August 5, 2003.
    Jones, Lawrence T.  "Long-Term Care Insurance: Advanced Tax Issues,"
    Journal of Financial Service Professionals, September 2004, pp. 51-59.

    Kaplow, Louis.  "The Income Tax as Insurance: The Casualty Loss and
    Medical Expense Loss Deductions and the Exclusion of Medical Insurance
    Premiums," California Law Review, v. 79, December 1991, pp. 1485-1510.
    Lyke, Bob.  Tax Benefits for Health Insurance and Expenses: Overview of
    Current Law and Legislation.  Library of Congress, Congressional Research
    Service Report RL33505, Washington, DC: June 30, 2006.
    Pauly Mark V.  "Taxation, Health Insurance, and Market Failure in the
    Medical Economy," Journal of Economic Literature, v. 24, no. 2. June 1986,
    pp. 629-75.
    O'Shaughnessy, Carol and Bob Lyke.  Long-Term Care: What Direction
    for Public Policy?.  Library of Congress, Congressional Research Service
    Report RS20784, Washington, DC, January 18, 2005.
    Rook, Lance W.  "Listening to Zantac:  The Role of Non-Prescription
    Drugs in Health Care Reform and the Federal Tax System,"  Tennessee Law
    Review, v. 62, Fall 1994, pp. 102-39.
    Sheiner, Louise.  "Health Expenditures, Tax Treatment," The
    Encyclopedia of Taxation and Tax Policy, ed. Joseph J. Cordes, Robert D.
    Ebel, and Jane G. Gravelle.  Washington:  Urban Institute Press, 2005, pp.
    175-176.
    Steuerle, Gene.  "Tax Policy Concerns: Long-Term Care Needs and the
    Government Response," Tax Notes, v. 83, May 10, 1999, pp. 917-918.
    Talley, Louis Alan.  Medical Expense Deduction: History and Rationale
    for Past Changes.  Library of Congress, Congressional Research Service
    Report RL30833, Washington, DC: February 6, 2001.
    U.S. Congress, Congressional Budget Office.  Tax Subsidies for Medical
    Care: Current Policies and Possible Alternatives.  Washington, DC: 1980.
    -, House Committee on the Budget.  Tax Expenditures for Health Care,
    Hearings, 96th Congress, 1st session, July 9-10, 1979.
    -, House Committee on Ways and Means, Subcommittee on Health.  Long-
    Term Care Tax Provisions in the Contract with America.  Hearing, Serial
    104-1, 104th Congress, 1st session.  Washington, DC:  U.S. Govt. Print. Off.,
    January 20, 1995.
    Vogel, Ronald.  "The Tax Treatment of Health Insurance Premiums as a
    Cause of Overinsurance," National Health Insurance: What Now, What
    Later, What Never? ed. M. Pauly.  Washington: American Enterprise Institute
    for Public Policy Research, 1980.
    Wilensky, Gail R.  "Government and the Financing of Health Care"
    American Economic Review, v. 72, no. 2.  May 1982, pp. 202-07.

    Health

    EXCLUSION OF WORKERS' COMPENSATION BENEFITS
    (MEDICAL BENEFITS)

    Estimated Revenue Loss*

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    6.5

    -

    6.5

    2007

    6.9

    -

    6.9

    2008

    7.4

    -

    7.4

    2009

    8.0

    -

    8.0

    2010

    8.5

    -

    8.5

    Authorization

    Section 104(a)(1).

    Description

    Payments for medical treatment of work-related injury or disease are
    provided as directed by various State and Federal laws governing workers'
    compensation.  Employers finance workers' compensation benefits through
    commercial insurance or self-insurance arrangements (with no employee
    contribution) and their costs are deductible as a business expense.  Employees
    are not taxed on the value of insurance contributions for workers'
    compensation medical benefits made on their behalf by employers, or on the
    medical benefits or reimbursements they actually receive.  This is similar to
    the tax treatment of other employer-paid health insurance.

    Impact

    The exclusion from taxation of employer contributions for workers'
    compensation medical benefits provides a tax benefit to any worker covered
    by the workers' compensation program, not just those actually receiving
    medical benefits in a particular year.

    Figures are not available on employer contributions specifically for
    workers' compensation medical benefits.  As an approximation, however, in
    2004, medical payments under workers' compensation programs totaled
    $26.1 billion.  This represented 47 percent of total workers' compensation
    benefits.  The rest consisted mainly of earnings-replacement cash benefits.
    (See entry on Exclusion of Workers' Compensation Benefits: Disability and
    Survivors Payments.)

    Rationale

    This exclusion was first codified in the Revenue Act of 1918.  The
    committee reports accompanying the Act suggest that workers' compensation
    payments were not subject to taxation before the 1918 Act.  No rationale for
    the exclusion is found in the legislative history.  But it has been maintained
    that workers' compensation should not be taxed because it is in lieu of court-
    awarded damages for work-related injury or death that, before enactment of
    workers' compensation laws (beginning shortly before the 1918 Act), would
    have been payable under tort law for personal injury or sickness and not
    taxed.

    Assessment

    Not taxing employer contributions to workers' compensation medical
    benefits subsidizes these benefits relative to taxable wages and other taxable
    benefits, for both the employee and employer.  The exclusion allows
    employers to provide their employees with workers' compensation coverage
    at a lower cost than if they had to pay the employees additional wages
    sufficient to cover a tax liability on these medical benefits.  In addition to the
    income tax benefits, workers' compensation insurance benefits are excluded
    from payroll taxation.

    The tax subsidy reduces the employer's cost of compensating employees
    for accidents on the job and can be viewed as blunting financial incentives to
    maintain safe workplaces.  Employers can  reduce their workers'
    compensation costs if the extent of accidents is reduced.  If the insurance
    premiums were taxable to employees, a reduction in employer premiums
    would also lower employees' income tax liabilities.  Employees might then be
    willing to accept lower before-tax wages, thereby providing additional
    savings to the employer from a safer workplace.

    Selected Bibliography

    Boyd, Lawrence W.  "Workers Compensation Reform Past and Present:
    An Analysis of Issues and Changes in Benefits," Labor Studies Journal,
    Summer 1999.  Pp. 45-62.
    National Foundation for Unemployment Compensation and Workers'
    Compensation.  "Fiscal Data for State Workers' Compensation Systems:
    1986-95," Research Bulletin 97 WC-2.  September 15, 1997, pp. 1-17.
    Sengupta, Ishita, et al.  Workers' Compensation: Benefits, Coverage and
    Costs, 2004.  Washington, DC: National Academy of Social Insurance, 2006.
    Social Security Administration, Office of Research and Statistics.  "Social
    Security Programs in the United States," Social Security Bulletin, v. 56.
    Winter, 1993, pp. 28-36.
    Thomason, Terry, Timothy Schmidle and John F. Burton.  Workers'
    Compensation, Benefits, Costs, and Safety under Alternative Insurance
    Arrangements.  Kalamazoo MI: Upjohn Institute for Employment Research.
    2001.
    U.S. Congress, House Committee on Ways and Means.  2000 Green Book:
    Background Material and Data on Programs within the Jurisdiction of the
    Committee on Ways and Means.  Committee Pring WMCP 106-14, 106th
    Congress, 2nd Session.  Washington, DC: U.S. Government Printing Office,
    October 6, 2000, pp. 983-989.
    Wentz, Roy.  "Appraisal of Individual Income Tax Exclusions," Tax
    Revision Compendium.  U.S. Congress, House Committee on Ways and
    Means Committee Print.  1959, pp. 329-340.
    Yorio, Edward.  "The Taxation of Damages: Tax and Non-Tax Policy
    Considerations," Cornell Law Review, v. 62.  April 1977, pp. 701-736.

    Health

    HEALTH SAVINGS ACCOUNTS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.1

    -

    0.1

    2007

    0.3

    -

    0.3

    2008

    0.6

    -

    0.6

    2009

    0.9

    -

    0.9

    2010

    1.2

    -

    1.2

    H.R. 6111 (December 2006) increased the cost by $0.1 billion in
    FY2008, FY2009, and FY2010.

    Authorization

    Section 223.

    Description

    Health Savings Accounts (HSAs) are a tax-advantaged way that people can
    pay for unreimbursed medical expenses such as deductibles, copayments, and
    services not covered by insurance.  Eligible individuals can establish and fund
    these accounts when they have qualifying high deductible health insurance
    (insurance with a deductible of at least $1,100 for single coverage and $2,200
    for family coverage, plus other criteria described below) and no other health
    care coverage, with some exceptions.   The minimum deductible levels do not
    apply to preventive care, which the IRS has defined by regulation.
    Prescription drugs are not exempt from the deductibles unless they are for
    preventive care.  Qualifying health plans cannot have limits on out-of-pocket
    expenditures that exceed $5,500 for single coverage and $11,000 for family
    coverage.   (The dollar amounts in this and other paragraphs are for 2007.)

    The annual contribution limit for single coverage is $2,850 and the  annual
    contribution limit for family coverage is $5,650.  Individuals who are at least
    55 years of age but not yet enrolled in Medicare may make an additional
    contribution of $800.  The additional contribution amount will increase by
    $100 each year through 2009, when it will be $1,000.  Individuals may
    deduct their HSA contributions from gross income in determining their
    taxable income.  Employer contributions are excluded from income and
    employment taxes of the employee and from employment taxes of the
    employer.

    Individuals do not lose their HSA or the right to access it by obtaining
    insurance with a low deductible; they simply cannot make further
    contributions until they become eligible once again. Individual members of a
    family may have their own HSA, provided they each meet the eligibility rules.
     They can also be covered through the HSA of someone else in the family; for
    example, a husband may use his HSA to pay expenses of his spouse even
    though she has her own HSA.

    Withdrawals from HSAs are exempt from federal income taxes if used for
    qualified medical expenses, with the exception of health insurance premiums.
     However, payments for four types of insurance are considered to be qualified
    expenses: (1) long-term care insurance, (2) health insurance premiums during
    periods of continuation coverage required by federal law (e.g., COBRA), (3)
    health insurance premiums during periods the individual is receiving
    unemployment compensation, and (4) for individuals age 65 years and older,
    any health insurance premiums (including Medicare Part B premiums) other
    than a Medicare supplemental policy.

    Withdrawals from HSAs not used for qualified medical expenses are
    included in the gross income of the account owner in determining federal
    income taxes; they also are subject to a 10% penalty tax.  The penalty is
    waived in cases of disability or death and for individuals age 65 and older.
    HSA account earnings are tax-exempt and unused balances may accumulate
    without limit.

    Under legislation adopted at the end of 2006, amounts can be rolled over
    from Health Flexible Spending Accounts and Health Reimbursement
    accounts on a one time basis before 2012.  Amounts can also be withdrawn
    from an IRA and contributed to an HSA without tax or penalty.

    Impact

    HSAs encourage people to purchase high deductible health insurance and
    build a reserve for routine and other unreimbursed health care expenses.
    They are more attractive to individuals with higher marginal tax rates since
    their tax savings are greater, though some younger, lower income taxpayers
    might try to build up account balances in anticipation of when their income
    will be higher.  Some higher income individuals may be reluctant to start or
    continue funding HSAs if they have health problems for which low
    deductible insurance would be more appropriate.  Two important questions
    affecting participation are whether some employers will only offer high
    deductible insurance plans, giving employees no other options, and whether
    they will make contributions to workers' accounts.  After three years of
    experience with HSAs (they were first authorized for 2004), there is little
    publicly available information with which to answer these questions.

    Interest in HSAs continues to grow in both the employer and individual
    health insurance markets.   Qualifying insurance was initially offered by
    insurers that previously had been selling high deductible policies (including
    policies associated with medical savings accounts, a precursor to HSAs), but
    today many insurers and even some health maintenance organizations offer
    qualifying coverage.  Some of the first employers to offer HSA plans had
    previously had health reimbursement accounts (HRAs) that were coupled
    with high deductible coverage.  (First authorized by the IRS in 2002, HRAs
    are accounts that employees can use for unreimbursed medical expenses; they
    can be established and funded only by employers and normally terminate
    when employees leave.)  More employers became interested after the IRS
    issued guidance clarifying how HSA statutory provisions would be
    interpreted.  The federal government began offering HSA plans to its
    employees in 2005.

    According to a survey by America's Health Insurance Plans, as of January,
    2006, nearly 3.2 million people were enrolled in qualifying high deductible
    insurance plans.  The number included both policy holders and their covered
    family members.  The January, 2006 figure was three times a March, 2005
    count, which in turn was twice the September, 2004 count.  While not all
    these policy holders have HSAs, let alone put money in them, it is reasonable
    to assume that the number of HSAs has been growing rapidly.    Nonetheless,
    it remains uncertain how popular HSAs will be in the long run.  While most
    people who consider them could reasonably expect to have gradually
    increasing account balances, it is unclear whether this incentive will be
    enough to offset the increased risks associated with high deductible insurance.
     Many people are very risk averse with respect to health insurance, even when
    they recognize that might be to their financial detriment.

    Rationale

    HSAs were authorized by the Medicare Prescription Drug, Improvement,
    and Modernization Act of 2003 (P.L. 108-173).  Congress adopted them as a
    replacement for Archer medical savings accounts (MSAs), which proponents
    considered unduly constrained by limitations on eligibility and contributions.
    (Archer MSAs, which are still available, are restricted to self-employed
    individuals and employees covered by a high deductible plan established by
    their small employer (50 or fewer workers).  MSA contributions are limited to
    65 percent of the insurance deductible (75% for family policies) or earned
    income, whichever is less.  Individuals cannot make contributions if their
    employer does.  Only about 100,000 MSAs have ever been established.)
    Like MSAs, HSAs were advanced as a way to slow the growth of
    health care costs by reducing reliance on insurance, to preserve
    freedom of choice in obtaining health care services, and to help
    individuals and families finance future health care costs.  Taxpayers
    can carry their HSAs with them when they change jobs, which may
    help maintain continuity of health care if their new employer offers
    different or perhaps no health insurance coverage.

       HSAs are seen as the cornerstone of consumer driven health care,
    which some employers hope will limit their exposure to rising health
    care costs.  Some health care providers favor consumer driven health
    care in order to avoid managed care restrictions on how they
    practice medicine.  HSAs are predicated upon market-based rather
    than regulatory solutions to health care problems, as the 108th
    Congress appeared to favor.

    Assessment

       HSAs could be an attractive option for many people.  They allow
    individuals to insure against large or catastrophic expenses while
    covering routine and other minor costs out of their own pocket.
    Properly designed, they may encourage more prudent health care
    use and the accumulation of funds for medical emergencies.  For
    these outcomes to occur, however, individuals will have to put money
    into their account regularly (especially if their employer doesn't) and
    refrain from spending it for things other than health care.  In
    addition, they must be able to find out what health care providers
    charge and be willing to switch to lower-cost providers.   Despite
    some promising small-scale studies and anecdotal evidence, it is too
    early to tell whether many people would respond in these ways, or if
    health care providers will be forthcoming about prices.

     	One issue surrounding HSAs is whether they drive up insurance
    costs for everyone else.  If HSAs primarily attract young, healthy
    individuals, premiums for plans without high deductibles are likely to
    rise since they would disproportionately cover the older and ill.  Over
    time, healthier people in higher cost plans would switch to lower cost
    plans, raising their premiums but increasing premiums in higher cost
    plans even more.  If this process continued unchecked, eventually
    people who need insurance the most would be unable to afford it.

    HSAs have limits on their capacity to substantially reduce
    aggregate health care spending, even assuming their widespread
    adoption and significant induction (price elasticity) effects of
    insurance.  Most health care spending is attributable to costs that
    exceed the high-deductible levels allowed under the legislation;
    consumers generally have little control over these expenditures.
    Even for smaller expenditures, the tax subsidies associated with HSAs
    may effectively reduce patient cost-sharing compared to typical
    comprehensive health insurance.  A further complication is that HSAs
    with large account balances (which will eventually occur for some
    people) might be seen as readily-available funds for health care,
    which could lead to increases in spending, just the opposite of the
    usual prediction.

    Regardless of their impact on aggregate expenditures, HSAs
    provide more equitable treatment for taxpayers who choose to
    self-insure more of their health care costs.  Employer-paid health
    insurance is excluded from employees' gross income regardless of the
    proportion of costs it covers.  Employers generally pay about 80% of
    the cost of a plan that has a low deductible ($400 a year, for
    example) and a 20% copayment requirement.  If the plan instead
    had a high-deductible ($2,000, for example) and the same
    copayment requirement, employees normally would have to pay for
    expenses associated with the increase in the deductible ($1,600
    minus the $320 copayment they would otherwise have made) with
    after-tax dollars.  They would lose a tax benefit for assuming more
    financial risk.  HSAs restore this benefit as long as an account is used
    for health care expenses.  In this respect, HSAs are like flexible
    spending accounts (FSAs), which also allow taxpayers to pay
    unreimbursed health care expenses with pre-tax dollars.  With FSAs,
    however, account balances unused at the end of the year and a brief
    grace period must be forfeited.

    Selected Bibliography

    Aaron, Henry J.  The "Sleeper" in the Drug Bill.  Tax Notes.  v. 102 no. 8
    (February 23, 2004).
    Buntin, Melinda Beeuwkes et al.  Consumer-Directed Health Care: Early
    Evidence About Effects on Cost and Quality.  Health Affairs.  vol. 25 (2006).
    Cannon, Michael F.  Health Savings Accounts: Do the Critics Have a
    Point?  Cato Institute.  Policy Analysis no. 569 (May 30, 2006).
    Gabel, Jon R. et al. Employers' Contradictory Views about Consumer-
    Driven Health Care: Results from a National Survey.  Health Affairs, Web
    exclusive (April 21, 2004).
    Hall, Mark A. and Clark C. Havighurst.  Reviving Managed Care with
    Health Savings Accounts.  Health Affairs.  vol. 24 (2005).
    Health Savings Accounts: January 2005 - December 2005.  eHealth, Inc.
    (May 10, 2006).
    Herzlinger, Regina E.  Consumer-Driven Health Care: Lessons from
    Switzerland.  JAMA, v. 292 no. 10 (September 8, 2004).
    Kofman, Mila.  Health Savings Accounts: Issue and Implementation
    Decisions for States.  Academy Health.  Issue Brief.  (September, 2004).
    Lyke, Bob.  Health Savings Accounts: Overview of Rules for 2006.
    Library of Congress.  Congressional Research Service.  Report RL33257.

    -------- Health Savings Accounts: Some Current Policy Issues.  Library of
    Congress.  Congressional Research Service.  Report RS22437.
    --------, Chris Peterson, and Neela Ranade.  Health Savings Accounts.
    Library of Congress.  Congressional Research Service Report RL32467.
    Patterson, Martha Priddy.  Defined Contribution Health Plan to Consumer-
    Driven Health Benefits: Evolution and Experience.  Benefits Quarterly, v. 20
    no. 2 (Second quarter, 2004).
    Peterson, Chris L.  Data on Enrollment, Premiums, and Cost-Sharing in
    HSA-Qualified Health Plans.  Library of Congress.  Congressional Research
    Service.  Report RS22417.
    Protecting Consumers in an Evolving Health Insurance Market.  National
    Committee for Quality Assurance. (June, 2006).
    Remler, Dahlia K. and Sherry A. Glied.  How Much More Cost-Sharing
    Will Health Savings Accounts Bring?  Health Affairs. vol. 25 (2006).
    Trude, Sally and Leslie Jackson Conwell.  Rhetoric vs. Reality: Employer
    Views on Consumer-Driven Health Care.  Center for Studying Health System
    Change.  Issue Brief no. 86.  (July, 2004).
    U.S. Government Accountability Office: Consumer-Directed Health
    Plans: Early Enrollee Experiences with Health Savings Accounts and
    Eligible Health Plans.  GAO-06-798 (August, 2006).
    --------  Consumer-Directed Health Plans: Small but Growing Enrollment
    Fueled by Rising Cost of Health Care Coverage.  GAO-06-514.  (April,
    2006).

    	Health

    	EXCLUSION OF INTEREST
    	ON STATE AND LOCAL GOVERNMENT BONDS
    	FOR PRIVATE NONPROFIT HOSPITAL FACILITIES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    1.7

    0.6

    2.3

    2007

    1.8

    0.7

    2.5

    2008

    1.9

    0.7

    2.6

    2009

    2.0

    0.8

    2.8

    2010

    2.1

    0.8

    2.9

    	Authorization

    Section 103, 141, 145, 146, and 501(c)(3).

    	Description

    Interest income on State and local bonds used to finance the construction of
    nonprofit hospitals and nursing homes is tax exempt.  These bonds are
    classified as private-activity bonds rather than governmental bonds because a
    substantial portion of their benefits accrues to individuals or businesses rather
    than to the general public.  For more discussion of the distinction between
    governmental bonds and private-activity bonds, see the entry under General
    Purpose Public Assistance: Exclusion of Interest on Public Purpose State
    and Local Debt.

    These nonprofit hospital bonds are not subject to the State private-activity
    bond annual volume cap.

    	Impact

    Since interest on the bonds is tax exempt, purchasers are willing to accept
    lower before-tax rates of interest than on taxable securities.  These low
    interest rates enable issuers to finance hospitals and nursing homes at reduced
    interest rates.

    Some of the benefits of the tax exemption also flow to bondholders.  For a
    discussion of the factors that determine the shares of benefits going to
    bondholders and users of the hospitals and nursing homes, and estimates of
    the distribution of tax-exempt interest income by income class, see the
    "Impact" discussion under General Purpose Public Assistance: Exclusion of
    Interest on Public Purpose State and Local Debt.

    	Rationale

    Pre-dating the enactment of the first Federal income tax, an early decision
    of the U.S. Supreme Court, Dartmouth College v. Woodward (17 U.S. 518
    [1819]), confirmed the legality of government support for charitable
    organizations that were providing services to the public.

    The income tax adopted in 1913, in conformance with this principle,
    exempted from taxation virtually the same organizations now included under
    Section 501(c)(3).  In addition to their tax-exempt status, these institutions
    were permitted to receive the benefits of tax-exempt bonds.  Almost all States
    have established public authorities to issue tax-exempt bonds for nonprofit
    hospitals and nursing homes.  Where issuance by public authority is not
    feasible, Revenue Ruling 63-20 allows nonprofit hospitals to issue tax-exempt
    bonds "on behalf of" State and local governments.

    Before enactment of the Revenue and Expenditure Control Act of 1968,
    States and localities were able to issue bonds to finance construction of
    capital facilities for private (proprietary or for-profit) hospitals, as well as for
    public sector and nonprofit hospitals.

    After the 1968 Act, tax-exempt bonds for proprietary (for-profit) hospitals
    were issued as small-issue industrial development bonds, which limited the
    amount for any institution to $5 million over a six-year period.  The Revenue
    Act of 1978 raised this amount to $10 million.

    The Tax Equity and Fiscal Responsibility Act of 1982 established
    December 31, 1986 as the sunset date for tax-exempt small-issue IDBs.  The
    Deficit Reduction Act of 1984 extended the sunset date for bonds used to
    finance manufacturing facilities, but left in place the December 31, 1986
    sunset date for nonmanufacturing facilities, including for-profit hospitals and
    nursing homes.

    The private-activity status of these bonds subjects them to severe
    restrictions that would not apply if they were classified as governmental
    bonds.

    	Assessment

    Recently, some efforts have been made to reclassify nonprofit bonds,
    including nonprofit hospital bonds, as governmental bonds.  The proponents
    of such a change suggest that the public nature of services provided by
    nonprofit organizations merit such a reclassification.  Opponents argue that
    the expanded access to subsidized loans coupled with the absence of
    sufficient government oversight may lead to greater misuse than if the
    facilities received direct federal spending.  Questions have also been raised
    about whether nonprofit hospitals fulfill their charitable purpose and if they
    deserve continued access to tax-exempt bond finance.

    Even if a case can be made for this federal subsidy for nonprofit
    organizations, it is important to recognize the potential costs.  As one of many
    categories of tax-exempt private-activity bonds, bonds for nonprofit
    organizations increase the financing cost of bonds issued for other public
    capital.  With a greater supply of public bonds, the interest rate on the bonds
    necessarily increases to lure investors.  In addition, expanding the availability
    of tax-exempt bonds increases the assets available to individuals and
    corporations to shelter their income from taxation.

    	Selected Bibliography

    Barker, Thomas R.  "Re-Examining the 501(c)(3) Exemption of Hospitals
    as Charitable Organizations," The Exempt Organization Tax Review.  July
    1990, pp. 539-553.
    Copeland, John and Gabriel Rudney.  "Federal Tax Subsidies for Not-for-
    Profit Hospitals," Tax Notes.  March 26, 1990, pp. 1559-1576.
    Freemont-Smith, Marion R.  "The Role of Government Regulation in the
    Creation and Operation of Conversion Foundations," Tax Notes.  February 2,
    1999.
    Gentry, William M., and John R. Penrod.  "The Tax Benefits of Not-For-
    Profit Hospitals," Cambridge, MA, National Bureau of Economic Research,
    1998.  Working Paper No. 6435.
    Gershberg, Alec I., Michael Grossman, and Fred Goldman.  "Health Care
    Capital Financing Agencies: the Intergovernmental Roles of Quasi-
    government Authorities and the Impact on the Cost of Capital," Public
    Budgeting and Finance, v. 20 (Spring 2000), pp. 1-23.
    Gershberg, Alec Ian, Michael Grossman, and Fred Goldman.
    "Competition and the Cost of Capital Revisited: Special Authorities and
    Underwriters in the Market for Tax-exempt Hospital Bonds,"  National Tax
    Journal.  June 2001, pp. 255-280.

    Jantzen, Robert and Patricia R. Loubeau.  "Managed Care and U.S.
    Hospitals' Capital Costs," International Advances in Economic Research, v.
    9, no. 3.  August 2003, pp. 206-217.
    Maguire, Steven.  Private Activity Bonds: An Introduction.  Library of
    Congress, Congressional Research Service Report RL31457.  November 10,
    2004.
    -.  Tax-Exempt Bonds: A Description of State and Local Government
    Debt.  Library of Congress, Congressional Research Service Report
    RL30638.  October 22, 2004.
    Zimmerman, Dennis.  "Nonprofit Organizations, Social Benefits, and Tax
    Policy." National Tax Journal.  September 1991, pp. 341-349.
    -.  The Private Use of Tax-Exempt Bonds: Controlling Public Subsidy of
    Private Activities.  Washington, DC: The Urban Institute Press, 1991.

    Health

    DEDUCTION FOR CHARITABLE CONTRIBUTIONS
    TO HEALTH ORGANIZATIONS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    3.7

    0.8

    4.5

    2007

    4.0

    0.8

    4.8

    2008

    4.3

    0.9

    5.2

    2009

    4.7

    0.9

    5.6

    2010

    4.8

    0.9

    5.7

    	Authorization

    Section 170 and 642(c).

    	Description

    Subject to certain limitations, charitable contributions may be deducted by
    individuals, corporations, and estates and trusts.  The contributions must be
    made to specific types of organizations, including organizations whose
    purpose is to provide medical or hospital care, or medical education or
    research.  To be eligible, organizations must be not-for-profit.

    Individuals who itemize may deduct qualified contribution amounts of up
    to 50 percent of their adjusted gross income (AGI) and up to 30 percent for
    gifts of capital gain property.  For contributions to nonoperating foundations
    and organizations, deductibility is limited to the lesser of 30 percent of the
    taxpayer's contribution base, or the excess of 50 percent of the contribution
    base for the tax year over the amount of contributions which qualified for the
    50-percent deduction ceiling (including carryovers from previous years).
    Gifts of capital gain property to these organizations are limited to 20 percent
    of AGI.

    The maximum amount deductible by a corporation is 10 percent of its
    adjusted taxable income.  Adjusted taxable income is defined to mean taxable
    income with regard to the charitable contribution deduction, dividends-
    received deduction, any net operating loss carryback, and any capital loss
    carryback.  Excess contributions may be carried forward for five years.
    Amounts carried forward are used on a first-in, first-out basis after the
    deduction for the current year's charitable gifts have been taken.  Typically, a
    deduction is allowed only in the year in which the contribution occurs.
    However, an accrual-basis corporation is allowed to claim a deduction in the
    year preceding payment if its board of directors authorizes a charitable gift
    during the year and payment is scheduled by the 15th day of the third month of
    the next tax year.

    If a contribution is made in the form of property, the deduction depends on
    the type of taxpayer (i.e., individual, corporate, etc.), recipient, and purpose.

    As a result of the enactment of the American Jobs Creation Act of 2004,
    P.L. 108-357, donors of noncash charitable contributions face increased
    reporting requirements.  For charitable donations of property valued at $5,000
    or more, donors must obtain a qualified appraisal of the donated property.
    For donated property valued in excess of $500,000, the appraisal must be
    attached to the donor's tax return.  Deductions for donations of patents and
    other intellectual property are limited to the lesser of the taxpayer's basis in
    the donated property or the property's fair market value.  Taxpayers can claim
    additional deductions in years following the donation based on the income the
    donated property provides to the donee.  The 2004 act also mandated
    additional reporting requirements for charitable organizations receiving
    vehicle donations from individuals claiming a tax deduction for the
    contribution, if it is valued in excess of $500.

    Taxpayers are required to obtain written substantiation from a donee
    organization for contributions which exceed $250.  This substantiation must
    be received no later than the date the donor-taxpayer files the required income
    tax return.  Donee organizations are obligated to furnish the written
    acknowledgment when requested with sufficient information to substantiate
    the taxpayer's deductible contribution.

    The Pension Protection Act of 2006 (P.L. 109-280) included several
    provisions that temporarily expand charitable giving incentives.  The
    provisions, effective after December 31, 2005 and before January 1, 2008,
    include enhancements to laws governing non-cash gifts and tax-free
    distributions from individual retirement  plans for charitable purposes.  The
    2006 law also tightened rules governing charitable giving in certain areas,
    including gifts of taxidermy, contributions of clothing and household items,
    contributions of fractional interests in tangible personal property, and record-
    keeping and substantiation requirements for certain charitable contributions.

    Impact

    The deduction for charitable contributions reduces the net cost of
    contributing.  In effect, the federal government provides the donor  with a
    corresponding grant that increases in value with the donor's marginal tax
    bracket.  Those individuals who use the standard deduction or who pay no
    taxes receive no benefit from the provision.

    A limitation applies to the itemized deductions of high-income taxpayers.
    Under this provision, in 2006, otherwise allowable deductions are reduced by
    3 percent of the amount by which a taxpayer's adjusted gross income (AGI)
    exceeds $150,500 (adjusted for inflation in future years).  The table below
    provides the distribution of all charitable contributions, not just those to
    health organizations.

    Distribution by Income Class of the Tax Expenditure
    for Charitable Contributions, 2005

    Income Class
    (in thousands of $)

    Percentage
    Distribution

    Below $10

    0.0

    $10 to $20

    0.1

    $20 to $30

    0.5

    $30 to $40

    1.1

    $40 to $50

    2.0

    $50 to $75

    8.3

    $75 to $100

     9.6

    $100 to $200

    28.7

    $200 and over

    49.7

    	Rationale

    This deduction was added by passage of the War Revenue Act of October
    3, 1917.  Senator Hollis, the sponsor, argued that high wartime tax rates
    would absorb the surplus funds of wealthy taxpayers, which were generally
    contributed to charitable organizations.

    The provisions enacted in 2004 resulted from Internal Revenue Service and
    congressional concerns that taxpayers were claiming inflated charitable
    deductions, causing the loss of federal revenue.  In the case of vehicle
    donations, concern was expressed about the inflation of deductions.  GAO
    reports published in 2003 indicated that the value of benefit to charitable
    organizations from donated vehicles was significantly less than the value
    claimed as deductions by taxpayers.  The 2006 enactments were, in part, a
    result of continued concerns from 2004.

    Assessment

    Supporters note that contributions finance desirable activities such as
    hospital care for the poor.  Further, the Federal Government would be forced
    to step in to assume some of the activities currently provided by health care
    organizations if the deduction were eliminated; however, public spending
    might not be available to make up all of the difference.  In addition, many
    believe that the best method of allocating general welfare resources is through
    a dual system of private philanthropic giving and governmental allocation.

    Economists have generally held that the deductibility of charitable
    contributions provides an incentive effect which varies with the marginal tax
    rate of the giver.  There are a number of studies which find significant
    behavioral responses, although a study by Randolph suggests that such
    measured responses may largely reflect transitory timing effects.

    Types of contributions may vary substantially among income classes.
    Contributions to religious organizations are far more concentrated at the lower
    end of the income scale than are contributions to health organizations, the
    arts, and educational institutions, with contributions to other types of
    organizations falling between these levels.  However, the volume of donations
    to religious organizations is greater than to all other organizations as a group.
     In 2005, the American Association of Fund-Raising Counsel Trust for
    Philanthropy, Inc. (AAFRC) estimated that contributions to religious
    institutions amounted to 45 percent of all contributions ($93.2 billion), while
    contributions to health care providers and associations amounted to less than
    21 percent ($22.5 billion).

    Using current dollars, AAFRC reported giving to health increased by 4.8
    percent in 2000, declined in 2001 and 2002, rose by 8.2 percent in 2003, 5.1
    percent in 2004, and 2.7 percent in 2005.

    There has been a debate concerning the amount of charity care being
    provided by health care organizations with tax-exempt status.  In the 109th
    Congress, hearings were held  by both the Senate Committee on Finance and
    the House Committee on Ways and Means to examine the charitable status of
    nonprofit health care organizations.  Those who support eliminating
    charitable deductions note that deductible contributions are made partly with
    dollars which are public funds.  They feel that helping out private charities
    may not be the optimal way to spend government money.

    Opponents further claim that the present system allows wealthy taxpayers
    to indulge special interests and hobbies.  To the extent that charitable giving
    is independent of tax considerations, federal revenues are lost without having
    provided any additional incentive for charitable gifts.  It is generally argued
    that the charitable contributions deduction is difficult to administer and that
    taxpayers have difficulty complying with it because of complexity.

    	Selected Bibliography

    Aprill, Ellen P.  "Churches, Politics, and the Charitable Contribution
    Deduction," Boston College Law Review, v. 42 (July 2001), pp. 843-873.
    Bennett, James T. and Thomas J. DiLorenzo.  Unhealthy Charities:
    Hazardous to Your Health and Wealth, New York: Basic Books, c. 1994.
    -.  "What's Happening to Your Health Charity Donations?,"  Consumers'
    Research, v. 77 (December 1994), pp. 10-15.
    -.  "Voluntarism and Health Care,"  Society, v. 31 (July-August 1994), pp.
    57-65.
    Bloche, M. Gregg. "Health Policy Below the Waterline; Medical Care and
    the Charitable Exemption."  Minnesota Law Review, v. 80 (December 1995),
    pp. 299-405.
    Giving USA 2006, The Annual Report on Philanthropy for the Year 2005,
    The Center on Philanthropy At Indiana University.  Indiana University-
    Purdue University, Indianapolis:  2006.
    Buckles, Johnny Rex. "The Case for the Taxpaying Good Samaritan:
    Deducting Earmarked Transfers to Charity Under Federal Income Tax Law,
    Theory and Policy," Fordham Law Review, v. 70 (March 2002), pp. 1243-
    1339.
    Burns, Jack. "Are Nonprofit Hospitals Really Charitable?: Taking the
    Question to the State and Local Level," Journal of Corporation Law, v.29,
    no. 3, pp. 665-681.
    Clark, Robert Charles.  "Does the Nonprofit Form Fit the Hospital
    Industry?"  Harvard Law Review, v. 93 (May 1980), pp. 1419-1489.
    Clotfelter, Charles T.  "The Impact of Tax Reform on Charitable Giving:
    A 1989 Perspective."  In Do Taxes Matter?  The Impact of the Tax Reform
    Act of 1986, edited by Joel Slemrod, Cambridge, Mass.:  MIT Press, 1990.
    -.  "The Impact of Fundamental Tax Reform on Non Profit Organizations."
     In Economic Effects of Fundamental Tax Reform, Eds. Henry J. Aaron and
    William G. Gale.  Washington, DC:  Brookings Institution, 1996.
    Colombo, John D.  "The Marketing of Philanthropy and the Charitable
    Contributions Deduction:  Integrating Theories for the Deduction and Tax
    Exemption," Wake Forest Law Review, v. 36 (Fall 2001), pp. 657-703.
    Crimm, Nina J.  "An Explanation of the Federal Income Tax Exemption
    for Charitable Organizations: A Theory of Risk Compensation," Florida Law
    Review, v. 50 (July 1998),  pp. 419-462.

    Feenberg, Daniel.  "Are Tax Price Models Really Identified: The Case of
    Charitable Giving," National Tax Journal, v. 40, no. 4 (December 1987), pp.
    629-633.
    Feldman, Naomi and James Hines, Jr. "Tax Credits and Charitable
    Contributions in Michigan," University of Michigan, Working Paper, October
    2003.
    Fisher, Linda A.  "Donor-Advised Funds: The Alternative to Private
    Foundations," Cleveland Bar Journal, v. 72 (July/Aug. 2001), pp. 16-17.
    Frank, Richard G., and David S. Salkever.  "Nonprofit Organizations in the
    Health Sector."  Journal of Economic Perspectives, v. 8 (Fall 1994), pp. 129-
    144.
    Gentry, William M. and John R. Penrod. "The Tax Benefits of Not-For-
    Profit Hospitals," National Bureau of Economic Research Working Paper
    Series, w6435, February 1998, pp. 1-58.
    Gravelle, Jane. Economic Analysis of the Charitable Contribution
    Deduction for Nonitemizers, Library of Congress, Congressional Research
    Service Report RL31108, April 29, 2005.
    Green, Pamela and Robert McClelland. "Taxes and Charitable Giving,"
    National Tax Journal, v. 54 (Sept. 2001), pp. 433-450.
    Greenwald, Leslie, Jerry Cromwell, Walter Adamache, Shulamit Bernard,
    et al. "Specialty Versus Community Hospitals: Referrals, Quality, And
    Community Benefits,"Health Affairs; v. 25, Jan/Feb 2006, pp. 106-119.
    Griffith, Gerald M.  "What the IRS is Examining in CEP Audits of Health
    Care Organizations," Journal of Taxation of Exempt Organizations, v. 11
    (March/April 2000), pp. 201-212.
    Hall, Mark A. and John D. Colombo.  "The Charitable Status of Nonprofit
    Hospitals: Toward a Donative Theory of Tax Exemption," Washington Law
    Review, v. 66 (April 1991), pp. 307-411.
    Horwitz, Jill R., "Making Profits And Providing Care: Comparing
    Nonprofit, For-Profit, And Government Hospitals," Health Affairs, v. 24,
    May/June 2005, pp.790-801.
    - ,"Why We Need the Independent Sector: The Behavior, Law, and Ethics
    of Not-For-Profit Hospitals," University of Michigan Public Law and Legal
    Theory Research Paper No. 35, August 2003, pp. 1345-1411.
    Hyman, David A.  "The Conundrum of Charitability: Reassessing Tax
    Exemption for Hospitals," American Journal of Law and Medicine, v. 16,
    (1990), pp. 327-380.
    Jacobson, Rachel. "The Car Donation Program: Regulating Charities and
    For-Profits," The Exempt Organization Tax Review, v. 45, August 2004, pp.
    213-229.
    Jones, Darryll K.  "When Charity Aids Tax Shelters," Florida Tax Review,
    v. 4 (2001), pp. 770-830.
    Joulfaian, David and Mark Rider. "Errors-In-Variables and Estimated
    Income and Price Elasticities of Charitable Giving,"  National Tax Journal, v.
    57 (March 2004), pp. 25-43.
    Kahn, Jefferey H.  "Personal Deductions: A Tax "Ideal" or Just Another
    "Deal"?," Law Review of Michigan State University, v. 2002 (Spring 2002),
    pp. 1-55.

    Morrisey, Michael A., Gerald J. Wedig, and Mahmud Hassan.  "Do
    Nonprofit Hospitals Pay Their Way?"  Health Affairs, v. 15 (Winter 1996),
    pp. 132-144.
    Omer, Thomas C. "Near Zero Taxable Income Reporting by Nonprofit
    Organizations," Journal of American Taxation Association, v. 25 (Fall 2003),
    pp. 19-34.
    Owens, Bramer. "The Plight of the Not-for-Profit," Journal of Healthcare
    Management, v. 50, July/August 2005, pp. 237-251.
    Randolph, William C.  "Dynamic Income, Progressive Taxes, and the
    Timing of Charitable Contributions,"  Journal of Political Economy, v. 103
    (August 1995), pp. 709-738.
    -.  "Charitable Deductions," in The Encyclopedia of Taxation and Tax
    Policy, eds. Joseph J. Cordes, Robert D. Ebel, and Jane G. Gravelle.
    Washington, DC: Urban Institute Press, 1999, pp.  52-54.
    Sanders, Susan M.,  "Measuring Charitable Contributions:  Implications for
    the Nonprofit Hospital's Tax-exempt Status,"  Hospital and Health Services
    Administration, v. 38 (Fall 1993), pp. 401-418.
    Smith, Bernard.  "Charitable Contributions: A Tax Primer," Cleveland Bar
    Journal, v. 72 (November 2000), pp. 8-11.
    Stokeld, Fred, "ETI Repeal Bill Would Tighten Rules on Vehicle, Patent
    Donations," Tax Notes, October 18, 2004, pp. 293-294.
    Teitell, Conrad.  "Tax Primer on Charitable Giving," Trust & Estates, v.
    139, (June 2000), pp. 7-16.
    Tiehen, Laura. "Tax Policy and Charitable Contributions of Money,"
    National Tax Journal, v. 54 (December 2001), pp. 707-723.
    Tobin, Philip T.  "Donor Advised Funds: A Value-Added Tool for
    Financial Advisors," Journal of Practical Estate Planning, v. 3
    (October/November 2001), pp. 26-35, 52.
    U.S. Congress, Congressional Budget Office.  Budget Options.  See
    Rev-12, Limit Deductions for Charitable Giving to the Amount Exceeding 2
    Percent of Adjusted Gross Income.  Washington, DC:  Government Printing
    Office (February 2005), p 281.
    U.S. Congress, Government Accountability Office.  Vehicle Donations:
    Benefits to Charities and Donors, but Limited Program Oversight, GAO
    Report GAO-04-73, Washington, DC: U.S. Government Printing Office
    (November 2003), pp. 1-44.
    - . Vehicle Donations: Taxpayer Considerations When Donating Vehicles
    to Charities, GAO Report GAO-03-608T, Washington, DC: U.S.
    Government Printing Office (April 2003), pp. 1-15.
    - .  Nonprofit Hospitals: Better Standards Needed for Tax Exemption.
    Washington, DC: U.S. Government Printing Office (May 1990).
    U.S. Congress, House Select Committee on Aging.  Hospital Charity Care
    and Tax Exempt Status: Resorting the Commitment and Fairness.
    Washington, DC: U.S. Government Printing Office (June 1990).
    - , Joint Committee on Taxation, Present Law and Background Relating to
    the Tax-Exempt Status of Charitable Hospitals, JCX-40-06, Washington, DC:
    U.S. Government Printing Office (September 2006), pp. 1-29.

    __ , Technical Explanation Of H.R. 4, The "Pension Protection Act Of
    2006," as Passed by the House on July 28, 2006, and as Considered by the
    Senate on August 3, 2006, JCX-38-06, Washington, DC: U.S. Government
    Printing Office (August 3, 2006), pp. 1-386.
    - .  Staff Discussion Draft: Proposals for Reforms and Best Practices in
    the Area of Tax-Exempt Organizations, Washington, DC: U.S. Government
    Printing Office (June 22, 2004), pp. 1-19.
    U.S. Department of Treasury.  "Charitable Giving Problems and Best
    Practices," testimony given by Mark Everson, Commissioner of Internal
    Revenue, Internal Revenue Service, IR-2004-81, Washington, DC: U.S.
    Government Printing Office (June 22, 2004), pp. 1-17.
    U.S. Government Accountability Office, Nonprofit, For-profit, and
    Government Hospitals: Uncompensated Care and Other Community
    Benefits, testimony of David M. Walker before the Committee on Ways and
    Means, House of Representatives, GAO-05-743T, Washington, DC: U.S.
    Government Printing Office (May 26, 2005), pp. 1-32.
    Wittenbach, James L. and Ken Milani.  "Charting the Interacting
    Provisions of the Charitable Contributions Deductions for Individuals,"
    Taxation of Exempts, v. 13 (July/August 2001), pp. 9-22.
    - , "Charting the Provisions of the Charitable Contribution Deduction for
    Corporations," Taxation of Exempts, v. 13 (November/December 2001), pp.
    125-130.
    Yetman, Michelle H. and Robert J. Yetman. "The Effect of Nonprofits'
    Taxable Activities on the Supply of Private Donations," National Tax
    Journal, v. 56 (March 2003), pp. 243-258.
    Zimmerman, Dennis.  "Nonprofit Organizations, Social Benefits, and Tax
    Policy," National Tax Journal, v. 44 (September 1991), pp. 341-349.

    Health

    TAX CREDIT FOR ORPHAN DRUG RESEARCH

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.2

    0.2

    2007

    0.3

    0.3

    2008

    0.3

    0.3

    2009

    0.3

    0.3

    2010

    0.3

    0.3

    Authorization

    Sections 41(b), 45C, and 280C.

    	Description

    Business taxpayers may claim a tax credit equal to 50 percent of certain
    clinical testing expenses they incur in developing drugs to treat rare diseases
    or conditions.  These drugs are often referred to as orphan drugs.  To qualify
    for the credit, the clinical testing expenses must be incurred or paid after an
    orphan drug has been approved for human testing by the Food and Drug
    Administration (FDA) but before the FDA has approved it for sale in the
    United States.  Under section 526 of the Federal Food, Drug, and Cosmetic
    Act, a rare disease or condition is defined as one affecting fewer than 200,000
    persons in the United States, or as one that may affect more than 200,000
    persons, but for which there is no reasonable expectation of recovering
    research and development costs from U.S. sales alone.  The credit has been a
    component of the general business credit since 1997, making it subject to its
    limitations and carryback and carryforward rules.  As a result, orphan drug
    credits that cannot be used because they exceed the limitations in a tax year
    may be carried back up to three years and forward up to 15 years.

    Not all expenses incurred in connection with clinical trials for orphan drugs
    qualify for the credit.  Specifically, while the cost of supplies and salaries
    does qualify, the cost of depreciable property does not.  Expenses that qualify
    for the orphan drug research credit may not also be used to claim the research
    tax credit under section 41.  What is more, qualified testing expenses
    generally may be deducted in the year when they are incurred or paid as
    qualified research expenditures under section 174.  If a business taxpayer
    claims the orphan drug tax credit, it must reduce any deduction for these
    expenditures it claims by the amount of the credit.

    Impact

    The orphan drug tax credit reduces the cost of capital for private
    investment in orphan drug development and increases the cash flow in the
    short run of firms making such investments.  Most of these benefits are
    captured by pharmaceutical firms, which account for about 80 percent of all
    claims for the credit.

    In the long run, the burden of the corporate income tax (and any benefits
    generated by reductions in the burden) probably extends beyond corporate
    stockholders to owners of capital in general.

    To the extent that the credit accelerates the development for orphan drugs,
    it also benefits persons suffering from rare diseases.  According to FDA's
    Office of Orphan Products Development, more than 280 orphan drugs and
    biological products have received regulatory approval for marketing in the
    United States since the passage of the Orphan Drug Act of 1983; by contrast,
    only 10 such medicines were approved in the decade before 1983.  An
    estimated 14 million Americans have been treated by the orphan drugs
    developed since 1983.

    Rationale

    The orphan drug tax credit first entered the federal tax code through the
    Orphan Drug Act of 1983.  Its main purpose was to provide a robust incentive
    for firms to invest in the development of drugs for diseases that were so rare
    there was little realistic chance of recovering development costs without
    federal support.  The act established two other forms of government support
    for orphan drugs:  federal grants for the testing of drugs, and a seven-year
    period of marketing exclusivity for orphan drugs approved by the FDA.
    Under the act, the only test for determining a drug's eligibility was that there
    be no reasonable expectation of recovering its cost of development from U.S.
    sales alone.

    This test soon proved unworkable, as it required business taxpayers to
    provide detailed proof that a drug in development would end up being
    unprofitable.  So in 1984, Congress passed Public Law 98-551, which added
    another eligibility test:  namely, that the potential domestic market for a drug
    not exceed 200,000 persons.

    The initial tax credit was scheduled to expire at the end of 1987, but it was
    extended in succession by the Tax Reform Act of 1986, the Omnibus Budget
    Reconciliation Act of 1990, the Tax Extension Act of 1991, and the Omnibus
    Reconciliation Act of 1993.  The credit expired at the end of 1994 but was
    reinstated for the period July 1, 1996, through May 31, 1997 by the Small
    Business Job Protection Act of 1996, which also allowed taxpayers with
    unused credits to carry them back up to three tax years or carry them forward
    up to 15 tax years.  The credit became a permanent part of the Internal
    Revenue Code with the passage of the Taxpayer Relief Act of 1997.

    To increase U.S. investment in the development of diagnostics and
    treatments for patients with rare diseases and disorders, Congress passed the
    Rare Diseases Act of 2002.  Among other things, the act established an Office
    of Rare Diseases at the National Institutes of Health and authorized increases
    in annual funding from FY2003 through FY2006.

    Assessment

    Supporters of the Orphan Drug Act cite the fact that over 280 orphan drugs
    have been approved for marketing since the passage of the act, and that over
    14 million Americans have been treated with them, as conclusive proof that
    the act's incentives are working as intended.

    But not everyone takes such a rosy view of the act.  Some critics charge
    that more than a few pharmaceutical and biotechnology firms have taken
    advantage of the incentives for orphan drug development to develop and
    market drugs that have earned billions in sales revenue worldwide since their
    approval by the FDA.  In 2003, for example, a total of nine such drugs each
    had worldwide sales in excess of $1 billion.  These critics argue that many of
    the highly profitable orphan drugs that have entered the market since 1983
    would have been developed without government support.  Supporters of the
    act dismiss this argument by noting that it is impossible to know in advance
    whether a drug intended to treat a very small population will eventually gain
    blockbuster status.

    Others have criticized the design of the Orphan Drug Act's incentives
    without calling into question the need for government support.  For example,
    some argue that current regulations for orphan drugs permit firms to classify
    drugs with multiple uses as being useful for a narrow range of applications
    only, making it easier for the drugs to qualify as orphans.

    The orphan drug tax credit encourages private investment in the
    development of drugs to treat rare diseases.  While some find this effect
    laudable, others view it as problematic.  For the latter, the credit raises the
    question of whether it is appropriate or desirable for federal tax policy to
    divert economic resources from the development of drugs that may benefit a
    multitude of persons to the development of drugs that benefit relatively few,
    albeit with dramatic results in some cases.

    	Selected Bibliography

    Asbury, Carolyn H.  "The Orphan Drug Act: the First 7 Years," Journal of
    the American Medical Association, v. 265.  February 20, 1991, pp. 893-897.
    Biotechnology Industry Organization.  Clarification Needed in the Orphan
    Drug Tax Credit to Accelerate Research in Rare Diseases. Washington:
    April 11, 2003.
    Edgerly, Maureen.  "Regulatory: Orphan Drug Regulation," Research
    Practitioner, v. 3 (Jan.-Feb. 2002), pp. 21-23.
    Flynn, John J.  "The Orphan Drug Act:  An Unconstitutional Exercise of
    the Patent Power," Utah Law Review, no. 2 (1992), pp. 389-447.
    Guenther, Gary.  Federal Taxation of the Pharmaceutical Industry: Effects
    on New Drug Development and Legislative Initiatives in the 109th Congress.
    Congressional Research Service Report RL31511.  Washington: June 1,
    2005.
    Haffner, Marlene E.  "Orphan Products-Ten Years Later and Then Some,"
    Food and Drug Law Journal,  v. 49 (1994), pp. 593-601.
    -.  "Adopting Orphan Drugs: Two Dozen Years of Treating Rare
    Diseases."  New England Journal of Medicine, vol. 354, no. 5, February 2,
    2006, p. 445.
    Hamilton, Robert A.  "'Orphans' Saving Lives," FDA Consumer, v. 24
    (November 1990), pp. 7-10.
    Henkel, John.  "Orphan Products - New Hope for People with Rare
    Disorders," FDA Consumer, 2nd. Ed. (1995), pp. 46-49.
    Kiely, Tom.  "Spoiled by Success?  Biotechnology Companies Abused the
    Intent of the Orphan Drug Act," Technology Review, v. 94, no. 3, (April
    1991), pp. 17-18.
    Lang, Jean and Susan C. Wood. "Development of Orphan Vaccines: An
    Industry Perspective," Emerging Infectious Diseases, v. 5 (Nov.-Dec. 1999),
    pp. 749-756.
    Levitt, Joseph A. and John V. Kelsey.  "The Orphan Drug Regulations and
    Related Issues," Food and Drug Law Journal, v. 48 (1993), pp. 525-535.
    Love, James and Michael Palmedo.  Costs of Human Use Clinical Trials:
    Surprising Evidence from the US Orphan Drug Act.  Consumer Project on
    Technology.  November 28, 2001, available at http://www.cptech.org.
    Shulman, Shelia R., Brigitta Bienz-Tadmor, Pheak Son Seo, Joseph A.
    DiMasi, and Louis Lasagna.  "Implementation of the Orphan Drug Act:
    1983-1991,"  Food and Drug Law Journal, v. 47 (1992), pp. 363-403.

    Thamer, Mae, Niall Brennan, and Rafael Semansky.  "A Cross-National
    Comparison of Orphan Drug Policies: Implications for the U.S. Orphan Drug
    Act," Journal of Health Politics, Policy and Law, v. 23 (April 1998), pp.
    265-290.
    Thomas, Cynthia A.  "Re-Assessing the Orphan Drug Act," Columbia
    Journal of Law and Social Problems, v. 23, No. 3.  1990, pp. 413-440.
    Treinish, Nathan J.  "Developing Drugs for Tropical Diseases Rare in the
    United States: A Case Study on African Sleeping Sickness," Food and Drug
    Law Journal, v. 48 (1993), pp. 533-535.
    U.S. Department of Health and Human Services, Public Health Service,
    Food and Drug Administration.  From Test Tube to Patient: New Drug
    Development in the United States, Rockville, MD: 1995. 67 p.

    Health

     TAX CREDIT FOR PURCHASE OF HEALTH INSURANCE
    BY CERTAIN DISPLACED PERSONS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.2

    -

    0.2

    2007

    0.2

    -

    0.2

    2008

    0.2

    -

    0.2

    2009

    0.2

    -

    0.2

    2010

    0.3

    -

    0.3

    Authorization

    Section 35.

    Description

    Eligible taxpayers are allowed a refundable tax credit for 65
    percent of the premiums they pay for qualified health insurance for
    themselves and family members.  The credit is now known as the
    health coverage tax credit (HCTC).  Eligibility is limited to three
    groups: (1) individuals who are receiving a Trade Readjustment
    Assistance (TRA) allowance, or who would be except their state
    unemployment benefits are not yet exhausted; (2) individuals who are
    receiving an Alternative Trade Adjustment Assistance allowance for
    people age 50 and over; and (3) individuals who are receiving a
    pension paid in part by the Pension Benefit Guaranty Corporation
    (PBGC), or who received a lump-sum PBGC payment, and are age
    55 and over.  For TRA recipients, eligibility for the HCTC generally
    does not extend beyond two years, the maximum length of time most
    can receive TRA allowances or benefits, and could be less in some
    states.

    The HCTC is not available to individuals who are covered under
    insurance for which an employer or former employer pays 50
    percent or more of the cost, who are entitled to benefits under
    Medicare part A or an armed services health plan, or who are
    enrolled in Medicare part B, Medicaid, the State Children's Health
    Insurance Program (SCHIP), or the federal employees health plan.
    The Treasury Department makes advance payments of the credit to
    insurers for eligible taxpayers who choose this option.

    The HCTC can be claimed only for ten types of insurance specified
    in the statute.  Seven require state action to become effective,
    including coverage through a state high risk pool, coverage under a
    plan offered to state employees, and, in some limited circumstances,
    coverage under individual market insurance.  As of October, 2006,
    42 states and the District of Columbia made at least one of the seven
    types of coverage available; in the remaining 8 states, only three
    automatically qualified types not requiring state action were
    available, though not necessarily to all individuals eligible for the
    credit.  For example, COBRA continuation coverage is available in
    all states, but it applies only if the taxpayer had employment-based
    insurance prior to losing his job and the employer continues to
    provide the insurance to the remaining employed workers.

    Impact

    The HCTC substantially reduces the after-tax cost of health
    insurance for eligible individuals and has enabled some to maintain or
    acquire coverage.  However, given the cost of health insurance,
    which in 2006 approached $4,300 a year for typical comprehensive
    single coverage and $11,500 a year for typical comprehensive family
    coverage, a 65 percent credit has often not been sufficient to ensure
    coverage for workers who are unemployed for extended periods (in
    the case of TRA recipients) or who are early retirees (in the case of
    those receiving pensions paid by the PBGC).  For these workers,
    paying the remaining 35 percent of the cost of the insurance can be
    difficult.  Sometimes cash-constrained individuals reassess their need
    for insurance altogether, particularly if they are young and single. In
    addition to not being able to afford the remaining 35% of the cost,
    taxpayers have had difficulty learning about eligibility, finding
    qualifying insurance, and quickly arranging for advance payments.

    According to the Treasury Department Inspector General, during
    2005 approximately 22,000 taxpayers participated in the advance
    payment arrangements while some 2,200 claimed the credit on their
    tax returns after the end of the year.  (The two groups might not be
    mutually exclusive.)

    Rationale

    The HCTC  was authorized by the Trade Act of 2002 (P.L.
    107-210).  One impetus for the legislation was to assist workers who
    had lost their jobs, and consequently their health insurance coverage,
    due to economic dislocations in the wake of the September 11, 2001
    terrorist attacks.  Difficulties in reaching consensus on who should be
    included in this group contributed to the decision to restrict eligibility
    for the credit primarily to workers adversely affected by international
    trade (e.g., imported goods contributed importantly to their
    unemployment, or their companies shifted production to other
    countries).  Extension to taxpayers receiving pensions paid by the
    PBGC occurred late in the legislative process.

    By adopting a tax credit, Congress signaled its intention to help
    individuals maintain or acquire private market health insurance
    rather than expand public insurance programs like Medicaid or
    SCHIP.   Both proponents and opponents see the credit as a
    legislative precedent for a broader tax credit that may become the
    principal strategy for reducing the number of uninsured, who by one
    measure now exceed 45 million.  Thus, the rationale for the credit
    may lie more in what it indicates for future policy than in what it
    presently accomplishes.

    Assessment

    Tax credits for health insurance can be assessed by their
    effectiveness in continuing and expanding coverage, particularly for
    those who would otherwise be uninsured, as well as from the
    standpoint of equity.  The HCTC is helping some unemployed and
    retired workers keep their insurance, at least temporarily; the impact
    may be greatest in the case of individuals who most need insurance
    (those with chronic medical conditions, for example) and who have
    the ability to pay the 35% of the cost not covered by the credit.  For
    many eligible taxpayers, the effectiveness of the credit may depend
    on the advance payment arrangements; these might work well where
    there is a concentration of eligible taxpayers (where a plant is closed,
    for example) and if the certification process is simple and not
    perceived as part of the welfare system.

    The HCTC has not reached many of the people it was intended to
    benefit.  According to estimates by Stan Dorn and others of the
    Economic and Social Research Institute, in July, 2005 there were
    about 234,000 eligible workers and retirees, of whom about
    118,000 did not have disqualifying coverage from another source
    (through a spouse, for example).  They estimated that at most
    25,500 taxpayers might receive the credit (a higher number than the
    later Treasury estimate cited above), or about 11% of all the eligibles
    and 22% of all eligibles without other coverage.  Considering the
    administrative cost of establishing and implementing the HCTC
    program (estimated by the GAO as $69 million through April, 2004,
    and $40 million a year thereafter), one might ask whether the HCTC
    costs exceed the benefits.

    The 65% HCTC rate is available to all eligible taxpayers with
    qualified insurance, regardless of income.  From the standpoint of
    inclusiveness, this seems equitable.  Using ability to pay as a measure,
    however, the one rate appears inequitable since it provides the same
    dollar subsidy to taxpayers regardless of income.  An unemployed
    taxpayer with an employed spouse, for example, can receive the
    same credit amount as a taxpayer in a household where no one
    works.  At the same time, the credit is refundable, so it is not limited
    to the taxpayer's regular tax liability.

    The 65% rate approaches the proportion of insurance typically
    paid by employers; from this perspective, the HCTC continues what
    employers would be paying if the workers had not lost their jobs.
    However, employers can claim a tax deduction for their insurance
    expense and likely shift most of their after-tax cost back to the
    workers in the form of reduced wages and other benefits.  By an
    economic measure, employer subsidies for health insurance probably
    are far less than 65%.  But if a 65% tax credit provides a more
    generous subsidy than employers, it apparently is still not high
    enough to help many cash-constrained families purchase insurance.

    The HCTC is limited to taxpayers in one of the three eligibility
    groups described above, who likely consider it appropriate to receive
    tax benefits for health insurance since most other taxpayers receive
    some as well.  However, unemployed workers who do not receive
    TRA allowances or benefits may question why they are denied the
    credit, as may early retirees whose pensions are not paid by the
    PBGC, or who receive no pension at all.

    The present tax credit is available to families that have individual
    market insurance only in limited circumstances.  (If they do not
    purchase such insurance through a state qualified plan, they must
    have had it during the entire 30-day period prior to the separation
    from employment that qualified the worker for the TAA or PBGC
    assistance. )  Some observers criticize these restrictions for limiting
    consumer choice; they argue that younger and healthier families
    could find less expensive individual coverage than what they must pay
    for group plans.  Others see the restriction as helping to preserve
    larger insurance pools, which help keep rates down for older and less
    healthy individuals.

    Some observers also criticize the requirements that state-operated
    health plans must meet in order to be considered qualified insurance
    for purpose of the credit, including guaranteed issue, no preexisting
    condition exclusions, nondiscriminatory premiums, and similar
    benefit packages.  In their view, these requirements drive up the cost
    of insurance and lead some to forego coverage altogether.  Other
    observers, however, maintain that these requirements are essential
    consumer protections.

    Selected Bibliography

    Gabel, Jon R. et al. Are Tax Credits Alone the Solution to
    Affordable Health Insurance?  Comparing Individual and Group
    Insurance Costs in 17 U.S. Markets.  Task Force on the Future of
    Health Insurance.  The Commonwealth Fund.  (May, 2002).
    Dorn, Stan, Janet Varon, and Fouad Pervez, Limited Take-Up of
    Health Coverage Tax Credits and the Design of Future Tax Credits
    for the Uninsured.  Economic and Social Research Institute.
    (November, 2005)

    Graney, Paul J.  Trade Adjustment Assistance for Workers: A Fact
    Sheet.  Library of Congress, Congressional Research Service Report
    94-478 EPW, Updated periodically.
    Institute for Health Policy Solutions.  Individual Tax Credits and
    Employer Coverage: Assessing and Reducing the Downside Risks.
    (August, 2002).
    Kaiser Family Foundation.  Retired Steelworkers and Their Health
    Benefits: Results from a 2004 Survey.  (May, 2006).
    Lyke, Bob.  Tax Benefits for Health Insurance.  Library of
    Congress, Congressional Research Service Issue Brief 98037.
    Updated regularly.
    Pauly, Mark, and John Hoff.  Responsible Tax Credits for Health
    Insurance.  The AEI Press (2002).
    Pauly, Mark, and Paul Hogan.  Expanding Coverage via Tax
    Credits: Trade-Offs and Outcomes.  Health Affairs. v. 20 no. 1
    ((January/February, 2001), pp. 9-26.
    Stone-Axelrad, Julie and Bob Lyke.  Health Coverage Tax Credit
    Authorized by the Trade Act.  Library of Congress, Congressional
    Research Service Report RL32620. (October, 2004).
    U.S. Government Accountability Office.  Health Coverage Tax
    Credit: Simplified and More Timely Enrollment Process Could
    Increase Participation. GAO-04-1029.  (September, 2004).
    ----- Trade Adjustment Assistance: Most Workers in Five Layoffs
    Received Services, but Better Outreach Needed on New Benefits.
    GAO-06-43 (January, 2006)
    U.S. Internal Revenue Service.  Information about the Health
    Coverage Tax Credit is available through the IRS website
    http://www.irs.gov/individuals/article/0,,id=109915,00.html.
    U.S. Treasury Inspector General for Tax Administration.
    Financial Controls Over the Health Coverage Tax Credit Advance
    Payment Process Need to be Enhanced.  Reference no. 2006-10-
    085 (May, 2006).

    	Medicare

    EXCLUSION OF UNTAXED MEDICARE BENEFITS:
    HOSPITAL INSURANCE

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    18.5

    -

    18.5

    2007

    20.7

    -

    20.7

    2008

    22.5

    -

    22.5

    2009

    24.5

    -

    24.5

    2010

    26.7

    -

    26.7

    Authorization

    Rev. Rul. 70-341, 1970-2 C.B. 31.

    Description

    The Medicare program has main three components:  A, B, and D.  In
    essence, part A offers hospital insurance (HI).  More specifically, it helps pay
    for most in-patient hospital care and up to 100 days a year of skilled nursing
    facility care, home health care, and hospice care for individuals who are age
    65 or over or disabled.  In 2005, an estimated 42 million aged and disabled
    persons were enrolled in Part A, and expenditures for Part A benefits totaled
    an estimated $182.9 billion.

    Medicare Part A is financed primarily by a payroll tax levied on the
    earnings of current workers.  The tax rate is 2.90 percent, and there is no
    ceiling on the earnings subject to the tax.  Self-employed individuals pay the
    full rate, while employees and employers each pay 1.45 percent.  The revenue
    from the tax is placed in a trust fund, from which payments are made to health
    care providers.  Such a financing scheme is intended to make it possible for
    individuals to contribute to the fund during their working years so that they
    can receive Part A benefits during their retirement years.

    The employer's share of the payroll tax is excluded from an employee's
    taxable income.  In addition, the expected lifetime value of Part A benefits
    under current law exceeds the amount of payroll tax contributions by current
    beneficiaries.  The projected excess benefits are excluded from the taxable
    income of Medicare Part A beneficiaries.

    Impact

    All Medicare Part A beneficiaries are assumed to receive the same dollar
    value of in-kind insurance benefits per year.  Nonetheless, there is substantial
    variation among individuals in the portion of those benefits covered by their
    payroll tax contributions - or the portion considered untaxed benefits.

    The portion of benefits received by a Medicare beneficiary that is
    considered untaxed depends on an individuals's history of taxable earnings
    and life expectancy when benefits are received.  Untaxed benefits are likely to
    be larger for persons who became eligible in the earliest years of the Medicare
    program, for persons who had low taxable wages in their working years or
    who qualified as a spouse with little or no payroll contributions of their own,
    and for persons who have a relatively long life expectancy.  Beyond these
    considerations, the tax expenditure arising from any dollar of untaxed
    insurance benefits depends on a beneficiary's marginal income tax rate during
    retirement.

    Rationale

    The exclusion of Medicare Part A benefits from the federal income tax has
    never been established or endorsed by statute.  Although the Medicare
    program was created in 1965, it was not until 1970 when the Internal
    Revenue Service ruled (Rev. Rul. 70-341) that the benefits under Part A of
    Medicare may be excluded from gross income because they are in the nature
    of disbursements intended to achieve the social welfare objectives of the
    Federal Government.  The ruling also made clear that in determining an
    individual's gross income under section 61 of the Internal Revenue Code,
    Medicare Part A benefits had the same legal status as the monthly Social
    Security payments to an individual.  An earlier IRS ruling (Rev. Rul. 70-217,
    1970-1 C.B. 13) allowed these payments to be excluded from gross income.

    Assessment

    In effect, the tax subsidy for Part A benefits lowers the after-tax cost to the
    elderly for the hospital care they receive under Medicare.  Consequently, it is
    thought to divert more resources to the delivery of medical care through
    hospitals than otherwise might be the case.

    Those who favor curtailing this subsidy, as a means of increasing federal
    revenue or dampening the use of hospitals by the elderly, would find it
    difficult to so in an equitable manner.  There are at least two reasons for this
    difficulty.  First, Medicare benefits receive the same tax treatment as most
    other health insurance benefits:  they are untaxed.  Second, taxing the value of
    the health care benefits actually received by an individual would have a
    disproportionately large impact on people who suffer health problems that are
    costly to treat, many of whom are elderly and living on relatively small
    incomes.

    Under the Omnibus Budget Reconciliation Act of 1993 (OBRA93), some
    of the Social Security payments received by taxpayers whose so-called
    provisional income exceeds certain income thresholds is subject to taxation,
    and the revenue is deposited in the HI trust fund.  A taxpayer's provisional
    income is his or her adjusted gross income, plus 50 percent of any Social
    Security benefit and the interest received from tax-exempt bonds.  If a
    taxpayer's provisional income falls between income thresholds of $25,000
    ($32,000 for a married couple filing jointly) and $34,000 ($44,000 for a
    married couple), then the portion of Social Security benefits that are taxed is
    the lesser of 50 percent of the benefits or 50 percent of provisional income
    above the first threshold.  If a taxpayer's provisional income is greater than
    the second threshold, then the portion of Social Security benefits subject to
    taxation is the lesser of 85 percent of the benefits or 85 percent of provisional
    income above the second threshold, plus the smaller of $4,500 ($6,000 for
    married couples) or 50 percent of benefits.  (See the entry on the exclusion of
    untaxed Social Security and railroad retirement benefits for more details).
    The same rules apply to railroad retirement tier 1 benefits.

    For future retirees, the share of HI benefits they receive beyond their
    payroll tax contributions is likely to decrease gradually over time, as the
    contribution period will cover more of their work years.  In addition, the
    absence of a cap on worker earnings subject to the Medicare HI payroll tax
    means that today's high-wage earners will contribute more during their
    working years and consequently receive a smaller (and possibly negative)
    subsidy once they begin to receive Medicare Part A benefits.

    Before 1991, the taxable earnings base for Medicare Part A was the same
    as the earnings base for Social Security.  But the Omnibus Budget
    Reconciliation Act of 1990 (P.L. 101-508) drove a wedge between the two
    bases by raising the annual cap on employee earnings subject to the Medicare
    HI tax to $125,000 in 1991 and indexing it for inflation in succeeding years.
    OBRA93 repealed the cap on wages and self-employment income subject to
    the Medicare HI tax, as of January 1, 1994.

    In adopting changes in the HI payroll tax in 1990 and 1993, Congress
    chose a more progressive approach to financing the HI trust fund than the
    chief alternative of raising HI payroll tax rates on the Social Security earnings
    base.

    Selected Bibliography

    Bryant, Jeffrey J.  "Medicare HI Tax Becomes a Factor in Planning for
    Compensation and SE Income," The Journal of Taxation.  January, 1995, pp.
    32-34.
    Christensen, Sandra.  "The Subsidy Provided Under Medicare to Current
    Enrollees," Journal of Health Politics, Policy, and Law, v. 17, no. 2.
    Summer 1992, pp. 255-64.
    Nuschler, Dawn.  Social Security and Medicare Taxes and Premiums: Fact
    Sheet.  Library of Congress, Congressional Research Service Report 94-28,
    Washington, DC:  January 13, 2004.
    O'Sullivan, Jennifer.  Medicare: Financing the Part A Hospital Insurance
    Program.  Library of Congress, Congressional Research Service Report
    RS20173, Washington, DC:  May 3, 2006.
    U.S. Congress, Congressional Budget Office.  Budget Options.
    Washington, DC: February 2001, p. 412.
    -, House Committee on Ways and Means.  2004 Green Book.  Committee
    Print, 108th Congress, 2nd Session.  Washington, DC: U.S. Govt. Print. Off.,
    March 2004.  pp. 2-1 to 2-155.
    Wilensky, Gail R. "Bite-Sized Chinks of Health Care Reform--Where
    Medicare Fits In," in Henry J. Aaron, The Problem That Won't Go Away.
    Washington, DC: The Brookings Institution, 1996.

    Medicare

    EXCLUSION OF MEDICARE BENEFITS:
    SUPPLEMENTARY MEDICAL INSURANCE

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    12.5

    -

    12.5

    2007

    14.2

    -

    14.2

    2008

    15.4

    -

    15.4

    2009

    16.7

    -

    16.7

    2010

    18.1

    -

    18.1

    Authorization

    Rev. Rul. 70-341, 1970-2 C.B. 31.

    Description

    The Medicare program currently has three main components:  A, B, and C.
     Part B of Medicare provides supplementary medical insurance (SMI).
    Among the services covered under Part B are certain physician services,
    outpatient hospital services, and durable medical equipment.  In 2005, an
    estimated 39.6 million aged and disabled Americans were enrolled in SMI,
    and expenditures for SMI totaled $153.5 billion.

    Unlike Part A of Medicare, participation in SMI is voluntary.  Enrollees
    must pay a monthly premium that varies over time; in 2006, it is $88.50.  The
    program generally pays for 80 percent of Medicare's fee schedule or other
    approved amount once a beneficiary has met an annual deductible, which is
    $124 in 2006.  Premiums are permanently set to cover 25 percent of the
    program's costs for most recipients; the remaining 75 percent is funded out of
    general revenues.  Starting in 2007, certain high-income Medicare enrollees
    will pay higher percentages of their Part B premiums.

    Transfers from the general fund of the U.S. Treasury to cover the cost of
    covered services are excluded from the taxable income of enrollees.

    Impact

    The tax expenditure associated with this exclusion hinges on the marginal
    tax rates of enrollees.  Unlike many other tax expenditures (where the amount
    of the subsidy can vary considerably among individual taxpayers), the
    general-fund premium subsidy for SMI is the same for all enrollees.  All
    enrollees are assumed to receive the same dollar value of in-kind benefits and
    hence are charged the same monthly premium.  As a result, they receive the
    same subsidy, which is measured as the difference between the value of
    insurance benefits and the premium.  Nonetheless, the tax savings from the
    exclusion are greater for enrollees in higher tax brackets.  Taxpayers who
    claim the itemized deduction for medical expenses under section 213 may
    include any Part B premiums they pay or have deducted from their monthly
    Social Security benefits.

    Rationale

    The exclusion of Medicare benefits has never been expressly established or
    endorsed by statute.  Rather, it emerged from two related regulatory rulings by
    the Internal Revenue Service (IRS).

    In 1966, the Internal Revenue Service (IRS) ruled (Rev. Rul. 66-216) that
    the premiums paid for coverage under Part B of Medicare may be deducted as
    a qualified medical expense under section 213.  But the ruling did not address
    the tax treatment of the benefits received through Part B.

    The IRS did address this issue four years later.  In 1970, the agency ruled
    (Rev. Rul. 70-341) that Medicare Part B benefits should be excluded from
    taxable income on the grounds that they have the same status under the tax
    code as "amounts received through accident and health insurance for personal
    injuries or sickness."  These amounts are excluded from taxable income under
    section 104(a).

    It is not clear from Rev. Rul. 70-341whether the exclusion of Part B
    benefits applies to all such benefits, or only to the portion of benefits financed
    out of premiums.  Nevertheless, the exclusion has applied to all Part B
    benefits (including the portion financed out of general revenues) received by a
    taxpayer in the years since 1970.  This tax treatment is supported by a line of
    reasoning used by the IRS to justify the exclusion of Medicare Part A
    benefits.  In Rev. Rul. 70-341, the agency noted that the benefits received by
    an individual under Part A are not "legally distinguishable from the monthly
    payments to an individual under title II of the Social Security Act."  The IRS
    also noted that the agency had ruled in an earlier revenue ruling (Rev. Rul.
    70-217) that monthly Social Security payments should not be included in the
    gross income of recipients, because they are "made in furtherance of the
    social welfare objectives of the Federal government."  Thus, it followed, in
    the view of the IRS, that the "basic medicare benefits received by (or on
    behalf of) an individual under part A title XVIII of the Social Security Act are
    not includible in the gross income of the individual for whom they are paid."

    Assessment

    Medicare benefits are similar to most other health insurance benefits in that
    they are exempt from taxation.

    Initially, Part B premiums were set to cover 50 percent of projected SMI
    program costs.  But between 1975 and 1983, that share gradually fell to less
    than 25 percent.  From 1984 through 1997, premiums were set to cover 25
    percent of program costs for the aged under successive laws (an exact dollar
    figure rather than a percentage applied over the 1991-1995 period).  The
    Balanced Budget Act of 1997 (P.L. 105-33) permanently made the Part B
    premium equal to 25 percent of projected program costs.

    The tax subsidy for Part B reduces the after-tax cost of supplementary
    medical insurance to retirees.  One possible result is that individuals end up
    purchasing excessive or inefficient amounts of health care.  Moreover, as the
    subsidy is not means-tested, many high-income elderly individuals do benefit
    from it.

    Some have proposed adding the value of the subsidy to taxable income.
    There appear to be no insurmountable administrative barriers to doing so.
    The value of the subsidy could be estimated, assigned to beneficiaries, and
    reported as income on their tax returns.  One drawback to such a proposal is
    that it would impose a burden on older individuals of moderate means who
    have little flexibility in their budgets to absorb an additional tax.

    Legislation to lower or eliminate the subsidy for high-income individuals
    would have the same effect as taxing it.  Several proposals introduced in
    recent Congresses would effectively raise the Part B premiums for high-
    income enrollees - in some cases, the increase would cover 100 percent of
    average benefits per enrollee - by recapturing the subsidy through the
    individual income tax.  All revenues raised by taxing the subsidy would be
    added to the Medicare SMI Trust Fund.  An individual would be permitted to
    deduct the recaptured amount to the same extent that is allowed with other
    health insurance premiums.  Any employer reimbursement of the recaptured
    amount would be excluded from the recipient's taxable income.

    Selected Bibliography

    Christensen, Sandra.  "The Subsidy Provided Under Medicare to Current
    Enrollees," Journal of Health Politics, Policy, and Law, v. 17, no. 2.  summer
    1992, pp. 255-64.

    O'Sullivan, Jennifer.  Medicare: Part B Premiums.  Library of Congress,
    Congressional Research Service Report RL32582.  Washington, DC: October
    19, 2006.
    U.S. Congress.  Congressional Budget Office.  Budget Options.
    Washington, DC: February 2001, p. 412.
    -, House Committee on Ways and Means.  2004 Green Book.  Committee
    Print, 108th Congress, 2nd Session.  Washington, DC: U.S. Govt. Print. Off.,
    March 2004.  pp. 2-1 to 2-155.
    Wilensky, Gail R. "Bite-Sized Chinks of Health Care Reform - Where
    Medicare Fits In," in Henry J. Aaron, The Problem That Won't Go Away.
    Washington, DC: The Brookings Institution, 1996.

    Medicare

    EXCLUSION OF SUBSIDY PAYMENTS TO EMPLOYERS
    OFFERING CERTAIN PRESCRIPTION DRUG BENEFITS TO
    RETIREES ELIGIBLE FOR MEDICARE

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    -

    0.7

    0.7

    2007

    -

    1.2

    1.2

    2008

    -

    1.4

    1.4

    2009

    -

    1.5

    1.5

    2010

    -

    1.6

    1.6

    Authorization

    Section 139A and Section 1860D-22 of the Social Security Act (42 U.S.C.
    1395w-132)

    Description

    The Medicare program has three main elements:  Parts A , B, and D.  Part
    D offers a voluntary outpatient prescription drug benefit that began on
    January 1, 2006.  Every individual enrolled in Medicare Parts A or B, or who
    receives Medicare benefits through a private heath plan under Part C, is
    eligible to take advantage of this benefit by enrolling in a qualified
    prescription drug plan.

    Under Part D, beneficiaries have the choice of purchasing standard drug
    coverage or alternative coverage with actuarially equivalent benefits from any
    approved plan.  In 2006, standard coverage has the following elements:  a
    $250 deductible; 25-percent coinsurance for qualified drug expenses from
    $251 to an initial coverage limit of $2,250; no coverage above this amount
    until an annual out-of-pocket threshold of $3,600 is reached; then unlimited
    coverage for expenses above $3,600, with enrollees paying the greater of $2
    for generic drugs and $5 for branded drugs or a 5-percent coinsurance fee.
    An enrollee's out-of-pocket spending on drugs counting toward the out-of-
    pocket threshold does not include amounts paid or reimbursed by most third
    parties, including retiree health plans.  In future years, the deductible, initial
    coverage limit, and the out-of-pocket threshold will be indexed to annual
    growth in per-capita spending by Medicare beneficiaries on drugs covered
    under Part D.

    Coverage is obtained through private prescription drug plans or Medicare
    comprehensive plans that integrate Part A and B benefits under a revised Part
    C known as Medicare Advantage.  Enrollees pay premiums that are intended
    to cover 26 percent of the overall cost of drug benefits under Part D; in 2006,
    the average premium is expected to be $35 a month.  Substantial subsidies are
    available to encourage extensive participation by low-income Medicare
    beneficiaries, and to dissuade large numbers of public and private employers
    and unions that offer prescription drug benefits to retirees from dropping or
    sharply curtailing such coverage.

    Public and private employers and unions providing prescription drug
    benefits to retirees eligible for Medicare face several options under Part D, all
    of which are intended to encourage them to retain or enhance these benefits.
    First, they can elect to receive subsidy payments from Medicare, if the drug
    benefits they offer to qualified retirees are actuarially equivalent to the
    standard drug coverage under Part D.  Second, they can coordinate their drug
    benefits for retirees with the standard drug coverage under Part D by
    supplementing the Medicare coverage.  Third, they can enter into a contract
    with an approved Medicare drug plan or a Medicare Advantage plan to
    provide drug benefits to retirees.  Finally, they can stop providing drug
    benefits to retirees altogether, forcing those who are eligible for Medicare to
    enroll in a Part D plan.

    Public and private employers and unions that choose to receive the subsidy
    payments must adhere to certain rules in order to remain eligible to receive
    them.  Under a ruling by the Centers for Medicaid and Medicare, so-called
    account-based health plans (e.g., flexible spending accounts, health savings
    accounts, and Archer medical savings accounts) do not qualify as creditable
    coverage under this standard.  A qualified retiree is an individual who is
    eligible for coverage under part D but not enrolled in it, and who is covered
    under an employment-based group health plan.  The Secretary of Health and
    Human Services (HHS) has the authority to audit the prescription drug
    benefits offered to qualified retirees by employers or unions seeking or
    receiving subsidy payments to determine whether they conform to this
    standard.  In addition, to continue to receive the payments, an employer or
    union must provide HHS with annual proof that the prescription drug benefits
    it provides Medicare-eligible retirees are actuarially equivalent to the standard
    coverage under Part D.

    In 2006, the subsidy payments are equal to 28 percent of a retiree's
    allowable gross prescription drug costs between $250 to $5,000.  These costs
    are defined as the combined amounts paid by a qualified retiree and his or her
    employer for prescription drugs covered under Part D, less rebates and
    discounts.  The maximum payment per retiree in 2006 is $1,330.  In future
    years, the upper limit will be indexed to annual growth in per-capita spending
    by Medicare beneficiaries on prescription drugs covered under Part D.

    Employers who choose to receive subsidy payments are allowed to exclude
    them from their taxable income under both the regular income tax and the
    alternative minimum tax.  In addition, the allowable drug costs used to
    determine the subsidy payments received by an employer may be included in
    the employer's deduction for contributions to health and accident plans for
    current and retired workers.

    Impact

    Generally, all sources of income are subject to taxation, except those
    specifically excluded by statute.  Section 61 identifies the sources of income
    that are usually taxed, including employee compensation, capital gains,
    interest, and dividends.  Nonetheless, some sources of income are granted a
    statutory exemption from taxation, including certain death benefits, interest
    on state and local bonds, amounts received under employer accident and
    health plans, certain other fringe benefits, and disaster relief payments.
    Sections 101 to 140 identify those sources and explain their tax treatment.
    The new Medicare subsidy payments for certain employers under section
    139A are one of these sources.  Their exclusion from taxable income is
    considered a tax expenditure.

    In combination, the subsidy and its preferential tax treatment significantly
    reduce the after-tax cost to employers of providing prescription drug benefits
    to retirees eligible for Medicare.  The exclusion for the subsidy payments
    means that they are equivalent to larger taxable payments tied to an
    employer's marginal tax rate.  For example, for employers taxed at a marginal
    rate of 35 percent, a subsidy payment of $1,000 would be equivalent to a
    taxable payment of $1,538:  $1,000/(1-.35) = $1,538.

    Rationale

    In passing the Medicare Prescription Drug, Improvement, and
    Modernization Act of 2003 (MMA, P.L. 108-173), Congress added a
    voluntary outpatient prescription drug benefit to Medicare.  Among other
    things, the act allows Medicare to make subsidy payments beginning in 2006
    to employers offering qualified prescription drug benefits to retirees eligible
    for Medicare.  The MMA also permits employers receiving such payments to
    exclude them from taxable income and to disregard the payments in
    determining their deductions for contributions to health and accident plans for
    current employees and retirees.

    In August 2005, the Internal Revenue Service announced (Rev. Rul. 2005-
    60) that business taxpayers do not have to take into account any Medicare
    Part D employer subsidy payments they receive in computing their minimum
    cost requirements for the transfer of excess pension assets to retiree health
    benefit accounts under section 420.

    The tax exclusion for the subsidy payments means that the effective
    subsidy rate over the range of qualified spending is 28 percent rather than
    some lower rate.  Any such lower rate would hinge on an employer's
    marginal tax rate.  For example, if an employer is taxed at a rate of 35 percent
    and there were no exclusion for the subsidy payments, then its effective
    subsidy rate would be 18.2 percent:  .28 x (1-.35) = .182.

    The subsidy payments and their preferential tax treatment are intended to
    prevent a large number of employers that currently provide prescription drug
    benefits to Medicare-eligible retirees from shifting them into the government
    program.  Supporters of the subsidy also maintain that it will end up saving
    the federal government money, even after allowing for the subsidy payments,
    while giving retirees better prescription drug coverage than they could obtain
    through any of the Part D plans.

    Assessment

    The Medicare Part D prescription drug benefit went into effect against a
    backdrop of eroding health benefits for retirees.  According to a 2005 survey
    of retiree health benefits jointly conducted by Hewitt Associates and the
    Kaiser Family Foundation, the percentage of employers with 200 or more
    employees offering health benefits to retirees fell from 66 percent in 1988 to
    33 percent in 2005.  What is more, in recent years, retirees receiving health
    benefits from former employers have been forced to pay larger shares of the
    premiums for those benefits, as well as higher co-payments and deductibles
    for the health care they receive under employer plans.  One of the key factors
    driving this erosion has been a sustained double-digit increase in the cost to
    employers of providing those benefits.  In the congressional debate leading up
    to the creation of the Part D drug benefit, a central concern was that the
    advent of the benefit would accelerate the decline in retiree health benefits.
    To allay this concern, the law establishing the new Medicare benefit included
    a robust incentive for employers to continue to provide or enhance drug
    benefits for their retirees.

    The incentive comes in the form of subsidy payments for employers who
    offer drug benefits to their retirees that are comparable to the standard drug
    coverage under Part D, and the exclusion of these payments from the taxable
    income of recipients.  This tax treatment serves to enhance the value of the
    new Medicare subsidy for employers that pay taxes.  For example, assume
    that an employer is taxed at a rate of 35 percent and receives part D subsidy
    payments totaling $1,000 in 2006.  Because of the exclusion, its after-tax cost
    of prescription drug benefits for retirees falls by $1,000; but if the payments
    were subject to taxation, this cost would fall by only $650.

    While the exclusion boosts the value of the subsidy payments to recipients,
    it also entails a revenue loss that adds to the total cost to the federal
    government of the Part D employer subsidies.  The extent of the revenue loss
    in a particular year hinges on the number of employers that receive the
    subsidy, their marginal tax rates, and the total amount of subsidy payments
    they receive.  In 2006, more than 4,400 public and private employers and
    unions opted to receive subsidy payments covering about 6.5 million retirees.

    The question of how many employers will opt for the subsidy payments in
    the future has important implications for the welfare of retirees eligible for
    Medicare, the financial health of larger employers, and the condition of the
    federal budget.

    It appears that most experts agree that the typical drug benefit available to
    retirees through employer health plans is more generous than the standard
    drug benefit available under Part D.  Therefore, a marked decrease in the
    number of employers claiming the subsidy payments in the next few years
    could have an adverse effect on the welfare of their retirees.  Such a decrease
    might mean that many (or most) of these retirees would be forced to enroll in
    a Part D prescription drug plan, whose coverage could be less generous than
    the drug benefit they had through their employer health plans.

    Large employers are much more likely than small or medium employers to
    provide health benefits to retirees.  Thus it comes as no surprise that many
    large employers have viewed the Part D benefit as an unprecedented
    opportunity to cut their spending on retiree health benefits, or to unburden
    themselves entirely of the responsibility of providing such benefits.
    According to a variety of surveys, around three-quarters of firms that were
    eligible for the Part D subsidy payments at the outset of the program opted to
    receive the payments in 2006.  The remaining firms chose to supplement the
    Medicare drug benefit through their own health plans, become a Part D drug
    plan sponsor and shift all their retirees into the plan, or discontinue coverage
    of prescription drugs for their retirees altogether.  There are reasons to think
    that the share of employers claiming the subsidy payments will shrink in the
    next few years.  As employers become more familiar with the options
    available to them under Part D, they may see financial or administrative
    advantages in following a course of action other than claiming the payments.
    A survey of 163 employers conducted by Watson Wyatt Worldwide in June
    2006 found that only 29% of them expect to claim the payments in the future.
     Many of them showed a strong interest in giving their retirees incentives to
    enroll in Medicare Advantage plans.  In addition, according to a study
    released by the Society of Actuaries in December 2005, the average employer
    could more than double its expected cost savings from 2006 to 2021 by
    dropping its current drug benefit for retirees and paying the premium for a
    Part D drug plan to cover the same retirees, instead of retaining its current
    drug benefit for retirees and receiving the subsidy payments.

    A decline over time in the number of employers receiving the subsidy
    payments could also lead to substantial increases in the cost to the federal
    government of the Part D drug benefit.  The Congressional Budget Office has
    estimated that the net federal subsidy for drug benefits under part D will be
    $1,211 per enrollee in 2006 for beneficiaries with no access to employer
    health plans but $766 per enrollee for beneficiaries who receive qualified
    drug benefits through employers that opt to receive the subsidy payments.

    Selected Bibliography

    Hewitt Associates and the Kaiser Family Foundation.  Prospects for
    Retiree Health Benefits as Medicare Prescription Drug Coverage Begins.
    Washington, DC: December 2005.
    Marchel, Richard and Kevin Dolsky.  Estimated Impact of Medicare Part
    D On Retiree Prescription Drug Costs.  Actuarial & Health Care Solutions,
    LLC, Mequon, WI:  December 6, 2005.
    Neuman, Patricia.  The State of Retiree Health Benefits: Historical Trends
    and Future Uncertainties.  Prepared statement for a hearing of Senate Special
    Committee on Aging held on May 17, 2004.  Available at www.kff.org.
    O'Sullivan, Jennifer. Medicare Drug Benefit: Retiree Benefits.  Library of
    Congress, Congressional Research Service Report RL33041.  Washington,
    DC: February 9, 2006.
    Shea, Dennis G., Bruce C. Stuart, and Becky Briesacher.  "Participation
    and Crowd-Out in a Medicare Drug Benefit: Simulation Estimates," Health
    Care Financing Review, no. 2, v. 25, December 22, 2003.
    U.S. Congress, Congressional Budget Office.  Issues in Designing a
    Prescription Drug Benefit for Medicare.  Washington, DC: October 2002.
    -,  A Detailed Description of CBO's Cost Estimate for the Medicare
    Prescription Drug Benefit.  Washington, DC: July 2004.
    U.S. Congress, Government Accountability Office.  Retiree Health
    Benefits: Options for Employment-Based Prescription Drug Benefits under
    the Medicare Modernization Act.  GAO-05-205, Washington, DC: February
    2005.
    U.S. Congress, Senate Committee on Finance, Implementing the Medicare
    Prescription Drug Benefit and Medicare Advantage Program: Perspectives
    on the Proposed Rules, Hearing, 108th Congress, 2nd session, September 14,
    2004.  Available at www.finance.senate.gov.
    U.S. Department of Health and Human Services, Centers for Medicare and
    Medicaid Services.  The Retiree Drug Subsidy.  Available at:
     www.cms.hhs.gov/EmployerRetireeSubsid/01_Overview.asp.
    Yamamoto, Dale H.  "What Comes After the Retiree Drug Subsidy?"
    Benefits Quarterly, vol. 22, no. 3, Third Quarter 2006, p. 13.

    Income Security

    EXCLUSION OF WORKERS' COMPENSATION BENEFITS
    (DISABILITY AND SURVIVORS PAYMENTS)

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    2.5

    -

    2.5

    2007

    2.6

    -

    2.6

    2008

    2.7

    -

    2.7

    2009

    2.7

    -

    2.7

    2010

    2.8

    -

    2.8

    Authorization

    Section 104(a)(1).

    	Description

    Workers' compensation benefits to employees in cases of work-related
    injury, and to survivors in cases of work-related death, are not taxable.
    Employers finance benefits through insurance or self-insurance arrangements
    (with no employee contribution), and their costs are deductible as a business
    expense.

    Benefits are provided as directed by various State and Federal laws and
    consist of cash earnings-replacement payments, payment of injury-related
    medical costs, special payments for physical impairment (regardless of lost
    earnings), and coverage of certain injury or death-related expenses (e.g.,
    burial costs).  Employees and survivors receive compensation if the injury or
    death is work-related.  No proof of employer negligence is needed, and
    workers' compensation is treated as the sole remedy for work-related injury or
    death.

    Cash earnings replacement payments typically are set at two-thirds of lost
    pre-tax earning capacity, up to legislated maximum amounts.  They are
    provided for both total and partial disability, generally last for the term of the
    disability, may extend beyond normal retirement age, and are paid as periodic
    (e.g., monthly) payments or lump-sum settlements.

    	Impact

    Generally, any amounts received for personal injury or sickness through an
    employer-paid accident or health plan must be reported as income for tax
    purposes.  This includes disability payments and disability pensions, as well
    as sick leave payments.  In contrast, an exception is made for the monthly
    cash payments paid under State workers' compensation programs, which are
    excluded from income taxation.

    Workers' compensation benefits in 2004 totaled $56.0 billion, about 53
    percent of which consisted of cash payments to injured employees and
    survivors replacing lost earnings, and 47 percent of which was paid for
    medical and rehabilitative services.  The costs to employers in 2004 came to
    $87.4 billion, equivalent to 1.76 percent of covered payrolls (up from 1.30
    percent in 2000 but still down from 2.16 percent as recently as 1993).

    The Census Bureau's Current Population Survey gives the following
    profile of those who reported receiving workers' compensation in 2001:

    Workers' compensation cash benefits were less than $5,000 for 58 percent
    of recipients, between $5,000 and $10,000 for 19 percent, between $10,000
    and $15,000 for 12 percent, and more than $15,000 for 11 percent.

    Recipients' income (including workers' compensation) was below $15,000
    for 24 percent, between $15,000 and $30,000 for 33 percent, between
    $30,000 and $45,000 for 22 percent, and above $45,000 for 21 percent.

    Total family income (including workers' compensation) was below
    $15,000 for about 9 percent of recipients, between $15,000 and $30,000 for
    18 percent, between $30,000 and $45,000 for 21 percent, and above $45,000
    for 51 percent.  Seven percent had family income below the Federal poverty
    thresholds.

    	Rationale

    This exclusion was first codified in the Revenue Act of 1918.  The
    committee reports accompanying the Act suggest that workers' compensation
    payments were not subject to taxation before the 1918 Act.  No rationale for
    the exclusion is found in the legislative history.  But it has been maintained
    that workers' compensation should not be taxed because it is in lieu of court-
    awarded damages for work-related injury or death that, before enactment of
    workers' compensation laws (beginning shortly before the 1918 Act), would
    have been payable under tort law for personal injury or sickness and not
    taxed.

    Assessment

    Exclusion of workers' compensation benefits from taxation increases the
    value of these benefits to injured employees and survivors, without direct cost
    to employers, through a tax subsidy.  Taxation of workers' compensation
    would put it on a par with the earned income it replaces.  It also would place
    the "true" cost of workers' compensation on employers if compensation
    benefits were increased in response to taxation.  It is possible that "marginal"
    claims would be reduced if workers knew their benefits would be taxed like
    their regular earnings.

    Furthermore, exclusion of workers' compensation payments from taxation
    is a relatively regressive subsidy because it replaces more income for (and is
    worth more to) those with higher earnings and other taxable income than for
    poorer households.  While States have tried to correct for this with legislated
    maximum benefits and by calculating payments based on replacement of
    after-tax income, the maximums provide only a rough adjustment and few
    jurisdictions have moved to after-tax income replacement.

    On the other hand, a case can be made for tax subsidies for workers'
    compensation because the Federal and State Governments have required
    provision of this "no-fault" benefit.  Moreover, because most workers'
    compensation benefit levels, especially the legal maximums, have been
    established knowing there would be no taxes levied, it is likely that taxation
    of compensation would lead to considerable pressure to increase payments.

    If workers' compensation were subjected to taxation, those who could
    continue to work or return to work (such as those with partial or short-term
    disabilities) or who have other sources of taxable income (such as a working
    spouse or investment earnings) are likely to be the most affected.  These
    groups represent the majority of beneficiaries.  Those who receive only
    workers' compensation payments (such as permanently and totally disabled
    beneficiaries) would be less affected, because their income is likely to be
    below the taxable threshold level.

    Some administrative issues would arise in implementing a tax on workers'
    compensation.  Although most workers' compensation awards are made as
    periodic cash income replacement payments, with separate payments for
    medical and other expenses, a noticeable proportion of the awards are in the
    form of lump-sum settlements.  In some cases, the portion of the settlement
    attributable to income replacement can be distinguished from that for medical
    and other costs, in others it cannot.  A procedure for pro-rating lump-sum
    settlements over time would be called for.  If taxation of compensation were
    targeted on income replacement and not medical payments, some method of
    identifying lump-sum settlements  (e.g., a new kind of "1099") would have to
    be devised.  In addition, a reporting system would have to be established for
    insurers (who pay most benefits), State workers' compensation insurance
    "funds," and self-insured employers, and a way of withholding taxes might be
    needed.

    Equity questions also would arise in taxing compensation.  Some of the
    work force is not covered by traditional workers' compensation laws.  For
    example, interstate railroad employees and seafaring workers have a special
    court remedy that allows them to sue their employer for negligence damages,
    similar to the system for work-related injury and death benefits that workers'
    compensation laws replaced for most workers.  Their jury-awarded
    compensation is not taxed.  Some workers' compensation awards are made for
    physical impairment, without regard to lost earnings.  Under current tax law,
    employer-provided accident and sickness benefits generally are taxable, but
    payments for loss of bodily functions are excludable.  Here, equity might call
    for continuing to exclude those workers' compensation payments that are
    made for loss of bodily functions as opposed to lost earnings.  Finally, States
    would face a decision on taxing compensation and  jurisdictions that use
    after-tax income replacement would be called on to change.

    	Selected Bibliography

    Boyd, Lawrence W.  "Workers Compensation Reform Past and Present:
    An Analysis of Issues and Changes in Benefits," Labor Studies Journal,
    Summer 1999.  Pp. 45-62.
    National Foundation for Unemployment Compensation and Workers'
    Compensation.  "Fiscal Data for State Workers' Compensation Systems:
    1986-95," Research Bulletin 97 WC-2.  September 15, 1997, pp. 1-17.
    Sengupta, Ishita, et al.  Workers' Compensation: Benefits, Coverage and
    Costs, 2000.  Washington, DC: National Academy of Social Insurance, 2002.
    Social Security Administration, Office of Research and Statistics.  "Social
    Security Programs in the United States," Social Security Bulletin, v. 56.
    Winter, 1993, pp. 28-36.
    Thomason, Terry, Timothy Schmidle and John F. Burton.  Workers'
    Compensation, Benefits, Costs, and Safety under Alternative Insurance
    Arrangements.  Kalamazoo MI: Upjohn Institute for Employment Research.
    2001.
    U.S. Congress, House Committee on Ways and Means.  2004 Green Book:
    Background Material and Data on Programs within the Jurisdiction of the
    Committee on Ways and Means.  Committee Print WMCP 108-6, 108th
    Congress, 2nd Session.  Washington, DC: U.S. Government Printing Office,
    March, 2004, pp. 15-137 to 15-148.
    Wentz, Roy.  "Appraisal of Individual Income Tax Exclusions," Tax
    Revision Compendium.  U.S. Congress, House Committee on Ways and
    Means Committee Print.  1959, pp. 329-340.
    Yorio, Edward.  "The Taxation of Damages: Tax and Non-Tax Policy
    Considerations," Cornell Law Review, v. 62.  April 1977, pp. 701-736.

    Income Security

    EXCLUSION OF DAMAGES ON ACCOUNT OF
    PERSONAL PHYSICAL INJURIES OR PHYSICAL SICKNESS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    1.4

    -

    1.4

    2007

    1.5

    -

    1.5

    2008

    1.5

    -

    1.5

    2009

    1.5

    -

    1.5

    2010

    1.5

    -

    1.5

    Authorization

    Sections 104(a)(2)-104(a)(5)

    	Description

    Damages paid, either through a court award or a settlement, to compensate
    for physical injury and sickness are not included in income of the recipient.
    This exclusion applies to both lump sum payments and periodic payments.
    They do not include punitive damages (except in certain cases where States
    only permit the awarding of punitive damages).

    	Impact

    Income received in the form of damages is not taxable to individuals even
    though it may substitute for wages that would have been taxable.  The tax
    treatment constitutes a benefit compared to some forms of income.  To the
    extent that payments substitute for medical payments that would have been
    received from insurance companies the tax treatment is consistent with the
    treatment that would otherwise have occurred for these payments. To the
    extent that the compensation compensates for forgone wages, the payments
    are beneficially treated by comparison with the wages (which would have
    been taxed).  To the extent that  awards are successful in reflecting the actual
    costs of injuries, the benefit of the provision, including the lack on tax on the
    interest earnings included in annuities or periodic payments, accrues to the
    recipients.

    	Rationale

    A provision allowing an exclusion for damages had been part of the tax
    law since 1918, based on the notion that these payments were compensating
    for a loss.  The statute was amended by the Periodic Payment Settlement Act
    of 1982 to allow full exclusion of periodic payments as well as lump sum
    payments.  Normally periodic payments would have been partially taxable to
    reflect the interest element. An argument for encouraging the full exclusion of
    periodic payments was to avoid circumstances where individuals used up
    lump sum payments and might then require public assistance.

    The provision was amended in 1996 by the Small Business Job Protection
    Act to make it clear that punitive damages (except for those cases where State
    law requires all damages to be paid as punitive damages) and damages arising
    from discrimination and emotional distress were not to be excluded.  This
    change was intended to settle and clarify the law, following considerable
    variation in the interpretation by the courts.

    Victims of Terrorism Tax Relief Act of 2001 (P.L. 107-134) expanded the
    present-law exclusion from gross income for disability income of U.S.
    civilian employees attributable to a terrorist attack outside the United States to
    apply to disability income received by any individual attributable to a terrorist
    or military action.  The provision is effective for taxable years ending on or
    after September 11, 2001.

    In general, interpretation of the provisions of these sections of the Code is
    frequently affected by case law.

    	Assessment

    The tax benefit is largely a benefit to individuals receiving compensation
    for injuries and illness. It parallels the treatment of workers compensation
    which covers on-the-job injuries.  However, since it is not paid for by
    excluded insurance and since the size of the payments is (at least in theory)
    tied specifically to the magnitude of the injury, the benefit accrues to the
    recipients.  It therefore especially benefits higher income individuals whose
    payments would typically be larger, reflecting larger lifetime earnings, and
    subject to higher tax rates.

    By restricting tax benefits to compensatory rather than punitive damages,
    the provision encourages plaintiffs to settle out of court so that the damages
    can be characterized as compensatory (an outcome that may usually be
    preferred by the defendant as well).  There is also an incentive to characterize
    damages as physical in nature, for example, to demonstrate that emotional
    distress led to physical symptoms.

    	Selected Bibliography

    Hanson, Randall K and James K. Smith.  "Taxability of Damages."  The
    CPA Journal, vol. 68, May 1998, pp. 22-28.
    Oestreich, Nathan, Will Snyder, and James E. Williamson.  "New Rules
    for Personal Injury Awards."  The National Public Accountant, vol. 43, May
    1997, pp. 16-22.
    U.S. Congress.  Joint Committee on Taxation.  General Explanation of Tax
    Legislation in the 104th Congress.  U.S. Government Printing office,
    Washington, DC, December 18, 1996, pp. 222-224.
    Wood, Robert W.  "Tax Language in Settlement Agreements: Binding or
    Not?  Tax Notes, vol. 93, December 31, 2001, pp. 1872-1874.
    -.  "Why Every Settlement Agreement Should Address Tax
    Consequences."  Tax Notes, vol. 93, July 16, 2001, pp. 405-409.

    Income Security

    EXCLUSION OF SPECIAL BENEFITS
    FOR DISABLED COAL MINERS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.1

    -

    0.1

    2007

    0.1

    -

    0.1

    2008

    (1)

    -

    (1)

    2009

    (1)

    -

    (1)

    2010

    (1)

    -

    (1)

    (1)Less than $50 million.

    Authorization

    30 U.S.C. 922(c), Section 104(a)(1), Revenue Ruling 72-400, 1972-2 C.B.
    75.

    	Description

    Cash and medical benefits to coal mine workers or their survivors for total
    disability or death resulting from coal workers' pneumoconiosis (black lung
    disease) paid under the Black Lung Benefits Act generally are not taxable.
    Comparable benefits paid under State workers' compensation laws also are
    not taxed.

    Black lung eligibility claims must meet the following general conditions:
    the worker must be totally disabled from, or have died of, pneumoconiosis
    arising out of coal mine employment.  However, the statute's broad definition
    of total disability makes it possible for a beneficiary to be working outside the
    coal industry (although earnings tests apply in some cases).

    Black lung benefits consist of monthly cash payments and payment of
    black-lung-related medical costs.  There are two distinct black lung programs,
    known as Part B and Part C.  They pay the same benefits, but differ in
    eligibility rules and funding sources.

    The Part B program provides cash benefits to those miners who filed
    eligibility claims prior to June 30, 1973 (or December 31, 1973, in the case of
    survivors).  It is financed by annual Federal appropriations.  The Part C
    program pays medical benefits for all eligible beneficiaries (both Parts B and
    C) and cash payments to those whose eligibility claims were filed after the
    Part B deadlines.  Part C benefits are paid either by the "responsible" coal
    mine operator or, in most cases, by the Black Lung Disability Trust Fund.

    To pay their obligations under the Part C program, coal mine operators
    may set up special "self-insurance trusts," contributions to which are tax-
    deductible and investment earnings on which are tax-free.  Otherwise, they
    may fund their liability through a third-party insurance arrangement and
    deduct the insurance premium costs.  The Black Lung Disability Trust Fund
    is financed by an excise tax on coal mined in and sold for use in the United
    States and by borrowing from the Federal Treasury.

    	Impact

    Generally, any income-replacement amounts received for personal injury or
    sickness through an employer-paid accident or health plan must be reported as
    income for tax purposes.  This includes disability payments and disability
    pensions, as well as sick leave.  An exception is made for the monthly cash
    payments paid under the Federal black lung program, and comparable cash
    benefits paid under State workers' compensation programs, which are
    excluded from income taxation.

    Black lung medical benefits, however,  are treated like other employer-paid
    or government-paid health insurance.  Recipients are not taxed on the
    employer or Federal contributions for their black lung health insurance, or on
    the value of medical benefits or reimbursements actually received.

    In fiscal year 2006 cash benefits were paid to over 81,000 primary
    beneficiaries and 13,000 dependents.  Seventy-four percent of the primary
    beneficiaries were widows of miners.  Part B cash payments totaled $316
    million and Part C cash payments $266 million for the fiscal year.  In
    addition, $41 million in payments for black-lung related medical treatment
    were made to, or on behalf of, miners enrolled in Part B and Part C.  Both the
    Part B and the Part C rolls are declining as elderly recipients die, although
    some new claims continue to be approved under Part C.  In calendar year
    2006, monthly black lung cash payments under both Part B and Part C ranged
    from $574 for a miner or widow alone to $1,149 for a miner or widow with
    three or more dependents.

    	Rationale

    Part B payments are excluded from taxation under the terms of title IV of
    the original Federal Coal Mine Health and Safety Act of 1969 (now entitled
    the Black Lung Benefits Act).  No specific rationale for this exclusion is
    found in the legislative history.  Part C benefits have been excluded because
    they are considered to be in the nature of workers' compensation under a 1972
    revenue ruling and fall under the workers' compensation exclusion of Section
    104(a)(1) of the Internal Revenue Code.  Like workers' compensation and in
    contrast to other disability payments, eligibility for black lung benefits is
    directly linked to work-related injury or disease (see entry on Exclusion of
    Workers' Compensation Benefits: Disability and Survivors Payments).

    	Assessment

    Excluding black lung payments from taxation increases their value to some
    beneficiaries, those with other taxable income. The payments themselves fall
    well below Federal income tax thresholds.  The effect of taxing black lung
    benefits and the factors to be considered in deciding on their taxation differ
    between Part B and Part C payments.

    Part B benefits could be viewed as earnings replacement payments and,
    thus, appropriate for taxation, as has been argued for workers' compensation.
    However, it would be difficult to argue for their taxation, especially now that
    practically all recipients are elderly miners or widows.  When Part B benefits
    were enacted, the legislative history emphasized that they were not workers'
    compensation, but rather a "limited form of emergency assistance."  They also
    were seen as a way of compensating for the lack of health and safety
    protections for coal miners prior to the 1969 Act and for the fact that existing
    workers' compensation systems rarely compensated for black lung disability
    or death.  Furthermore, it can be maintained that, in effect, taxation of Part B
    payments would take back with one hand what Federal appropriations give
    with the other, although almost no beneficiaries would likely pay tax, given
    their age, retirement status, and low income.

    A stronger argument can be made for taxing Part C benefits.  If workers'
    compensation were to be made taxable, Part C benefits would automatically
    be taxed because their tax-exempt status flows from their treatment as
    workers' compensation.  Taxing Part C payments would give them the same
    treatment as the earnings they replace.  It would remove a subsidy to those
    with other taxable income.  On the other side, black lung benefits are
    legislatively established (as a percentage of minimum Federal salaries).  They
    are not directly reflective of a worker's pre-injury earnings as is workers'
    compensation.  They can be viewed as a special kind of disability or death
    "grant" that should not be taxed.  Because the number of beneficiaries on both
    the Part B and Part C rolls is declining, the revenue forgone from not taxing
    their benefits should decrease over time.

    	Selected Bibliography

    Barth, Peter S.  The Tragedy of Black Lung: Federal Compensation for
    Occupational Disease.  Kalamazoo, Mich.:  W.E. Upjohn Institute for
    Employment Research, 1987.
    -.  "Revisiting Black Lung: Can the Feds Deliver Workers' Compensation
    for Occupational Disease?"  In Workplace Injuries and Diseases: Prevention
    and Compensation, ed. Karen Roberts, John F. Burton Jr., and Matthew M.
    Bodah, 253-74.  Kalamazoo, Mich.:  W.E. Upjohn Institute for Employment
    Research, 2005.
    Lazzari, Salvatore.  The Black Lung Excise Tax on Coal.  Library of
    Congress.  Congressional Research Service Report RS21935.  Washington,
    DC: September 15, 2004.
    McClure, Barbara.  Federal Black Lung Disability Benefits Program.
    Library of Congress, Congressional Research Service Report 81-239 EPW.
    Washington, DC: October 27, 1981.
    -. Summary and Legislative History of P.L. 97-119, Black Lung Benefits
    Revenue Act of 1981.  Library of Congress, Congressional Research Service
    Report 82-59 EPW.  Washington, DC: March 29, 1982.
    Rappaport, Edward.  The Black Lung Benefits Program.  Library of
    Congress, Congressional Research Service Report RS21239.  Washington,
    DC: June 12, 2002.
    U.S. Congress, House Committee on Education and Labor.  Black Lung
    Benefits Reform Act and Black Lung Benefits Revenue Act of 1977.
    Committee Print, 96th Congress, 1st session, February 1979.
    -, Committee on Ways and Means.  Black Lung Benefits Trust.  Report to
    Accompany H.R. 13167.  House Report No. 95-1656, 95th Congress, 2nd
    session, 1978.
    -.  2004 Green Book: Background Material and Data on the Programs
    within the Jurisdiction of the Committee on Ways and Means.  Committee
    Print WMCP No. 108-6, 108th Congress, 1st session, March 2004, pp. 13:51-
    52; 15:145.
    -, Senate Committee on Finance.  Tax Aspects of Black Lung Benefits
    Legislation.  Hearing, 94th Congress, 2nd session, on H.R. 10706, September
    21, 1976.
    -, Committee on Finance, Subcommittee on Taxation and Debt
    Management Generally.  Tax Aspects of the Black Lung Benefits Reform Act
    of 1977.  Hearing, 95th Congress, 1st session, on S. 1538, June 17, 1977.
     	Walter, Douglas H.  "Tax Changes Effected by the Black Lung Revenue
    Act of 1977,"  Taxes, v. 56, May 1978, pp. 251-254.

    Income Security

    EXCLUSION OF CASH PUBLIC ASSISTANCE BENEFITS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    3.4

    -

    3.4

    2007

    3.6

    -

    3.6

    2008

    3.7

    3.7

    2009

    3.9

    -

    3.9

    2010

    4.0

    -

    4.0

    	Authorization

    The exclusion of public assistance payments is not specifically authorized
    by law.  However, a number of revenue rulings under Section 61 of the
    Internal Revenue Code, which defines "gross income," have declared specific
    types of means-tested benefits to be nontaxable.

    	Description

    The Government provides public assistance benefits tax free to individuals
    either in the form of cash welfare or noncash transfers (in-kind benefits such
    as certain goods and services received free or for an income-scaled charge).
    Cash payments come from programs such as Temporary Assistance for Needy
    Families (TANF), which replaced Aid to Families with Dependent Children
    during FY 1997, Supplemental Security Income (SSI) for the aged, blind, or
    disabled, and state and local programs of General Assistance (GA), known
    also by other names such as Home Relief or Safety Net.

    Traditionally, the tax benefits from in-kind payments have not been
    included in the tax expenditure budget because of the difficulty of
    determining their value to recipients.  (However, the Census Bureau publishes
    estimates of the value and distribution of major noncash welfare benefits.)

    	Impact

    Exclusion of public assistance cash payments from taxation gives no
    benefit to the poorest recipients and has little impact on the incomes of many.
     This is because welfare payments are relatively low and many recipients have
    little if any non-transfer cash income.  For example, TANF payments per
    family (averaging 2.4 persons) averaged $360 monthly in FY2004; and the
    weighted average maximum benefit (for a family of three with no other
    income) was $483 monthly, far below the federal income tax threshold.
    Further, relatively few TANF families have earnings (19% of adult recipients
    reported earnings in FY2004), and these earnings usually qualify for the
    earned income tax credit.  If family cash welfare payments were made
    taxable, most recipients still would owe no tax.

    However, some welfare recipients do benefit from the exclusion of public
    assistance cash payments.  They are persons who receive relatively high cash
    aid (including aged, blind, and disabled persons enrolled in SSI in States that
    supplement the basic federal income guarantee, which is $564 monthly per
    individual and $846 per couple in 2004) and persons who have earnings for
    part of the year and public assistance for the rest of the year (and whose actual
    annual cash income would exceed the taxable threshold if public assistance
    were counted).  Public assistance benefits are based on monthly income, and
    thus families whose fortunes improve during the year generally keep welfare
    benefits received earlier.

    During FY2004, TANF ongoing cash benefits were received by a monthly
    average of about 5.4 million persons in 2.2 million families.   As of
    December, 2004, 6.7 million persons received federal SSI benefits (and
    another 293,000 received federally administered SSI supplements paid with
    state funds).  Most recipients of cash help also receive some non-cash aid.

    An unpublished Census Bureau table (Income Distribution Measures, by
    Definition of Income, 2004) estimates that in 2004, $37.9 billion was received
    in means-tested cash transfers from TANF, SSI, GA, and veterans' pensions.
    Per recipient household, cash payments averaged $5,594.  A total of 6.4
    million households (5.7% of all U.S. households) were estimated to have
    received aid from one of the means-tested cash programs, and 52.2% of these
    households were in the bottom quintile of the income distribution.  (Note:
    Means-tested veterans' benefits are included in cash transfers by the Census
    Bureau.)  The Census Bureau estimated that other means-tested cash aid
    totaling $27.0 billion was received in the form of federal and state earned
    income tax credits.  These credits went to an estimated 15.7 million
    households, 59.7% of whom were in the two lowest quintiles of the income
    distribution.  The average value of earned income tax credits in 2004 was
    estimated to be $1,715 per recipient household.

    In addition, the Census Bureau estimates that the 2004 value of major
    noncash means-tested benefits at $91.0 billion. The Bureau estimated the
    noncash transfer for Medicaid at $45.9 billion ($4,371 on average per
    recipient household, counting only households with a Medicaid transfer), and
    the value of other noncash aid at $31.4 billion.  On average, recipient
    households received an estimated $2,121 in other noncash aid.  Of the 13.6
    million estimated households receiving a noncash transfer for Medicaid,
    49.2% were in the lowest two quintiles of the income distribution.

    	Rationale

    Revenue rulings generally exclude government transfer payments from
    income because they have been considered to have the nature of "gifts" in aid
    of the general welfare.  While no specific rationale has been advanced for this
    exclusion, the reasoning may be that Congress did not intend to tax with one
    hand what it gives with the other.

    	Assessment

    Several reasons are advanced for treating means-tested cash payments as
    taxable income.  First, excluding these cash payments results in treating
    persons with the same cash income differently.

    Second, removing the exclusion would not harm the poorest because their
    total cash income still would be below the income tax thresholds.

    Third, the general view of cash welfare has changed.  Cash benefits to
    TANF families now widely are regarded not as "gifts" but as payments that
    impose obligations on parents to work or prepare for work through schooling
    or training, and many GA programs require work.  Thus, it may no longer be
    appropriate to treat cash welfare transfers as gifts.  (The SSI program imposes
    no work obligation, but offers a financial reward for work.)

    Fourth, the exclusion of cash welfare increases the work disincentives
    inherent in need-tested aid.  A welfare recipient who goes to work replaces
    some nontaxable cash with taxable income.  This increases his/her potential
    "marginal tax" rate.  (When recipients work, they face a reduction in need-
    tested benefits.  The loss in benefits serves as a "tax", which increases the
    marginal tax rate.)

     Fifth, using the tax system to subsidize needy persons without direct
    spending masks the total cost of aid and is inefficient.

    Sixth, taxing welfare payments would increase the ability to integrate the
    tax and transfer system.

    Several objections are made to the removal of the tax exemption from
    means-tested cash transfers.  First, cash welfare programs have the effect of
    providing guarantees of minimum cash income; these presumably represent
    target levels of disposable income.  Making these benefits taxable might
    reduce disposable income below the targets.

    Second, unless the income tax thresholds were set high enough, some
    persons deemed needy by their state might be harmed by the change (a
    recipient may be subject to federal, state, or local income taxes based on
    different income thresholds).  TANF and SSI minimum income guarantees
    differ by state, but the federal tax threshold is uniform for taxpayers with the
    same filing status and family size.  If cash welfare payments were made
    taxable, the actual effect would vary among the states.

    Third, if cash welfare were made taxable, it is argued that noncash welfare
    also should be counted (raising difficult measurement issues).  Further, if
    noncash means-tested benefits were treated as income, it is argued that other
    noncash income (ranging from employer-paid health insurance to tax
    deductions for home mortgage interest) also should be counted, raising new
    problems.  Fourth, the public might perceive the change (to taxing cash or
    noncash welfare) as violating the social safety net, and, thus, object.

    	Selected Bibliography

    AFL-CIO.  Recommendations on tax treatment of welfare-to-work
    payments.  Memo prepared on May 8, 1998 on behalf of the AFL-CIO, and at
    the request of the Treasury.  See Tax Notes, June 8, 1998, p. 1239.
    Entin, Stephen J. "Fundamental Tax Reform:  The Inflow Outflow Tax __.
     A Savings-Deferred  Neutral Tax System."   Prepared testimony before the
    House Committee on Ways and Means, April 13, 2000.
    Weisbach, David A. and Jacob Nussim. "The Integration of Tax and
    Spending Programs," Yale Law Journal, March 2004, p. 955.

    Income Security

    NET EXCLUSION OF PENSION CONTRIBUTIONS AND
     EARNINGS PLANS FOR EMPLOYEES AND
    SELF-EMPLOYED INDIVIDUALS (KEOGHS)

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    113.5

    -

    113.5

    2007

    120.5

    -

    120.5

    2008

    126.0

    -

    126.0

    2009

    132.1

    -

    132.1

    2010

    138.3

    -

    138.3

    Authorization

    Sections 401-407, 410-418E, and 457.

    Description

    Employer contributions to qualified pension, profit-sharing, stock-bonus,
    and annuity plans on behalf of an employee are not taxable to the employee.
    The employer is allowed a current deduction for these contributions (within
    limits).  Earnings on these contributions are not taxed until distributed.

    The employee or the employee's beneficiary is generally taxed on benefits
    when benefits are distributed.  (In some cases, employees make direct
    contributions to plans that are taxed to them as wages; these previously taxed
    contributions are not subject to tax when paid as benefits).

    A pension, profit-sharing, or stock-bonus plan is a qualified plan only if it
    is established by an employer for the exclusive benefit of employees or their
    beneficiaries.  In addition, a plan must meet certain requirements, including
    standards relating to nondiscrimination, vesting, requirements for
    participation, and survivor benefits.  Nondiscrimination rules are designed to
    prevent the plans from primarily benefitting highly paid, key employees.
    Vesting refers to the period of employment necessary to obtain non-forfeitable
    pension rights.

    Tax-favored pension plans, referred to as Keogh plans, are also allowed for
    the self-employed;  they account for only a relatively small portion of the cost
    ($9.4, $10.3, $10.8, $11.3, and $11.6 billion in 2006-2010).

    There are two major types of pension plans: defined-benefit plans, where
    employees are ensured of a certain benefit on retirement, and defined-
    contribution plans, where employees have a right to accumulated
    contributions (and earnings on those contributions).

    The tax expenditure is measured as the tax revenue that the government
    does not currently collect on contributions and earnings amounts, offset by the
    taxes paid on pensions by those who are currently receiving retirement
    benefits.

    Impact

    Pension plan treatment allows an up-front tax benefit by not including
    contributions in wage income.  In addition, earnings on invested contributions
    are not taxed, although tax is paid on both original contributions and earnings
    when amounts are paid as benefits.  The net effect of these provisions,
    assuming a constant tax rate, is effectively tax exemption on the return.  (That
    is, the rate of return on the after-tax contributions is equal to the pre-tax rate
    of return).  If tax rates are lower during retirement years than during the years
    of contribution and accumulation, there is a "negative" tax. (In present value
    terms, the government loses more than it receives in taxes).

    The employees who benefit from this provision consist of taxpayers whose
    employment is covered by a plan and whose service has been sufficiently
    continuous for them to qualify for benefits in a company or
    union-administered plan.  The benefit derived from the provision by a
    particular employee depends upon the level of tax that would have been paid
    by the employee if the provision were not in effect.

    Analysis of the March 2006 Current Population Survey shows that pension
    income constituted less than 7 percent of total family income for elderly
    individuals in the poorest two income quintiles (the poorest 40 percent of
    elderly individuals).  Pension income, however, accounted for about 20
    percent of total family income for those in the richest two income quintiles.

    There are several reasons that the tax benefit accrues disproportionately to
    higher-income individuals.  First, employees with lower salaries are less likely
    to be covered by an employer plan.  In 2005, only 16 percent of working
    prime-aged (25 to 54 years of age) individuals earning less than $20,000 were
    covered by a pension plan.  In contrast, almost three-quarters of working
    prime-aged individuals earnings over $65,000 were covered by a pension
    plan.

    Although some of these differences reflect the correlation between low
    income and age, the differences in coverage by income level hold across age
    groups.  For example, in the 45 to 49 age group, only 19 percent with wage
    income less than $20,000 were covered, 49 percent with income $20,000 to
    $35,000 were covered, 67 percent with income $35,000 to $50,000 were
    covered, 70 percent with income $50,000 to $65,000, and 76 percent with
    income over $65,000 were covered.

    Second, in addition to fewer lower-income individuals being covered by
    the plans, the dollar contributions are much larger for higher-income
    individuals.  This disparity occurs not only because of their higher salaries,
    but also because of the integration of many plans with social security.  Under
    a plan that is integrated with social security, employer-derived social security
    benefits or contributions are taken into account as if they were provided under
    the plan in testing whether the plan discriminates in favor of employees who
    are officers, shareholders, or highly compensated.  These integration rules
    allow a smaller fraction of income to be allocated to pension benefits for
    lower-wage employees.

    Finally, higher-income individuals derive a larger benefit from tax benefits
    because their tax rates are higher and thus the value of tax reductions are
    greater.

    In addition to differences across incomes, workers are more likely to be
    covered by pension plans if they work in certain industries, if they are
    employed by large firms, or if they are unionized.

    Rationale

    The first income tax law did not address the tax treatment of pensions, but
    Treasury Decision 2090 in 1914 ruled that pensions paid to employees were
    deductible to employers.  Subsequent regulations also allowed pension
    contributions to be deductible to employers, with income assigned to various
    entities (employers, pension trusts, and employees).  Earnings were also
    taxable.  The earnings of stock-bonus or profit-sharing plans were exempted
    in 1921 and the treatment was extended to pension trusts in 1926.

    Like many early provisions, the rationale for these early decisions was not
    clear, since there was no recorded debate.  It seems likely that the exemptions
    may have been adopted in part to deal with technical problems of assigning
    income.  In 1928, deductions for contributions to reserves were allowed.

    In 1938, because of concerns about tax abuse (firms making contributions
    in profitable years and withdrawing them in loss years), restrictions were
    placed on withdrawals unless all liabilities were paid.

    In a major development, in 1942 the first anti-discrimination rules were
    enacted, although these rules allowed integration with social security.  These
    regulations were designed to prevent the benefits of tax deferral from being
    concentrated among highly compensated employees.  Rules to prevent over-
    funding (which could allow pension trusts to be used to shelter income) were
    adopted as well.

    Non-tax legislation in the Taft-Hartley Act of 1947 affected collectively
    bargained multi-employer plans and the Welfare and Pensions Plans
    Disclosure Act of 1958 added various reporting, disclosure and other
    requirements.

    In 1962, the Self-Employed Individuals Retirement Act allowed self-
    employed individuals to establish tax-qualified pension plans, known as
    Keogh (or H.R. 10) plans, which also benefitted from deferral.

    Another milestone in the pension area was the Employee Retirement
    Income Security Act of 1974, which provided minimum standards for
    participation, vesting, funding, and plan asset management, along with
    creating the Pension Benefit Guaranty Corporation (PBGC) to provide
    insurance of benefits.  Limits were established on the amount of benefits paid
    or contributions made to the plan, with both dollar limits and percentage-of-
    pay limits.

    A variety of changes have occurred since this last major revision.  In 1978,
    simplified employee pensions (SEPS) and tax-deferred savings (401(k)) plans
    were allowed.  The limits on SEPS and 401(k)'s were raised in 1981.   In
    1982, limits on pensions were cut back and made the same for all employer
    plans, and special rules were established for "top-heavy" plans.  The 1982
    legislation also eliminated disparities in treatment between corporate and
    noncorporate (i.e., Keogh) plans, and introduced further restrictions on
    vesting and coverage.

    The Deficit Reduction Act of 1984 maintained lower limits on
    contributions, and the Retirement Equity Act of that same year revised rules
    regarding spousal benefits, participation age, and treatment of breaks in
    service.

    In 1986, a variety of changes were enacted, including substantial
    reductions in the maximum contributions under defined-contribution plans,
    and a variety of other changes (anti-discrimination rules, vesting, integration
    rules).  In 1987, rules to limit under-funding and over-funding of pensions
    were adopted.  The Small Business Job Protection Act of 1996 made a
    number of changes to increase access to plans for small firms, including safe-
    harbor nondiscrimination rules.  In 1997, taxes on excess distributions and
    accumulations were eliminated.

    The 2001 tax cut raised the contribution and benefit limits for pension
    plans, allowed additional contributions for those over 50, increased the full-
    funding limit for defined benefit plans, allowed additional ability to roll over
    limits on 401(k) and similar plans, and provided a variety of other regulatory
    changes.  These provisions were to sunset at the end of 2010, but were made
    permanent by the Pension Protection Act of 2006.

    The Economic Growth and Tax Relief Reconciliation Act of 2001 created
    the Roth 401(k), which went into effect on January 1, 2006.  Contributions to
    Roth 401(k)s are taxed, but qualified distributions are not taxed.

    Assessment

    To tax defined-benefit plans can be very difficult since it is not always easy
    to allocate pension accruals to specific employees.  It might be particularly
    difficult to allocate accruals to individuals who are not vested.  This
    complexity would not, however, preclude taxation of trust earnings at some
    specified rate.

    The major economic justification for the favorable tax treatment of pension
    plans is that they are argued to increase savings and increase retirement
    security.  The effects of these plans on savings and overall retirement income
    are, however, subject to some uncertainty.

    The incentive to save relies on an individual's realizing tax benefits on
    savings about which he can make a decision.  Since individuals cannot
    directly control their contributions to plans in many cases (defined-benefit
    plans), or are subject to a ceiling, the tax incentives to save may not be very
    powerful, because tax benefits relate to savings that would have taken place in
    any case.  At the same time, pension plans may force saving and retirement
    income on employees who otherwise would have total savings less than their
    pension-plan savings.  The empirical evidence is mixed, and it is not clear to
    what extent forced savings is desirable.

    There has been some criticism of tax benefits to pension plans, because
    they are only available to individuals covered by employer plans.  Thus they
    violate the principle of horizontal equity (equal treatment of equals).  They
    have also been criticized for disproportionately benefitting high-income
    individuals.

    The Enron collapse focused attention on another important issue in pension
    plans: the displacement of defined benefit plans by defined contribution plans
    (particularly those with voluntary participation, such as the 401(k) plan)
    which are not insured) and the instances in which defined contribution plans
    were heavily invested in employer securities, increasing the risk to the
    employee who could lose retirement savings (as well as a job) when his firm
    failed.   Research has suggested that individuals do not diversify their
    portfolios in the way that investment advisors would suggest, that they
    actually increase the share of their own contributions invested in employer
    stock when the employer stock is also used to make matching contributions,
    and that they are strongly affected by default choices  in the level and
    allocation of investment.

    	Selected Bibliography

    Cagan, Philip.  The Effect of Pension Plans on Aggregate Savings.  New
    York: Columbia University Press, 1965.
    Choi, James J., David Laibson, and Brigitte C. Madrian, "Plan Design and
    401(k) Savings Outcomes,"National Tax Journal, v. 57, June 2004, pp. 275-
    298.
    Gale, William G.  "The Effects of Pensions on Household Wealth: A Re-
    Evaluation of Theory and Evidence," Journal of Political Economy, v. 106,
    August 1998, pp. 706-723.
    Gravelle, Jane G.  Economic Effects of Taxing Capital Income, ch. 8.
    Cambridge, MA: MIT Press, 1994.
    Even, William E. and David Macpherson.  "Company Stock in Pension
    Plans," National Tax Journal, v. 57, June 2004, pp. 299-314.
    Gravelle, Jane G.,  Employer Stock in Pension Plans: Economic and Tax
    Issues, Library of Congress, Congressional Research Service Report
    RL31551, September 4, 2002.
    -.  "The Enron Debate: Lessons for Tax Policy," Urban-Brookings Tax
    Policy Center Discussion Paper 6, Washington, DC: The Urban Institute,
    February 2003.
    Engen, Eric M., William G. Gale and John Karl Scholz.  "The Effects of
    Tax-Based Saving Incentives on Saving and Wealth," National Bureau of
    Economic Research Working Paper 5759.  September 1996.
    -.  "Personal Retirement Saving Programs and Asset Accumulation:
    Reconciling the Evidence," National Bureau of Economic Research Working
    Paper 5599.  May 1996.
    -.  "The Illusory Effects of Savings Incentives on Saving," Journal of
    Economic Perspectives, v. 10, Fall 1996, pp. 113-138.
    Fox, John O.  "The Troubling Shortfalls and Excesses of Tax Subsidized
    Pension Plans," ch. 11, If Americans Really Understood the Income Tax,
    Boulder Colorado, Westview Press, 2001.
    Friedberg, Leora. and Michael T. Owyang, "Not Your Father's Pension
    Plan: The Rise of 401(k) and Other Defined Contribution Plans."  Federal
    Reserve Bank of St. Louis Review, v. 84, January-February, 2002, pp. 23-34.
    Gale, William G., J. Mark Iwry, and Gordon McDonald. "An Analysis of
    the Roth 401(k)." Tax Notes, January 9, 2006, pp. 163-167.
    Howard, Christopher.  The Hidden Welfare State: Tax Expenditure and
    Social Policy in the United States.  Princeton, NJ: Princeton Univ. Press,
    1997.
    Hubbard, R. Glenn.  "Do IRAs and Keoghs Increase Savings?"  National
    Tax Journal, v. 37.  March 1984, pp. 43-54.
    -, and Jonathan S. Skinner.  "Assessing the Effectiveness of Savings
    Incentives."  Journal of Economic Perspectives, v. 10 (Fall 1996), pp. 73-90.
    Hungerford, Thomas L. Saving Incentives: What May Work, What May
    Not. Library of Congress, Congressional Research Service Report RL33482,
    Washington, DC: June 20, 2006.
    Ippolito, Richard.  "How Recent Tax Legislation Has Affected Pension
    Plans,"  National Tax Journal, v. 44.   September 1991, pp. 405-417.

    Johnson, Richard W. and Cori E. Uccello, "Cash Balance Plans: What Do
    They Mean for Retirement Security?"National Tax Journal, v. 57, June 2004,
    pp. 315-328.
    Joulfaian, David and David Richardson.  "Who Takes Advantage of Tax-
    Deferred Saving Programs?  Evidence from Federal Income Tax Data."
    National Tax Journal, v. 54, September 2001, pp. 669-688.
    Katona, George.  Private Pensions and Individual Savings, Survey
    Research Center, Institute for Social Research, University of Michigan, 1965.
    Madrian, Brigette C. and Dennis F. Shea. " The Power of Suggestion:
    Inertia in 401(k) Participation and Savings Behavior," Quarterly Journal of
    Economics, v. 116, November 2001, pp. 1149-1187.
    Lindeman, David, and Larry Ozanne.  Tax Policy for Pensions and Other
    Retirement Savings.  U.S. Congress, Congressional Budget Office.
    Washington, DC: U.S. Government Printing Office, April 1987.
    Munnell, Alicia.  "Are Pensions Worth the Cost?" National Tax Journal,
    v. 44,  September 1991, pp. 406-417.
    -. "Current Taxation of Qualified Plans: Has the Time Come?" New
    England Economic Review.  March-April 1992, pp. 12-25.
    -. "The Impact of Public and Private Pension Schemes on Saving and
    Capital Formation,"  Conjugating Public and Private: The Case of Pensions.
     Geneva: International Social Security Association, Studies and Research No.
    24, 1987.
    -.  "Private Pensions and Saving: New Evidence," Journal of Political
    Economy, v. 84.  October 1976, pp. 1013-1032.
    Munnell, Alicia H. and Annika Sunden. Coming Up Short: The Challenge
    of 401(k) Plans. Washington, DC: Brookings Institution Press, 2004.
    Pence, Karen. 	"Nature or Nurture,: Why do 401(k) Participants Save
    Differently than Other Workers?"National Tax Journal, v. 55, September
    2002, pp. 596-616.
    -.  "Reducing Bias in Estimates of the Effect of the 401(K) Program on
    Savings," in Proceedings of the 94th Annual Conference 2001, Washington
    DC, National Tax Association, 2002, pp. 130-135.
    Poterba, James M., Steven F. Venti and David Wise.  "Do 401(K)
    Contributions Crowd Out Other Personal Saving?" Journal of Public
    Economics, v. 58.  1995, pp. 1-32.
    -.  "How Retirement Saving Programs Increase Savings," Journal of
    Economic Perspectives, v. 10, Fall 1996, pp. 91-112.
    -.  "Targeted Retirement Saving and the Net Worth of Elderly Americans,"
    American Economic Review, v. 84, May 1995, pp 180-185.
    Purcell, Patrick.  Pension Reform: The Economic Growth and Tax Relief
    Reconciliation Act of 2001. Library of Congress, Congressional Research
    Service Report RS20629, Washington, DC.: Updated June 18, 2002.
    _.  Pensions and Retirement Savings Plans: Sponsorship and
    Participation.  Library of Congress,  Congressional Research Service Report
    RL30122, Washington, DC.: Updated September 10, 2004.
    Turner, John A.  "Pension Tax Treatment," in The Encyclopedia of
    Taxation and Tax Policy, eds. Joseph J. Cordes, Robert O. Ebel, and Jane G.
    Gravelle.  Washington, DC: Urban Institute Press, 2005.

    U.S. Congress, House Committee on Ways and Means.  Background
    Material: 2004 Green Book, Committee Print, 108th Congress, 2nd session.
    March, 2004, pp. 13-3 to 13-15.
    U.S. Department of Labor, Pension and Welfare Benefits Administration,
    Trends in Pensions.  Washington, DC: U.S. Government Printing Office,
    1989.
    U.S. Department of Treasury.  Report to Congress on the Effect of the Full
    Funding Limit on Pension Benefit Security.  Department of the Treasury, May
    1991.
    U.S. General Accounting Office. Answers to Key Questions About Private
    Pensions. Washington, DC: U.S. Government Printing Office, GAO-02-
    7455P, September 18, 2002.
    _. Effects of Changing the Tax Treatment of Fringe Benefits.  Washington,
    DC: U.S. Government Printing Office, April 1992.
    _.  Private Pensions: Improving Worker Coverage and Benefits.
    Washington, DC: U.S. Government Printing Office,  GAO-2-225.  April 16,
    2002.
    _.  Private Pensions: Key Issues to Consider Following the Enron
    Collapse.  Testimony of David Walker,   Washington, DC: U.S. Government
    Printing Office, GAO-02-480T, February 27, 2002.
    Utgoff, Kathleen.  "Public Policy and Pension Regulation," National Tax
    Journal, v. 44,  September 1991, pp. 383-391.

    	Income Security

    NET EXCLUSION OF PENSION CONTRIBUTIONS AND
    EARNINGS: INDIVIDUAL RETIREMENT PLANS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    11.2

    -

    11.2

    2007

    14.0

    -

    14.0

    2008

    15.5

    -

    15.5

    2009

    16.9

    -

    16.9

    2010

    18.4

    -

    18.4

    Authorization

    Sections 219 and 408.

    Description

    There are two types of individual retirement accounts (IRAs): the
    traditional IRA and the Roth IRA.  The traditional IRA allows for the tax
    deferred accumulation of investment earnings, and some individuals are
    eligible to make tax-deductible contributions to their traditional IRAs while
    others are not.  Some or all distributions from traditional IRAs are taxed at
    retirement.  In contrast, contributions to Roth IRAs are not tax deductible, but
    distributions from Roth IRAs are not taxed on withdrawal in retirement.

    The deduction for contributions is phased out for active participants in a
    pension plan.  Individuals not covered by a pension plan and whose spouse is
    also not covered can deduct the full amount of their IRA contribution.  The
    deduction for IRA contributions is phased out for pension plan participants.
    For 2006, the phase-out range for single taxpayers is $50,000 to $60,000 in
    modified adjusted gross income and $75,000 to $85,000 for joint returns.
    Individuals may choose a backloaded IRA (a Roth IRA) where contributions
    are not deductible but no tax applies to withdrawals.  These benefits are
    phased out at $150,000 to $160,000 for a joint return and $95,000 to
    $110,000 for singles.

    The annual limit for IRA contributions is the lesser of $4,000 or 100
    percent of compensation .  The ceiling will rise to $5,000 in 2008.  It will
    then be indexed for inflation in $500 increments.  Individuals age 50 and
    older may make an additional catch-up contribution of $1,000.

    There is a nonrefundable tax credit of up to $1,000 for contributions to a
    qualified retirement plan by individuals with adjusted gross income less than
    $25,000 and couples with adjusted gross income under $50,000.

    A married taxpayer who is eligible to set up an IRA is permitted to make
    deductible contributions up to $4,000 to an IRA for the benefit of the spouse.

    Distributions made before age 59 � (other than those attributable to
    disability or death) are subject to an additional 10-percent income tax unless
    they are rolled over to another IRA or to an employer plan.  Exceptions
    include withdrawals of up to $10,000 used to purchase a first home, education
    expenses, or for unreimbursed medical expenses.

    Distributions must begin after age 70 �.  Contributions may, however, still
    be made to a Roth IRA after that age.

    The tax expenditure estimates reflect the net of tax losses due to failure to
    tax contributions and current earnings in excess of taxes paid on withdrawals.

    Under legislation adopted at the end of 2006 (H.R. 6111), amounts may be
    withdrawn, on a one-time basis, from IRAs and contributed to Health Savings
    Accounts (HSAs) without tax or penalty.

    Impact

    Deductible IRAs allow an up-front tax benefit by deducting contributions
    along with not taxing earnings, although tax is paid when earnings are
    withdrawn.  The net overall effect of these provisions, assuming a constant
    tax rate, is the equivalent of tax exemption on the return (as in the case of
    Roth IRAs).  (That is, the individual earns the pre-tax rate of return on his
    after-tax contribution).  If tax rates are lower during retirement years than they
    were during the years of contribution and accumulation, there is a "negative"
    tax on the return.  Non-deductible IRAs benefit from a postponement of tax
    rather than an effective forgiveness of taxes, as long as they incur some tax on
    withdrawal.

    IRAs tend to be less focused on higher-income levels than some types of
    capital tax subsidies, in part because they are capped at a dollar amount.
    Their benefits do tend, nevertheless, to accrue more heavily to the upper half
    of the income distribution.  This effect occurs in part because of the low
    participation rates at lower income levels.  Further, the lower marginal tax
    rates at lower income levels make the tax benefits less valuable.

    The current tax expenditure reflects the net effect from three types of
    revenue losses and gains.   The first is the forgone taxes from the deduction of
    IRA contributions by certain taxpayers.  The distribution table below shows
    that almost half of this tax benefit goes to low- and middle-income taxpayers
    with adjusted gross income below $75,000.  (The median tax return in 2004
    had adjusted gross income of about $25,000.)

    The second is the forgone taxes from not taxing IRA earnings.  The
    distribution table shows that about a quarter of these tax benefits accrue to
    low- and middle-income taxpayers.  The primary reason is upper income
    taxpayers have larger IRA balances and the higher marginal tax rate makes
    this tax benefit more valuable to upper income taxpayers.

    The final type is the tax revenue gain from the taxation of IRA
    distributions.  Distributions from traditional IRAs are taxed.  If the
    contributions were deductible, then the entire distribution is taxed.  Only the
    investment earnings are taxed for distributions from nondeductible traditional
    IRAs.  Qualified distributions from Roth IRAs are not taxed.  The distribution
    table shows  that low- and middle-income taxpayers account for about one
    third of the tax revenue gain.

    The total tax benefit of IRAs are the combination of these three effects.
    The final column of the distribution table reports the net tax benefit by
    income class.  The table shows that less than 25 percent of the net tax benefit
    accrues to low- and middle-income taxpayers with income below $75,000.

    Estimated Percentage Distribution of IRA Benefits

    Income Class

    Deductions

    Earnings

    Distributions

    Net Effect

    less than $10,000

    1.1

    1.2

    1.1

    1.4

    $10,000-30,000

    8.5

    5.8

    7.2

    4.5

    $30,000-50,000

    20.2

    8.6

    10.2

    7.9

    $50,000-75,000

    17.8

    11.4

    14.0

    9.1

    $75,000-100,000

    17.0

    15.9

    18.6

    13.0

    $100,000-
    200,000

    23.4

    25.6

    27.5

    23.4

    Over $200,000

    12.1

    31.6

    21.4

    40.8

       Note: Derived from 2004 IRS, Statistics of Income data.

    Rationale

    The provision for IRAs was enacted in 1974, but it was limited to
    individuals not covered by pension plans.  The purpose of IRAs was to reduce
    discrimination against these individuals.

    In 1976, the benefits of IRAs were extended to a limited degree to the
    nonworking spouse of an eligible employee.  It was thought to be unfair that
    the nonworking spouse of an employee eligible for an IRA did not have
    access to a tax-favored retirement program.

    In 1981, the deduction limits for all IRAs were increased to the lesser of
    $2,000 or 100 percent of compensation ($2,250 for spousal IRAs). The 1981
    legislation extended the IRA program to employees who are active
    participants in tax-favored employer plans, and permitted an IRA deduction
    for qualified voluntary employee contributions to an employer plan.

    The current rules limiting IRA deductions for higher-income individuals
    not covered by pension plans were phased out at $40,000 to $50,000
    ($25,000 to $35,000 for singles) as part of the Tax Reform Act of 1986.  Part
    of the reason for this restriction arose from the requirements for revenue and
    distributional neutrality.  The broadening of the base at higher income levels
    through restrictions on IRA deductions offset the tax rate reductions.  The
    Taxpayer Relief Act of 1997 increased phase-outs and added Roth IRAs to
    encourage savings.

    The 2001 tax cut act raised the IRA contribution limit to $3,000, with an
    eventual increase to $5,000 and inflation indexing.  These provisions were to
    sunset at the end of 2010, but were made permanent by the Pension
    Protection Act of 2006.  The 2001 tax act also added the tax credit and catch
    up contributions.  The elimination of the income limit on Roth IRA
    conversions starting in 2010 was added by the Tax Increase Prevention and
    Reconciliation Act of 2005.

    Assessment

    The tendency of capital income tax relief to benefit higher-income
    individuals has been reduced in the case of IRAs by the dollar ceiling on the
    contribution, and by the phase-out of the deductible IRAs as income rises for
    those not covered by a pension plan.  Providing IRA benefits to those not
    covered by pensions may also be justified as a way of providing more equity
    between those covered and not covered by an employer plan.

    Another economic justification for IRAs is that they are argued to increase
    savings and increase retirement security.  The effects of these plans on
    savings and overall retirement income are, however, subject to some
    uncertainty, and this issue has been the subject of a considerable literature.

    	Selected Bibliography

    Attanasio, Orazio and Thomas De Leire.  "The Effect of Individual
    Retirement Accounts on Household Consumption and Savings," Economic
    Journal, v. 112, July 2002, pp. 504-538.
    Burman, Leonard, Joseph J. Cordes, and Larry Ozanne.  "IRAs and
    National Savings," National Tax Journal, v. 43.  September 1990, pp. 123-
    128.
    Burman, Leonard, William G. Gale, and David Weiner, "The Taxation of
    Retirement Saving: Choosing Between Front-Loaded and Back-Loaded
    Options."  National Tax Journal, v. 54, September 2001, pp. 689-702.
    Burnham, Paul and Larry Ozanne.  "Individual Retirement Accounts," in
    The Encyclopedia of Taxation and Tax Policy, eds. Joseph J. Cordes, Robert
    O. Ebel, and Jane G. Gravelle.  Washington, DC: Urban Institute Press, 2005.
    Engen, Eric M., William G. Gale and John Karl Scholz.  "The Illusory
    Effects of Saving Incentives on Saving," Journal of Economic Perspectives,
    v. 10, Fall 1996, pp. 113-138.
    -.  "Personal Retirement Saving Programs and Asset Accumulation:
    Reconciling the Evidence," National Bureau of Economic Research Working
    Paper 5599.  May 1996.
    Feenberg, Daniel, and Jonathan Skinner.  "Sources of IRA Savings," Tax
    Policy and the Economy 1989, ed. Lawrence H. Summers.  Cambridge,
    Mass.: M.I.T. Press, 1989, pp. 25-46.
    Gale, William G., and John Karl Scholz.  "IRAs and Household Savings,"
    American Economic Review, v. 84, no. 5, December 1994, pp. 1233-1260.
    Gravelle, Jane G.  "Do Individual Retirement Accounts Increase Savings?"
     Journal of Economic Perspectives, v. 5,  Spring 1991, pp. 133-148.
    -.  Economic Effects of Taxing Capital Income, ch. 8. Cambridge, MA:
    MIT Press, 1994.
    Gravelle, Jane G. and Maxim Shvedov, Proposed Savings Accounts:
    Economic and Budgetary Effects, Library of Congress, Congressional
    Research Service Report RL32228.  Updated April 2, 2004.
    Hubbard, R. Glenn and Jonathan S. Skinner.  "Assessing the Effectiveness
    of Savings Incentives," Journal of Economic Perspectives, v. 10, Fall 1996,
    pp. 73-90.
    Hungerford, Thomas L. and Jane G. Gravelle.  Individual Retirement
    Accounts (IRAs): Issues and Proposed Expansion, Library of Congress,
    Congressional Research Service Report RL30255.  Updated July 31, 2006.
    Imrohoroglu, Selahattn and Douglas Joins.  "The Effect of Tax Favored
    Retirement Accounts on Capital Accumulation," American Economic Review,
    v. 88 (September 1988), pp. 749-768.
    Joulfaian, David and David Richardson.  "Who Takes Advantage of Tax-
    Deferred Saving Programs? Evidence from Federal Income Tax Data."
    National Tax Journal, v. 54, September 2001, pp.  669-688.
    Kotlikoff, Laurence J.  "The Crisis in U.S. Saving and Proposals to
    Address the Crisis,"  National Tax Journal, v. 43, September 1990, pp. 233-
    246.

    Poterba, James, Steven Venti, and David A. Wise.  "How Retirement
    Savings Programs Increase Saving," Journal of Economic Perspectives, v. 10,
    Fall 1996, pp. 91-112.
    Purcell, Patrick.  "Pension Reform: The Economic Growth and Tax Relief
    Reconciliation Act of 2001,"  Library of Congress, Congressional Research
    Service Report RS20629, Washington, DC.: Updated June 18, 2002.
    Stevens, Kevin T., and Raymond Shaffer.  "Expanding the Deduction for
    IRAs and Progressivity," Tax Notes.  August 24, 1992, pp. 1081-1085.
    Venti, Steven F., and David A. Wise.  "Have IRAs Increased U.S.
    Savings?" Quarterly Journal of Economics, v. 105,  August 1990, pp. 661-
    698.
    U.S. Congress, Congressional Budget Office.  Tax Policy for Pensions and
    Other Retirement Savings, by David Lindeman and Larry Ozanne.
    Washington, DC: U.S. Government Printing Office, April 1987.
    -, House Committee on Ways and Means.  Background Materials: 2000
    Green Book, Committee Print, 106th Congress, 2nd session.  October 6, 2000,
    pp. 789-792.
    -, Joint Committee on Taxation.  Present Law, Proposals, and Issues
    Relating to Individual Retirement Arrangements and Other Savings
    Incentives, Joint Committee Print, 101st Congress, 2nd session.  March 26,
    1990.
    -.  General Explanation of the Tax Legislation Enacted in 1997, Joint
    Committee Print, 105th Congress, 1st Session, December 17, 1997.
    -.  Description and Analysis of S. 612 (Savings and Investment Incentive
    Act of 1991), Joint Committee Print.
    -. Senate Committee on Finance.  Hearing on Bentson-Roth IRA, 102nd
    Congress, 1st session.  May 16, 1991.

    Income Security

    TAX CREDIT FOR CERTAIN INDIVIDUALS FOR
    ELECTIVE DEFERRALS AND IRA CONTRIBUTIONS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.9

     -

    0.9

    2007

    0.6

    -

    0.6

    2008

    (1)

    -

    (1)

    2009

    -

    -

    -

    2010

    -

    -

    -

       (1) Less than $50 million.

    	Authorization

    Section 25B.

    	Description

    Taxpayers who are 18 or over and not full time students or dependents can
    claim a tax credit for elective contributions to qualified retirement plans or
    IRAs.  The maximum amount eligible for the credit is $2,000.  Credit rates
    depend on filing status and adjusted gross income.  For joint returns the credit
    is 50% for adjusted gross income under $30,000, 20% for incomes between
    $30,000 and $32,500, and 10% for incomes above $32,500 and less than
    $50,000.  Income categories are half as large for singles ($15,000, $16,250,
    and $25,000) and between those for singles and joint returns for heads of
    household ($22,500, $24,375, and $37,500).  The income thresholds are
    indexed to inflation.  The credit may be taken in addition to general
    deductions or exclusions.

    	Impact

    Because of the phaseout, the credit's benefits are targeted to lower income
    individuals.  However, the ability to use the credit is limited because so many
    lower income individuals have no tax liability.  According to the Treasury
    Department, about 57 million taxpayers would be eligible for the credit, but
    about 26 million would receive no credit because they have no tax liability.
    Of those actually able to benefit from the credit, the amount of benefit will
    probably be relatively small.  The average credit for the 2004 tax year was
    less than $200.  One study finds that the credit has a modest effect on take-up
    and on amounts contributed to retirement savings plans by low and moderate
    income families.

    Historically, most lower income individuals do not tend to save or
    participate in voluntary plans such as individual retirement accounts, perhaps
    because of pressing current needs.  Thus, the number of families and
    individuals claiming the credit may be relatively small.  In tax year 2004,
    about 6% of taxpayers with adjusted gross income of $50,000 or less took the
    retirement savings contribution credit.

    	Rationale

    This provision was enacted as part of the Economic Growth and Tax Relief
    Reconciliation Act of 2001 and was set to expire after 2006.  The Pension
    Protection Act of 2006 made this credit permanent.  Its purpose was to
    provide savings incentives for lower income individuals who historically have
    had inadequate retirement savings or none at all.  The credit is comparable to
    a matching contribution received by many 401(k) participants from their
    employers.

     	Assessment

    The expectation is that the credit would have limited impact on  increasing
    savings for its target group because so many lower income individuals will
    not have enough tax liability to benefit from the credit.  Among those who are
    eligible, the higher incomes necessary for them to have tax liability mean that
    the credit rate will be lower.   The credit could be redesigned to cover more
    lower income individuals by stacking it first, before the refundable child
    credit, or making the credit refundable.  Gale, Iwry, and Orszag (2005)
    estimate that the annual revenue cost of a refundable retirement savings
    contribution credit would be about $4.2 billion between 2007 and 2015.

    As with other savings incentives, there is no clear evidence that these
    incentives are effective in increasing savings.  The credit also has a cliff
    effect: because the credit is not phased down slowly, a small increase in
    income can trigger a shift in the percentage credit rate and raise taxes
    significantly.

    	Selected Bibliography

    Brady, Peter and Warren B. Hrung. Assessing the Effectiveness of the
    Saver's Credit: Preliminary Evidence from the First Year. Paper presented at
    the National Tax Association Meetings, Miami, Fl. November 2005.
    Duflo, Ester, et al., "Saving Incentives for Low- and Middle-Income
    Families: Evidence from a Field Experiment with H&R Block," National
    Bureau of Economic Research working paper 11680, September 2005.
    Gale, William G., J. Mark Iwry, and Peter R. Orszag, "The Saver's Credit:
    Expanding Retirement Savings for Middle- and Lower-Income Americans,"
    The Retirement Security Project, No. 2005-2. March 2005.
    Kiefer, Donald, et al., "The Economic Growth and Tax Relief
    Reconciliation Act of 2001: Overview and Assessment of Effects on
    Taxpayers."  National Tax Journal, v. 55, March 2002, pp. 89-118
    Orszag, Peter.  "The Retirement Savings Component of Last Year's Tax
    Bill: Why it is Premature to Make Them Permanent."  Center on Budget
    Policies and Priorities.  September 18, 2003.
    White, Craig G.  "Does the Saver's Credit Offer an Incentive to Lower
    Income Families?"  Tax Notes, v. 96, September 16, 2002, pp. 1633-1640.
    Sullivan, Martin.  "Economic Analysis: With Little Fanfare, Gephardt
    Introduces Sweeping Pension Reform."  Tax Notes, v. 95, June 17, 2002, pp.
    1709-1710.

    Income Security

    TAX CREDIT FOR NEW RETIREMENT PLAN EXPENSES
    OF SMALL BUSINESSES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2005

    (1)

    (1)

    (1)

    2006

    (1)

    (1)

    (1)

    2007

    (1)

    (1)

    (1)

    2008

    (1)

    (1)

    (1)

    2009

    (1)

    (1)

    (1)

    (1)Less than $50 million.

    	Authorization

    Section 45E.

    	Description

    Eligible small employers that began to offer qualified pension plans to their
    employees starting in 2002 and each year thereafter may claim a tax credit for
    qualified costs they incur in starting the plans and maintaining them in their
    first few years.  The credit is equal to 50 percent of up to $1,000 in these costs
    incurred in each of the first three years the plans are in effect, beginning with
    the tax year in which the plans become effective.

    An eligible small employer is one that had no more than 100 employees
    receiving a minimum of $5,000 in total compensation in the preceding tax
    year.  The credit applies to the following new pension plans:  defined benefit
    plans, defined contribution plans (including 401(k) plans), savings incentive
    match plans for employees (SIMPLE), and simplified employee pension
    (SEP) plans.  At least one employee who is not considered highly
    compensated must participate.  Qualified costs are any ordinary and necessary
    expenses incurred to establish and administer an eligible plan or to educate
    employees about the plan and retirement planning.  Qualified costs offset by
    any credit claimed may not also be deducted as ordinary and necessary
    business expenses.

    The credit is part of the general business credit, and therefore is subject to
    its limitations and carryover rules.  It is scheduled to expire at the end of
    2010.

    	Impact

    The provision is intended to encourage smaller employers to set up and
    maintain retirement savings plans for their employees.  Survey data for 2002
    collected by the Employee Benefit Research Institute indicated that the cost of
    establishing a pension plan was the most important reason for not having such
    a plan for 10 percent of firms and a major reason for a third of them.  In
    addition, the survey results suggested that most small business owners were
    unaware of the credit in its first year of existence.  Arguably, it is too soon to
    tell how effective the credit will be in spurring the creation of new pension
    plans among eligible small employers.

    	Rationale

    This provision was enacted as part of the Economic Growth and Tax Relief
    Reconciliation Act of 2001.  Its principal purpose was to expand access to
    retirement savings plans in the private sector by removing an administrative
    obstacle to such plans among small businesses.  According to data collected
    by the Employee Benefit Research Institute, in 1999, 64 percent of full-time
    employees at firms with more than 100 employees were covered by an
    employment-based retirement plan, whereas only 34 percent of full-time
    employees at firms with 100 or fewer employees were covered by such a plan.

    	Assessment

    The credit reduces the after-tax cost to qualified small employers of setting
    up qualified pension plans for their employees.  In effect, the Federal
    Government assumes a small share of the cost of starting up and maintaining
    these plans.

    A reduction in start-up costs may lead some small firms to set up pension
    plans that otherwise would not come into existence.  Yet it is unclear how
    responsive eligible small firms will be to the cost reduction. Because of the
    small annual limit on the size of the credit ($500), it may prove more
    influential with very small firms than larger eligible firms.  While the credit is
    of no benefit to firms with more than 100 employees, it could be viewed as an
    attempt to create a more level playing field in that the credit may offset some
    or all of the cost advantage they may enjoy in establishing employee
    retirement plans.  Some argue that there are at least two reasons why it is
    reasonable to expect that the credit will have little effect on overall saving for
    retirement.  First, it is unlikely that the credit will induce many eligible firms
    to set up pension plans.  Second, there is little evidence that pension plans
    actually increase the savings of individuals.

    	Selected Bibliography

    Lee, Karen.  "Taking the Plunge: Economy Keeps Small Employers
    Nervous About Offering Retirement Plans." Employee Benefit News, April 1,
    2004.
    Lurie, Alvin D.  "The 2001 Tax Law:  A Congressional Vanishing Act,
    But With Real Magic for Retirement Plans," Compensation & Benefits
    Management; V. 17, autumn 2001, pp. 1-9.
    Employee Benefit Research Institute.  "The 2003 Small Employer
    Retirement Survey (SERS): Summary of Findings."  Available at
    http://www.ebri.org/sers.
    Storey, James R.  Pension Reform: SIMPLE Plans for Small Employers.
    Library of Congress, Congressional Research Service Report 96-758,
    Washington, DC: February 9, 2001.
    U.S. Department of the Treasury.  Internal Revenue Service.  Retirement
    Plans for Small Businesses, 2003 tax year, Publication 560.

    Income Security

    EXCLUSION OF OTHER EMPLOYEE BENEFITS:
    PREMIUMS ON GROUP TERM LIFE INSURANCE

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    2.5

    -

    2.5

    2007

    2.6

    -

    2.6

    2008

    2.6

    -

    2.6

    2009

    2.7

    -

    2.7

    2010

    2.7

    -

    2.7

    	Authorization

    Section 79 and L.O. 1014, 2 C.B. 8 (1920).

    Description

    The cost of group-term life insurance purchased by an employer for an
    employee is excluded from the employee's gross income to the extent that the
    insurance is less than $50,000.

    If a group-term life insurance plan discriminates in favor of any key
    employee (generally an individual who is an officer, a five-percent owner, a
    one-percent owner earning more than $150,000, or one of the top 10
    employee-owners), the full cost of the group-term life insurance for any key
    employee is included in the gross income of the employee.

    The cost of an employee's share of group-term life insurance generally is
    determined on the basis of uniform premiums, computed with respect to
    five-year age-brackets and provided in a table furnished by the tax authorities.
     In the case of a discriminatory plan, however, the amount included in income
    will be measured by the actual cost rather than by the table cost prescribed by
    the Treasury.

    Impact

    These insurance plans, in effect, provide additional income to employees.
    Because the full value of the insurance coverage is not taxable, this income
    can be provided at less cost to the employer than the gross amount of taxable
    wages that would have to be paid to an employee to purchase an equal
    amount of insurance. Group term life insurance is a significant portion of total
    life insurance.  However, since neither the value of the insurance coverage
    nor the life insurance proceeds are included in gross income, the value of this
    fringe benefit is never subject to income tax.

    Individuals who are self-employed or who work for an employer without
    such a plan do not have the advantage of this tax subsidy for life insurance
    protection.  While there is little information on the distributional consequence
    of this provisions, if the coverage is similar to that of other fringe benefits,
    higher-income individuals are more likely to be covered by group life
    insurance.

    Rationale

    This exclusion was originally allowed, without limitation of coverage, by
    administrative legal opinion (L.O. 1014, 2 C.B. 8 (1920)).  The reason for the
    ruling is unclear, but it may have related to supposed difficulties in valuing
    the insurance to individual employees, since the value is closely related to age
    and other mortality factors.  Studies later indicated valuation was not a
    problem.

    The $50,000 limit on the amount subject to exclusion was enacted in 1964.
     Reports accompanying that legislation reasoned that the exclusion would
    encourage the purchase of group life insurance and assist in keeping the
    family unit intact upon death of the breadwinner.

    The further limitation on the exclusion available for key employees in
    discriminatory plans was enacted in 1982, and expanded in 1984 to apply to
    post-retirement life insurance coverage. In 1986, more restrictive rules
    regarding anti-discrimination were adopted, but were repealed in the debt
    limit legislation (P.L. 101-140) of 1989.

    The President's Advisory Panel on Federal Tax Reform, which issued its
    final report in November 2005, recommended elimination of the group-term
    life insurance exemption, on equity grounds.  The Advisory Panel argued that
    providing this tax benefit to a small number of employees requires higher tax
    rates on others.  Congress has adopted no legislation that would implement
    recommendations of the Advisory Panel.

    In January 2005, Representative Michael Burgess introduced H.R.51,
    which would amend the Internal Revenue Code of 1986 to increase the dollar
    limitation on employer-provided group term life insurance that can be
    excluded from the gross income of the employee.  This bill was referred to the
    Committee on Ways and Means.  No further action has been taken.

    Assessment

    There may be some justification for encouraging individuals to purchase
    more life insurance than they would otherwise do on their own.  Since society
    is committed to providing a minimum standard of living for dependent
    individuals, it may be desirable to subsidize life insurance coverage.

    There is, however, no evidence on the extent to which the subsidy
    increases the amount of insurance rather than substituting for insurance that
    would be privately purchased.  Moreover, by restricting this benefit to
    employer-provided insurance, the subsidy is only available to certain
    individuals, depending on their employer, and probably disproportionally
    benefits high-income individuals.  These limitations in coverage may raise
    questions of both horizontal and vertical equity.

    	Selected Bibliography

    Butler, Richard J. The Economics of Social Insurance and Employee
    Benefits. Berlin: Springer, 1999.
    Hacker, Jacob S.  The Divided Welfare State: The Battle over Public and
    Private Social Benefits in the United States.  New York: Cambridge, 2002.
    Internal Revenue Service.  Employer's Tax Guide to Fringe Benefits For
    Benefits Provided in 2006. Publication 15-B, revised December 2005.
    International Fiscal Association, The Taxation of Employee Fringe
    Benefits: A Report Based on the Proceedings of a Seminar Held in Florence,
    Italy, in 1993, IFA Congress Seminar Series, No 18b.  Dordrecht, The
    Netherlands: Kluwer, September 1995.
    Sunley, Emil.  "Employee Benefits and Transfer Payments,"
    Comprehensive Income Taxation, ed. Joseph A. Pechman.  Washington, DC:
    The Brookings Institution, 1977, pp. 75-106.
    Turner, Robert W.  "Fringe Benefits," in The Encyclopedia of Taxation
    and Tax Policy (2nd ed.), eds. Joseph J. Cordes, Robert O. Ebel, and Jane G.
    Gravelle.  Washington, DC: Urban Institute Press, 2005, pp.159-162.
    President's Advisory Panel on Federal Tax Reform. Simple, Fair, and
    Pro-Growth: Proposals to Fix America's Tax System: Report of the
    President's Advisory Panel on Federal Tax Reform.  Washington, DC:
    November 2005, p. 85.
    U.S. General Accounting Office.  Effects of Changing the Tax Treatment
    of Fringe Benefits.  Washington, DC: U.S. Government Printing Office, April
    1992.

    Income Security

    EXCLUSION OF OTHER EMPLOYEE BENEFITS:
    PREMIUMS ON ACCIDENT AND DISABILITY INSURANCE

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    2.6

    -

    2.6

    2007

    2.8

    -

    2.8

    2008

    2.9

    -

    2.9

    2009

    3.0

    -

    3.0

    2010

    3.1

    -

    3.1

    Authorization

    Sections 105 and 106.

    Description

    Premiums paid by employers for employee accident and disability
    insurance plans are not included in the gross income of employees.  Although
    in general benefit payments to employees are taxable, an exclusion is
    provided for payments related to permanent injuries and computed without
    regard to the period the employee is absent from work.

    	Impact

    As with term life insurance, since the value of this insurance coverage is
    not taxable, the employer's cost is less than he would have to pay in wages
    that are taxable, to confer the same benefit on the employee.  Employers thus
    are encouraged to buy such insurance for employees.  Because some proceeds
    from accident and disability insurance plans, as well as the premiums paid by
    the employer, are not included in gross income, the value of the fringe benefit
    is never subject to income tax.

    While there is little information on the distributional effects of this
    provisions, if the coverage is similar to that of other fringe benefits, higher-
    income individuals are more likely to be covered by accident and disability
    insurance.

    Rationale

    This provision was enacted in 1954.  Previously, only payments for plans
    contracted with insurance companies could be excluded from gross income.
    The committee report indicated this provision equalized the treatment of
    employer contributions regardless of the form of the plan.

    Assessment

    Since public programs (social security and workman's compensation)
    provide a minimum level of disability payments, it is not clear what
    justification there is for providing a subsidy for additional benefits.
    Moreover, by restricting this benefit to employer-provided insurance, the
    subsidy is only available to certain individuals, depending on their employer,
    and probably disproportionally benefits high-income individuals.  These
    limitations in coverage may raise questions of both horizontal and vertical
    equity.

    The computation of the value of the premiums could, however, be difficult
    to calculate, especially if they are combined with health plans.

    	Selected Bibliography

    Butler, Richard J. The Economics of Social Insurance and Employee
    Benefits. Berlin: Springer, 1999.
    Hacker, Jacob S.  The Divided Welfare State: The Battle over Public and
    Private Social Benefits in the United States.  New York: Cambridge, 2002.
    International Fiscal Association, The Taxation of Employee Fringe
    Benefits: A Report Based on the Proceedings of a Seminar Held in Florence,
    Italy, in 1993, IFA Congress Seminar Series, No 18b.  Dordrecht, The
    Netherlands: Kluwer, September 1995.
    "Taxation of Employee Accident and Health Plans Before and Under the
    1954 Code,"  Yale Law Journal, v. 64, no. 2.  December 1954, pp. 222-247.
    Turner, Robert W.  "Fringe Benefits," in The Encyclopedia of Taxation
    and Tax Policy (2nd ed.), eds. Joseph J. Cordes, Robert O. Ebel, and Jane G.
    Gravelle.  Washington, DC: Urban Institute Press, 2005, pp.159-162.
    U.S. Congress, House Committee on Ways and Means, "An Appraisal of
    Individual Income Tax Exclusions" (Roy Wentz), Tax Revision Compendium.
     Committee Print, 1959, pp. 329-40.
    U.S. General Accounting Office.  Effects of Changing the Tax Treatment
    of Fringe Benefits.  Washington, DC: U.S. Government Printing Office, April
    1992.

    Income Security

    ADDITIONAL STANDARD DEDUCTION
    FOR THE BLIND AND THE ELDERLY

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    1.6

     -

    1.6

    2007

    1.6

     -

    1.6

    2008

    1.7

     -

    1.7

    2009

    1.7

     -

    1.7

    2010

    1.8

     -

    1.8

    Authorization

    Section 63(f).

    	Description

    An additional standard deduction is available for blind and elderly
    taxpayers.  To qualify for the additional standard deduction amount, a
    taxpayer must be age 65 (or blind) before the close of the tax year. The added
    standard deduction amounts, $1,000 for a married individual or surviving
    spouse or $1,250 for an unmarried individual for tax year 2006, are added to
    the basic standard deduction amounts.  A couple could receive additional
    deductions totaling $4,500 if both were blind and elderly.  These amounts are
    adjusted for inflation.

    Impact

    The additional standard deduction amounts raise the income threshold at
    which taxpayers begin to pay taxes.  The benefit depends on the marginal tax
    rate of the individual.  Most benefits go to taxpayers with incomes under
    $50,000.

    Distribution by Income Class of the Tax Expenditure
    for the Additional Standard Deduction Amount for
    the Blind and Elderly
    at 2004 Income Levels

    Adjusted Gross Income Class
    (in thousands of $)

    Percentage
    Distribution

    Below $10

    18.7

    $10 to $20

    30.9

    $20 to $30

    16.4

    $30 to $40

    10.1

    $40 and over

    21.4

    Source: Data obtained from IRS Statistics of Income,
    http://www.irs.gov/pub/irs-soi/04in14ar.xls visited Oct. 6, 2006.  Amounts may not
    add up due to rounding.
    Note: This is not a distribution of the tax expenditures, but of the deductions.  It is
    classified by adjusted gross income, not expanded adjusted gross income.

    	Rationale

    Special tax treatment for the blind first became available under a provision
    of the Revenue Act of 1943 (P.L. 78-235) which provided a $500 itemized
    deduction.  The purpose of the deduction was to help cover the additional
    expenses directly associated with blindness, such as the hiring of readers and
    guides.  The deduction evolved to a $600 personal exemption in the Revenue
    Act of 1948 (P.L. 80-471) so that the blind did not forfeit use of the standard
    deduction and so that the tax benefit could be reflected directly in the
    withholding tables.

    At the same time that the itemized deduction was converted to a personal
    exemption for the blind, relief was also provided to the elderly by allowing
    them an extra personal exemption.  Relief was provided to the elderly because
    of a heavy concentration of small incomes in that population, the rise in the
    cost of living, and to counterbalance changes in the tax system resulting from
    World War II.  It was argued that those who were retired could not adjust to
    these changes and that a general personal exemption was preferable to
    piecemeal exclusions for particular types of income received by the elderly.

    As the personal and dependency exemption amounts increased over the
    years, so too did the amount of the additional exemption.  The exemption
    amount increased to $625 in 1970, $675 in 1971, $750 in 1972, $1,000 in
    1979, $1,040 in 1985 and $1,080 in 1986.

    A comprehensive revision of the Code was enacted in 1986 designed to
    lead to a fairer, more efficient and simpler tax system.  Under a provision in
    the Tax Reform Act of 1986 (P.L. 99-514) the personal exemptions for age
    and blindness were replaced by an additional standard deduction amount.
    This change was made because higher income taxpayers are more likely to
    itemize and because a personal exemption amount can be used by all
    taxpayers whereas the additional standard deduction will be used only by
    those who forgo itemizing deductions.  Thus, the rationale is to target the
    benefits to lower and moderate income elderly and blind taxpayers.

    	Assessment

    Advocates of the blind justify special tax treatment based on higher living
    costs and additional expenses associated with earning income.  However,
    other taxpayers with disabilities (deafness, paralysis, loss of limbs) are not
    accorded similar treatment and may be in as much need of tax relief.  Just as
    the blind incur special expenses so too do others with different handicapping
    impairments.

    Advocates for the elderly justify special tax treatment based on need,
    arguing that the elderly face increased living costs primarily due to inflation;
    medical costs are frequently cited as one example.  However, social security
    benefits are adjusted annually for cost inflation and the federal government
    has established the Medicare Program.  Opponents of the provision argue that
    if the provision is retained the eligibility age should be raised.  It is noted that
    life expectancy has been growing longer and that most 65 year olds are
    healthy and could continue to work.  The age for receiving Social Security
    benefits has been increased for future years.

    One notion of fairness is that the tax system should be based on ability-to-
    pay and that ability is based upon the income of taxpayers-not age or
    handicapping condition.  The additional standard deduction amounts violate
    the economic principle of horizontal equity in that all taxpayers with equal net
    incomes are not treated equally.  The provision also fails the effectiveness test
    since low-income blind and elderly individuals who already are exempt from
    tax without the benefit of the additional standard deduction amount receive no
    benefit from the additional standard deduction but are most in need of
    financial assistance.

    Nor does the provision benefit those blind or elderly taxpayers who itemize
    deductions (such as those with large medical expenditures in relation to
    income).  Additionally, the value of the additional standard deduction is of
    greater benefit to taxpayers with a higher rather than lower marginal income
    tax rate.  Alternatives would be a tax credit or a direct grant.

    	Selected Bibliography

    Chen, Yung-Ping.  "Income Tax Exemptions for the Aged as a Policy
    Instrument," National Tax Journal, v. 16, no. 4.  December 1963, pp. 325-
    336.
    Ehrenhalt, Alan.  "The Temptation to Hand Out Irrelevant Entitlements,"
    Governing, v. 9 (November 1995), pp. 7-8.
    Forman, Jonathan Barry. "Reconsidering the Income Tax Treatment of the
    Elderly: It's Time for the Elderly to Pay Their Fair Share," University of
    Pittsburgh Law Review, v. 56, Spring 1995, pp. 589-626.
    Groves, Harold M.  Federal Tax Treatment of the Family.  Washington,
    DC: The Brookings Institution, 1963, pp. 52-55.
    Kahn, Jeffrey. "Personal Deductions - A Tax "Ideal" or Just Another
    "Deal"?" Law Review of Michigan State University - Detroit College of Law,
    Spring 2002, pp. 1-55.
    Lightman, Gary P.  "Tax Expenditure Analysis of I.R.C. 151(d), The
    Additional Exemption for the Blind: Lack of Legislative Vision?"  Temple
    Law Quarterly, v. 50, no. 4.  1977, pp. 1086-1104.
    Livsey, Herbert C.  "Tax Benefits for the Elderly: A Need for Revision."
    Utah Law Review, v. 1969, No. 1.  1969, pp. 84-117.
    Jackson, Pamela J.  Additional Standard Tax Deduction for the Blind: A
    Description and Assessment, Library of Congress, Congressional Research
    Service Report RS20555.  July 12, 2006.
    -.  Additional Standard Tax Deduction for the Elderly: A Description and
    Assessment, Library of Congress, Congressional Research Service Report
    RS20342.  June 28, 2006.
    Tate, John.  "Aid to the Elderly: What Role for the Income Tax?"
    University of Cincinnati Law Review, v. 41, no. 1.  1972, pp. 93-115.
    U.S.  Congress, House Committee on Ways and Means.  2000 Green
    Book; Background Material and Data on Programs Within the Jurisdiction
    of the Committee on Ways and Means.  Committee Print, 106th Congress, 2d
    Session.  October 6, 2000, pp. 822-823.
    -.  Overview of Entitlement Programs.  May 15, 1992, pp. 1035-1037.
    U.S. President (Reagan).  The President's Tax Proposals to the Congress
    for Fairness, Growth and Simplicity.  Washington, DC: U.S. Government
    Printing Office, 1985, pp. 11-14.

    	Income Security

    	TAX CREDIT FOR THE ELDERLY AND DISABLED

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    (1)

     -

    (1)

    2007

    (1)

     -

    (1)

    2008

    (1)

     -

    (1)

    2009

    (1)

     -

    (1)

    2010

    (1)

     -

    (1)

    (1)Positive tax expenditure of less than $50 million.

    	Authorization

    Section 22.

    	Description

    Individuals who are 65 years of age or older may claim a tax credit equal to
    15 percent of their taxable income up to a base amount.  The credit is also
    available to individuals under  the age of 65 if they are retired because of a
    permanent and total disability and have disability income from either a public
    or private employer based upon that disability.  The maximum base amount
    for a married couple where both spouses are 65 or over is $7,500.  When one
    spouse is 65 or over and the other spouse is under 65 but disabled, the
    maximum amount is the lesser of $7,500 or $5,000 plus "disability income"
    (income from wages, or payments in lieu of wages, due to disability).

    A maximum base amount of $5,000 is provided for a single taxpayer 65 or
    over and a married couple where only one spouse is over 65.  Where both are
    under 65 and both are disabled, the maximum base amount is the lesser of
    $7,500 or total "disability income."  When one is disabled but neither is 65 or
    over or in the case of a single disabled individual under 65, the maximum
    base amount is the lesser of $5,000 or "disability income."  For a married
    individual filing separately the maximum base amount is $3,750 (the lesser of
    $3,750 or the "disability income" received if disabled).

    The maximum base amount is reduced by certain amounts received as
    pensions or disability benefits which are excluded from gross income (such as
    nontaxable pension or annuity income, social security benefits, railroad
    retirement, and veterans benefits).  Also, a reduction from the maximum base
    amount is made by one-half of the excess over the following amounts: $7,500
    adjusted gross income (AGI) for a single individual, $10,000 for a joint
    return, or $5,000 for a married individual filing a separate return.

    Impact

    The maximum credit per individual is $750 (15 percent of $5,000) and
    $1,125 in the case of a married couple both 65 or over (15 percent of $7,500).
     Because the base amount is reduced by Social Security benefits, the primary
    beneficiaries are persons with disabilities and retirees who are not eligible to
    receive tax-exempt Social Security benefits.

    Because the provision is a credit, its value to the taxpayer is affected only
    by the level of benefits and the credit rate, and not by the tax bracket of the
    taxpayer.  However, the adjusted gross income phaseout serves to limit relief
    to low- and very-moderate-income taxpayers.  Additionally, tax credits are
    used to reduce income tax liability, as opposed to tax deductions which
    reduce income available to be taxed.  Individuals with low tax liabilities may
    be ineligible to claim the credit, or the full value of the credit, since it is
    nonrefundable.

    Preliminary Distribution by Income Class
    of the Tax Expenditure for Credit
     for the Elderly and Disabled at 2004 Income Levels

    Adjusted Gross Income Class
    (in thousands of $)

    Percentage
    Distribution

    Below $10

    0.2%

    $10 to $20

    79%

    $20 to $30

    20.8%

    $30 and over

    0.0%

    Source: Data obtained from IRS Statistics of Income,
    http://www.irs.gov/pub/irs-soi/04in33ar.xls visited Oct. 6, 2006.  Amounts may not
    add up due to rounding.
    Note: This table classifies by adjusted gross income, not expanded adjusted gross
    income.

    	Rationale

    The retirement income credit first enacted with the codification of the
    Internal Revenue Code of 1954 (P.L. 83-591) was intended to remove the
    inequity between individuals who received taxable retirement income with
    those who received tax-exempt Social Security payments.  In 1976, the
    retirement income credit was redesigned into the tax credit for the elderly.

    In the Social Security Amendments of 1983 (P.L. 98-21), Social Security
    benefits were made taxable above certain income levels.  In response to this
    change the tax credit's base amounts were increased to provide some
    coordination with the level at which Social Security benefits became taxable.
    In addition, the credit for the elderly was expanded to include those
    permanently and totally disabled.  This change was designed to provide the
    same tax relief to aged and disabled taxpayers who do not receive tax-free
    Social Security retirement or disability payments.

    Assessment

    While the tax credit affords some elderly and disabled taxpayers receiving
    taxable retirement or disability income a measure of comparability with those
    receiving tax-exempt (or partially tax-exempt) Social Security benefits, it does
    so only at low-income levels because of the adjusted gross income phaseout.
    Social Security recipients with higher levels of income always continue to
    receive at least a portion of their Social Security income tax free.  Such is not
    the case for those who use the tax credit.

    The Congress has not reviewed the tax credit to provide inflation
    adjustments since 1983.  Therefore, tax relief currently provided by the tax
    credit lags behind tax relief provided to Social Security recipients.  Thus, as
    Social Security income continues to increase with the consumer price index
    (CPI), a greater differential will exist between the value of the tax credit and
    the portion of Social Security income that is tax exempt.

    The provision has been criticized for being relatively complex, with some
    taxpayers unaware of its availability.

    	Selected Bibliography

    Butrica, Barbara A., Richard W. Johnson, Karen E. Smith, and C. Eugene
    Steuerle. The Implicit Tax on Work at Older Ages, National Tax Journal,
    vol. 59, (June 2006.), pp. 211-234.
    Cairns, Scott N. and Diane A. Riordan.  "Nonbusiness Credits: A Proposal
    for Change Based on Break-Even Analysis. Reforming the Elderly or
    Permanently Disabled Credit and the Dependent and Child Care Credit,"
    Taxes, v. 70 (May 1992), pp. 347-356.

    Dickert-Conlin, Stacy, Katie Fitzpatrick, and Andrew Hanson. "Utilization
    of Income Tax Credits by Low-Income Individuals," National Tax Journal,
    vol.58, iss. 4 (Dec. 2005), pp. 743-785.
    Forman, Jonathan Barry. "Reconsidering the Income Tax Treatment of the
    Elderly: It's Time for the Elderly to Pay Their Fair Share," University of
    Pittsburgh Law Review, v. 56, Spring 1995, pp. 589-626.
    Hulse, David S.  "Is Inflation Phasing Out the Credit for the Elderly," Tax
    Notes, v. 60 (July 12, 1993), pp. 211-216.
    U.S. Department of the Treasury.  Internal Revenue Service.  Publication
    524: Credit for the Elderly or the Disabled.  2003.
    U.S. Department of the Treasury.  Internal Revenue Service.  National
    Taxpayer Advocate, FY 2001 Annual Report to Congress.  December 31,
    2001, pp. 218-219.
    U.S.  Congress, House Committee on Ways and Means.  "2000 Green
    Book; Background Material and Data on Programs Within the Jurisdiction
    of the Committee on Ways and Means." Committee Print, 106th Congress, 2d
    Session.  October 6, 2000, pp. 823-824.
    -.  Overview of Entitlement Programs; 1998 Green Book; Background
    Material and Data on Programs Within the Jurisdiction of the Committee on
    Ways and Means.  Washington, DC: U.S. Government Printing Office, May
    19, 1998, pp. 882-883.
    U.S. Congress, Joint Committee on Taxation.  General Explanation of the
    Tax Reform Act of 1976 (H.R. 10612, 94th Congress, Public Law 94-455).
    Washington, DC: U.S. Government Printing Office,  December 29, 1976, pp.
    117-123.
    U.S. President (1981-1989: Reagan).  The President's Tax Proposals to the
    Congress for Fairness, Growth and Simplicity.  1985, pp. 11-14.

    	Income Security

    	DEDUCTIBILITY FOR CASUALTY
    	AND THEFT LOSSES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.7

    -

    0.7

    2007

    0.8

    -

    0.8

    2008

    0.3

    -

    0.3

    2009

    0.3

    -

    0.3

    2010

    0.3

    -

    0.3

    Authorization

    Sections 165(c)(3), 165(e), 165(h) - 165(k).

    	Description

    An individual may claim an itemized deduction for unreimbursed personal
    casualty or theft losses in excess of $100 per event and in excess of 10
    percent of adjusted gross income (AGI)  for combined net losses during the
    tax year.  Eligible losses are those arising from fire, storm, shipwreck, or other
    casualty, or from theft.  The cause of the loss should be considered a sudden,
    unexpected, and unusual event.

    The Katrina Emergency Tax Relief Act of 2005 (P.L. 109-73) eliminated
    limitations of deductible losses arising from the consequences of Hurricane
    Katrina.  Such losses are deductible without regard to whether aggregate net
    losses exceed 10 percent of the taxpayer's adjusted gross income, and need
    not exceed $100 per casualty or theft.

    	Impact

    The deduction grants some financial assistance to taxpayers who suffer
    substantial casualties and itemize deductions.  It shifts part of the loss from
    the property owner to the general taxpayer and thus serves as a form of
    government coinsurance.  Use of the deduction is low for all income groups.
    There is no maximum limit on the casualty loss deduction.  If losses exceed
    the taxpayer's income for the year of the casualty, the excess can be carried
    back or forward to another year without reapplying the $100 and 10 percent
    floors.  A dollar of deductible losses is worth more to taxpayers in higher
    income tax brackets because of their higher marginal tax rates.  The deduction
    is unavailable for taxpayers who do not itemize.  Typically, lower income
    taxpayers tend to be less likely to itemize the deductions.

    	Rationale

    The deduction for casualty losses was allowed under the original 1913
    income tax law without distinction between business-related and
    non-business-related losses.  No rationale was offered then.  The Revenue Act
    of 1964 (P.L. 88-272) placed a $100-per-event floor on the deduction for
    personal casualty losses, corresponding to the $100 deductible provision
    common in property insurance coverage at that time.  The deduction was
    intended to be for extraordinary, nonrecurring losses which go beyond the
    average or usual losses incurred by most taxpayers in day-to-day living.  The
    $100 floor was intended to reduce the number of small and often improper
    claims, reduce the costs of record keeping and audit, and focus the deduction
    on extraordinary losses.

    The Tax Equity and Fiscal Responsibility Act of 1982 (P.L. 97-248)
    provided that the itemized deduction for combined nonbusiness casualty and
    theft losses would be allowed only for losses in excess of 10 percent of the
    taxpayer's AGI.  While Congress wished to maintain the deduction for losses
    having a significant effect on an individual's ability to pay taxes, it included a
    percentage-of-adjusted-gross-income floor because it found that the size of a
    loss that significantly reduces an individual's ability to pay tax varies with
    income.

    The casualty loss deduction is exempt from the overall limit on itemized
    deductions for high-income taxpayers which took effect in 1991.

    Assessment

    Critics have pointed out that when uninsured losses are deductible but
    insurance premiums are not, the income tax discriminates against those who
    carry insurance and favors those who do not.  It similarly discriminates
    against people who take preventive measures to protect their property but
    cannot deduct their expenses.  No distinction is made between loss items
    considered basic to maintaining the taxpayer's household and livelihood
    versus highly discretionary personal consumption.  The taxpayer need not
    replace or repair the item in order to claim a deduction for an unreimbursed
    loss.

    Up through the early 1980s, while tax rates were as high as 70 percent and
    the floor on the deduction was only $100, high income taxpayers could have a
    large fraction of their uninsured losses offset by lower income taxes,
    providing them reason not to purchase insurance.  IRS statistics for 1980
    show a larger percentage of itemized returns in higher income groups
    claiming a casualty loss deduction.

    The imposition of the 10-percent-of-AGI floor effective in 1983, together
    with other changes in the tax code during the 1980s, substantially reduced the
    number of taxpayers claiming the deduction.  In 1980, 2.9 million tax returns,
    equal to 10.2 percent of all itemized returns, claimed a deduction for casualty
    or theft losses.  In 2001, the latest available year, only 97,424 returns claimed
    such a deduction.

    Use of the casualty and theft loss deduction can fluctuate widely from year
    to year.  Deductions have risen substantially for years witnessing a major
    natural disaster - such as a hurricane, flood, or earthquake.  In some years
    (such as 1989, 1993, and 1994) the increase in deductions is due to a jump in
    the number of returns claiming the deduction.  In other years (such as 1992) it
    reflects a large increase in the average dollar amount of deductions per return
    claiming the loss deduction.

    	Selected Bibliography

    Fulcher, Bill.  "Casualty Losses Can Be Deductible," National Public
    Accountant, v. 44 (July 1999), pp. 46-47.
    Kahn, Jeffrey H.  "Personal Deductions: A Tax 'Ideal' or Just Another
    'Deal'?," Law Review of Michigan State University, v. 2002, Spring 2002,
    pp. 1-55.
    Kaplow, Louis.  "The Income Tax as Insurance: The Casualty Loss and
    Medical Expense Loss Deductions and the Exclusion of Medical Insurance
    Premiums,"  California Law Review, v. 79. December 1991, pp. 1485-1510.
    -.  "Income Tax Deductions for Losses as Insurance,"  American Economic
    Review, v. 82, no. 4.  September 1992, pp. 1013-1017.
    Ritter, Gregory J. and Joel S. Berman.  "Casualty Losses (A Tax
    Perspective)," Florida Bar Journal, v. 67 (April 1993), pp. 43-38.
    Milam, Edward E. and Donald H. Jones, Jr.  "Casualty and Theft Losses
    Can Provide Significant Tax Deductions," Taxes, The Tax Magazine, v. 80,
    no. 10, October 2002, pp. 45-50.
    Thompson, Steven C. and Nell Adkins.  "Casualty Gains-An Oxymoron,
    or Just a Trap for Unwary Taxpayers?," Taxes, v. 73.  June 1995, pp. 318-24.
    Internal Revenue Service.  Casualties, Disasters, and Thefts. Publication
    547, for use in preparing 2006 returns.

    Income Security

    EARNED INCOME CREDIT (EIC)

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    42.1

    -

    42.1

    2007

    42.8

    -

    42.8

    2008

    43.5

    -

    43.5

    2009

    44.5

    -

    44.5

    2010

    45.4

    -

    45.4

    	Authorization

    Section 32.

    	Description

    Eligible married couples and single individuals meeting certain earned
    income and adjusted gross income (AGI) limits may be eligible for an earned
    income credit (EIC).  For purposes of the credit, earned income includes
    wages, salaries, tips, and net income from self employment.  In addition to
    earned income and AGI, the value of the credit will depend on whether or not
    the taxpayer has a qualifying child.  A qualifying child for the EIC must meet
    the following three criteria for a qualifying child for the personal exemption:
    (1) relationship - the child must be a son, daughter, stepson, stepdaughter, or
    descendent of such a relative; a brother, sister, stepbrother, stepsister, or
    descendent of such a relative cared for by the taxpayer as his/her own child;
    or a foster child; (2) residence - the child must live with the taxpayer for more
    than half the year; and (3) age - the child must be under age 19 (or under age
    24, if a full-time student) or be permanently and totally disabled.  If a
    taxpayer does not have a qualifying child, the taxpayer must be at least 25
    years of age but not more than 64 years of age, be a resident of the United
    States for more than half of the year, and not be claimed as a dependent on
    another taxpayer's return.  A taxpayer will be disqualified from receiving the
    credit if investment income exceeds a specified amount ($2,800 in tax year
    2006, the amount is indexed for inflation).  Married couples generally must
    file a joint tax return.

      The EIC increases with earnings up to a maximum, remains flat for a
    given range of income, and then declines to zero as income continues to
    increase.  The credit is calculated as a percentage of the taxpayer's earned
    income up to a statutory maximum earned income amount.  The credit
    remains at this maximum until earned income or AGI (whichever is larger)
    reaches a point at which it begins to phase out.  Above this level, the EIC is
    reduced (phased out) by a percentage of the income above the phase out
    income amount.  The maximum earned income and phase out income
    amounts are adjusted for inflation.

    For tax year 2006, the maximum EIC is equal to 34.0 percent of the first
    $8,080 of earned income for one qualifying child (i.e. the maximum basic
    credit is $2,747) and 40.0 percent of earned income up to $11,340 for two or
    more qualifying children (i.e. the maximum basic credit is $4,536).

    For individuals with children, in tax year 2006,  the EIC begins to phase
    out at  $14,810 of earned income or AGI, whichever is larger.  For married
    couples with children the phase out begins at an income level that is $2,000
    higher ($16,810).  For families above the phase out income amount,  the
    credit is phased out at a rate of 15.98 percent of income above the phase out
    income level for one qualifying child, and 21.06 percent for two or more
    qualifying children.

    For married couples and  individuals without children, in tax year 2006, the
    EIC is 7.65 percent of the first $5,380 for a maximum credit of $412.  The
    credit begins to phase out at $6,740 of earned income (or AGI whichever is
    larger) and at a 7.65 percent rate.  For married couples with children the
    phase out begins at an income level that is $2,000 higher ($8,740). The
    maximum earned income and phase out income amounts are adjusted for
    inflation.

    If the credit is greater than Federal income tax owed, the difference is
    refunded.  The portion of the credit that offsets (reduces) income tax is a tax
    expenditure, while the portion refunded to the taxpayer is treated as an outlay.
     Working parents may arrange with their employers to receive the credit in
    advance (before filing an annual tax return) through reduced tax withholding
    during the year.

    While gross income for tax purposes does not generally include certain
    combat pay earned by members of the armed forces, P.L. 108-311 allowed
    members of the armed forces to include this combat pay for purposes of
    computing the earned income credit for tax years that ended after October 4,
    2004 and before January 1, 2007.

    	Impact

    The earned income credit increases the after-tax income of lower- and
    moderate-income working couples and individuals, particularly those with
    children.  Alternative measures of income  by the U.S. Census Department,
    which are designed to show the impact of taxes and transfers on poverty,
    estimate that the earned income credit reduced the number of people in
    poverty in 2004 by approximately 5.8 million.  Because the  number of
    people in poverty is 42.4 million before the EIC (using an alternative income
    definition, and not the official definition), the reduction due to the EIC is
    13.7%.

    The following table provides estimates of the distribution of the earned
    income credit by income level, and includes the refundable portion of the
    credit.  Because the estimates use an expanded definition of income, the
    estimates contain a distribution for incomes above the statutory limits.  For
    further information on the definition of income see page 5 of the introduction
    to this document.

    Distribution by Income Class of the Tax Expenditure
    for the Earned Income Credit, 2005

    Income Class
    (in thousands of $)

    Percentage
    Distribution

    Below $10

    15.3

    $10 to $20

    38.8

    $20 to $30

    28.5

    $30 to $40

    13.6

    $40 to $50

    3.2

    $50 to $75

    0.5

    $75 to $100

    0.0

    $100 to $200

    0.0

    $200 and over

    0.0

    	Rationale

    The earned income credit was enacted by the Tax Reduction Act of 1975
    as a temporary refundable credit to offset the effects of the social security tax
    and rising food and energy costs on lower income workers and to provide a
    work incentive for parents with little or no earned income.

    The credit was temporarily extended by the Revenue Adjustment Act of
    1975, the Tax Reform Act of 1976, and the Tax Reduction and Simplification
    Act of 1977.  The Revenue Act of 1978  made the credit permanent,  raised
    the maximum amount of the credit, and provided for advance payment of the
    credit.  The 1978 Act also created a range of income for which the maximum
    credit is granted before the credit begins to phase out.

    The maximum credit was raised by both the Deficit Reduction Act of 1984
    and the Tax Reform Act of 1986.  The 1986 Act also indexed the maximum
    earned income and phase out income amounts to inflation.  The Omnibus
    Budget Reconciliation Act (OBRA) of 1990 increased the percentage used to
    calculate the credit, created an adjustment for family size, and created
    supplemental credits for young children (under age 1) and health insurance.

    OBRA 1993 increased the credit, expanded the family-size adjustment,
    extended the credit to individuals without children, and repealed the
    supplemental credits for young children and health insurance.  To increase
    compliance, the Taxpayer Relief Act of 1997 included a provision denying
    the credit to persons improperly claiming the credit in prior years.

    The Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of
    2001 simplified calculation of the credit by excluding nontaxable employee
    compensation from earned income, eliminating the credit reduction due to the
    alternative minimum tax, and using adjusted gross income rather than
    modified adjusted gross income for calculation of the credit phase out.
    EGTRRA also expanded the phase out range for married couples filing a joint
    return to reduce the marriage penalty.  The EGTRRA changes do not apply to
    tax years after 2010.

    	Assessment

    The earned income credit raises the after-tax income of several million
    lower- and moderate-income families, especially those with children.  The
    credit has been promoted as an alternative to raising the minimum wage, as a
    method for reducing the burden of social security tax increases, and as an
    incentive to work.  The credit has, in dollar terms, become the largest cash
    welfare program.

    Up to the maximum earned income amount (at which the credit reaches a
    maximum) the credit generally provides a work incentive:  the more a person
    earns, the greater the amount of the credit.  But within the income range over
    which the credit is phased out, the credit may act as a work disincentive: as
    the credit declines, the taxes owed increase.  As income increases a credit
    recipient may switch from receiving a refund (because of the credit) to
    receiving no credit or paying taxes.  The combination of higher taxes and a
    lower credit increases the marginal tax rate of the individual.  The marginal
    tax rate may in many cases be higher than the rate for taxpayers with
    substantially higher incomes.  This creates an incentive for the individual to
    reduce work hours (to avoid the increase in taxes and maintain the credit).

    While the credit encourages single parents to enter the work force, the
    decline of the credit above the phase out amount can discourage the spouse of
    a working parent from entering the workforce.  This "marriage penalty" may
    also discourage marriage when one or both parties receive the earned income
    credit.  EGTRRA may have moderated this effect somewhat.

     Some eligible individuals do not receive the credit because of incorrect or
    incomplete tax return information, or because they do not file.  Conversely,
    payments to ineligible individuals, and overpayments to eligible recipients,
    have been a source of concern, resulting in IRS studies of EIC compliance
    and federally funded initiatives to improve administration of the credit.  For
    tax year 2003, the IRS conducted a pre-certification study in which
    approximately 25,000 tax filers were asked to certify, before filing their tax
    returns, that the child claimed for the credit had lived with the tax filer for
    more than half of the tax year (making the child a qualifying child for the
    taxpayer to claim the EIC).  The final report estimated that erroneous claims
    related to the child residency requirement were $2.9 to $3.3 million.
    However, the study also estimated that there was a reduction in the credit
    claimed by eligible claimants of between $1.1 and $1.4 million due to the
    unintended deterrence effect of the pre-certification study.

    The credit also differs from other transfer payments in that most
    individuals receive it as an annual lump sum rather than as a monthly benefit.
     Very few credit recipients elect advance payments.  There are a number of
    reasons why a recipient may not choose advance payments, including not
    wanting to inform an employer that he/she is a credit recipient.  A recipient
    may also be making a choice between consumption (using advance payments
    for current needs) and savings (using an annual payment for future needs or
    wants).

    	Selected Bibliography

    Dickert-Conlin, Stacy, and Scott Houser.  "EITC and Marriage," National
    Tax Journal, v. 55, no. 1, March 2002, pp. 25-43.
    Ellwood, David T.  "The Impact of the Earned Income Tax Credit and
    Social Policy Reforms on Work, Marriage, and Living Arrangements,"
    National Tax Journal, v. 53, no. 4, part 2,  December 2000, pp. 1063 - 1106.
    Gravelle, Jane G.  The Earned Income Tax Credit (EITC): Effects on Work
    Effort, Library of Congress, Congressional Research Service Report 95-928.
    Washington, DC: August 30, 1995.(Available upon request from author)
    Gravelle, Jane G. The Marriage Penalty: An Overview of the Issues,
    Library of Congress, Congressional Research Service Report RL30419.
    Washington, DC: June 21, 2001.
    Holtzblatt, Janet, and Robert Rebelein.  "Measuring the Effect of the EITC
    on Marriage Penalties and Bonuses," National Tax Journal, v. 53, no. 4, part
    2, December 2000, pp. 1107 - 1129.
    Horowitz, John B. "Income Mobility and the Earned Income Credit,"
    Economic Inquiry, v. 40, n. 3, July 2001, pp. 334-347.

    Hotz, V. Joseph, and  John Karl Scholz, The Earned Income Tax Credit,
    National Bureau of Economic Research Working Paper 8078, January 2001.
    Liebman, Jefferey B.  "Who are the ineligible EITC Recipients?" National
    Tax Journal, v. 53, n. 4, part 2,  December 2000, pp. 1165 - 1190.
    McCubbin, Janet.  "EITC Noncompliance: the Determinants of the
    Misreporting of Children," National Tax Journal, v. 53, no. 4, part 2,
    December 2000, pp. 1135 - 1163.
    Meyer, Bruce and Dan T. Rosenbaum, "Making Single Mothers Work:
    Recent Tax and Welfare Policy and its Effects," National Tax Journal, v. 53,
    no. 4, part 2, December 2000, pp. 1027 - 1054.
    Moffit, Robert. Welfare Programs and Labor Supply, National Bureau of
    Economic Research Working paper 9168, September 2002.
    Neumark, David, and William Wascher. "Using the EITC to Help Poor
    Families: New Evidence and a Comparison with the Minimum Wage,"
    National Tax Journal, v.54, no. 2,  June 2001, pp. 281-317.
    Scholz, John Karl.  In "Work Benefits in the United States: The Earned
    Income Tax Credit, Economic Journal, v. 106, n. 1,  January 1996, pp. 159-
    169.
    Scott, Christine, The Earned Income Credit (EITC):  Legislative Issues,
    Library of Congress, Congressional Research Service Report RS21477.
    Washington, DC.
     	Scott, Christine, The Earned Income Credit (EITC): An Overview, Library
    of Congress, Congressional Research Service Report RL31768.  Washington,
    DC.
    Smeeding, Timothy M.,  Katherine Ross Phillis and Michael O'Conner,
    "The EITC: Expectation, Knowledge, Use, and Economic and Social
    Mobility", National Tax Journal, v. 53, no. 4, part 2,  December 2000, pp.
    1187 - 2109.
    U.S. Census Department, Poverty in the United States:  2001, September
    2002.
    U. S. Census Department, Current Population Survey, Annual
    Demographic Supplement, Historical Poverty Tables - Table 5, September
    2002.
    U.S. Congress, House Committee on Ways and Means.  Background
    Materials: 1998 Green Book, Committee Print, 106th Congress, 2nd session.
    December 22, 2000, pp. 547-552.
    U.S. General Accounting Office. "Earned Income Tax Credit:
    Qualifying Child Certification Test Appears Justified, but Evaluation
    Plan Is Incomplete." GAO-03-794. Washington, D.C., September
    2003.
    U.S. Department of Treasury, Internal Revenue Service, Compliance
    Estimates for Earned Income Tax Credit Claimed on 1999 Returns.  February
    2002.
    U.S. Department of the Treasury, Internal Revenue Service, IRS Earned
    Income Tax Credit (EITC) Initiative, Final Report to Congress, October
    2005.
    Ventry, Dennis J. "The Collision of Tax and Welfare Politics: The Political
    History of the Earned Income Credit, 1969-99", National Tax Journal, v. 53
    n. 4, part 2, pp. 983 - 1026.

    Income Security

    EXCLUSION OF CANCELLATION OF INDEBTEDNESS
    INCOME OF HURRICANE KATRINA VICTIMS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    0.2

    -

    0.2

    2007

    0.1

    -

    0.1

    2008

    -

    -

    -

    2009

    -

    -

    -

    2010

    -

    -

    -

    (1) Less than $50 million.

    Authorization

    Sections 61(a)(12), and 108.

    Description

    When a debt is forgiven, the amount of the forgiveness is included income,
    with some exceptions, such as in the case of bankruptcy.  One of those
    exemptions is forgiveness of non-business debt of an individual between
    August 24, 2005 and January 1, 2007 for an individual who either lived in the
    core disaster area of Hurricane Katrina, or who lived in the covered disaster
    area and incurred an economic loss due to the hurricane.  The covered disaster
    area designated by the Federal Emergency Management Agency (FEMA) is
    eligible for public assistance and includes all of Louisiana and Mississippi,
    counties in western Alabama and counties in western Florida panhandle.  The
    core disaster area is designated by FEMA as eligible for individual aid as well
    and covers the southern part of Louisiana and Mississippi, and southwestern
    counties in Alabama.  This core emergency area was also designated the Gulf
    Opportunity Zone (GO Zone).  Debt secured by property outside the disaster
    area is not eligible.

    Individuals with loans secured by property with basis, such as home or
    rental property,  must reduce basis by the amount of the loan forgiveness
    which could result in tax liability in the future through capital gains taxes or
    depreciation deductions.

    Impact

    Forgiveness of debt reduces the taxes that would be immediately due when
    debt is forgiven.  Individuals affected by a disaster may, as is the case with
    bankruptcy, be relieved of a tax they do not have the cash flow to pay, and
    one that could be large relative to current income.

    To the extent the provision affects debt related to property, the benefit is
    more concentrated among higher income individuals, although other forms of
    debt may be involved as well.

     	Rationale

    This provision was enacted as part of the Katrina Emergency Relief Act of
    2005 (P.L. 109-73).  While no official reports exist, the purpose of this
    legislation, adopted within a month of the hurricane, was largely directed at
    providing relief to the hurricane victims.

    Assessment

    This provision provides relief to those who were forgiven debt after the
    disaster, by eliminating the tax that would be due.

    While the provision was aimed at individuals who had suffered a loss,
    some questions might be raised as to why relief provisions were allowed for a
    major disaster, such as a large scale hurricane, but not for smaller scale
    disasters (e.g. tornadoes) or losses proceeding from other sources.

    	Selected Bibliography

    Gravelle, Jane, Tax Policy Options After Hurricane Katrina, Library of
    Congress, Congressional Research Service Report RL33088, October 23,
    2006.
    Internal Revenue Service, Information for Taxpayers Affected by
    Hurricanes Katrina, Wilma and Rita, Publication 4492, January 1, 2006.
    	U.S. Congress, Joint Committee on Taxation, Technical Explanation of the
    Revenue Provisions of H.R. 3768, The Katrina Emergency Relief Act of
    2005, As Passed by the House of Representatives and the Senate, JC69-05,
    Washington, DC, September 21, 2005.

    Social Security and Railroad Retirement

    EXCLUSION OF UNTAXED SOCIAL SECURITY
    AND RAILROAD RETIREMENT BENEFITS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    23.1

    -

    23.1

    2007

    24.1

    -

    24.1

    2008

    24.8

    -

    24.8

    2009

    25.9

    -

    25.9

    2010

    27.2

    -

    27.2

    Authorization

    Sec. 86 I.R.C. 1954 and I.T. 3194, 1938-1 C.B. 114 and I.T. 3229,
    1938-2136, as superseded by Rev. Ruling 69-43, 1969-1 C.B. 310; I.T. 3447,
    1941-1 C.B. 191, as superseded by Rev. Ruling 70-217, 1970-1 C.B. 12.

    	Description

    In general, the Social Security and Railroad Retirement benefits of most
    recipients are not subject to tax.  A portion of Social Security and certain
    (Tier I) Railroad Retirement benefits is included in income for taxpayers
    whose "provisional income" exceeds certain thresholds.

    Tier I Railroad Retirement benefits are those provided by the Railroad
    Retirement System that are equivalent to the Social Security benefit that
    would be received by the railroad worker were he or she covered by Social
    Security.  "Provisional income" is  adjusted gross income plus one-half the
    Social Security benefit and otherwise tax-exempt "interest" income (i.e.,
    interest from tax-exempt bonds).

    The thresholds below which no Social Security or Tier I Railroad
    Retirement benefits are taxable are $25,000 (single), and $32,000 (married
    couple filing a joint return).

    If provisional income is between the $25,000 threshold ($32,000 for a
    married couple) and a second-level threshold of $34,000 ($44,000 for a
    married couple), the amount of benefits subject to tax is the lesser of: (1) 50
    percent of benefits; or (2) 50 percent of provisional income in excess of the
    first threshold.

    If provisional income is above the second threshold, the amount of benefits
    subject to tax is the lesser of:
    (1) 85 percent of benefits or
    (2) 85 percent of income above the second threshold, plus
    the smaller of	(a) $4,500 ($6,000 for a married couple) or,
    (b) 50 percent of benefits.

    For a married person filing separately who has lived with his or her spouse
    at any time during the tax year, taxable benefits are the lesser of 85 percent of
    benefits or 85 percent of provisional income.

    The tax treatment of Social Security and Tier I Railroad Retirement
    benefits differs from that of  pension benefits.  For pension benefits, all
    benefits that exceed (or are not attributable to) the amount of the employee's
    contribution are fully taxable.

    The proceeds from taxation of Social Security and Tier I Railroad
    Retirement benefits at the 50 percent rate are credited to the Social Security
    Trust Fund and the National Railroad Retirement Investment Trust,
    respectively.  Proceeds from taxation of Social Security benefits and Tier I
    Railroad Retirement benefits at the 85 percent rate are credited to the Hospital
    Insurance Trust Fund (for Medicare).

    	Impact

    The Congressional Budget Office estimates that about 61 percent of Social
    Security and Tier I Railroad Retirement recipients pay no tax on their
    benefits.  The distribution of the tax expenditure is shown below.

    Distribution by Income Class of
     Tax Expenditure, Untaxed Social Security and
    Railroad Retirement Benefits, 2005

    Income Class
    (in thousands of $)

    Percentage
    Distribution

    Below $10

    0.0

    $10 to $20

    8.6

    $20 to $30

    11.0

    $30 to $40

    16.7

    $40 to $50

    16.4

    $50 to $75

    33.0

    $75 to $100

    9.6

    $100 to $200

    3.5

    $200 and over

    1.2

    	Rationale

    Until 1984, Social Security benefits were exempt from the federal income
    tax.  The original exclusion arose from rulings made in 1938 and 1941 by the
    then Bureau of Internal Revenue (I.T. 3194, I.T. 3447).  The exclusion of
    benefits paid under the Railroad Retirement System was enacted in the
    Railroad Retirement Act of 1935.

    For years many program analysts questioned the basis for the rulings on
    Social Security and advocated that the treatment of Social Security benefits
    for tax purposes be the same as it is for other pension income.  Pension
    benefits are now fully taxable except for the proportion of projected lifetime
    benefits attributable to the worker's contributions.  Financial pressures on the
    Social Security program in the early 1980s also increased interest in taxing
    benefits.  The 1981 National Commission on Social Security Reform
    proposed taxing one-half of Social Security benefits received by persons
    whose income exceeded certain amounts and crediting the proceeds to the
    Social Security Trust Fund.  The inclusion of one-half of benefits represented
    the employer contribution to the benefits.

    In enacting the 1983 Social Security Amendments (P.L. 98-21) in March
    1983, Congress essentially adopted the Commission's recommendation, but
    modified it to phase in the tax on benefits gradually, as  income rose above
    threshold amounts.  At the same time, it modified the tax treatment of Tier I
    Railroad Retirement benefits to conform to the treatment of Social Security
    benefits.

    In his FY 1994 budget, President Clinton proposed that the taxable propor-
    tion of Social Security and Tier I Railroad Retirement benefits be increased to
    85 percent effective in 1994, with the proceeds credited to Medicare's
    Hospital Insurance (HI) Trust Fund.  At that time is was estimated that the
    highest paid category of worker would, during the worker's lifetime,
    contribute fifteen percent of the value of the Social Security benefits received
    by the worker.  That is, at least eighty-five percent of the Social Security
    benefits received by a retiree could not be attributed to contributions by the
    retiree.  Congress approved this proposal as part of the Omnibus Budget
    Reconciliation Act of 1993 (P.L. 103-66), but limited it to recipients whose
    threshold incomes exceed $34,000 (single) or $44,000 (couple).  This
    introduced the current two levels of taxation.

    	Assessment

    Principles of horizontal equity (equal treatment of those in equal
    circumstances) generally support the idea of treating Social Security and Tier
    I Railroad Retirement benefits similarly to other sources of retirement income.
    Horizontal equity suggests that equal income, regardless of source, represents
    equal ability to pay taxes, and therefore should be equally taxed. Just as the
    portion of other pension benefits and IRA distributions on which taxes have
    never been paid is fully taxable, so too should the portion of Social Security
    and Tier I Railroad Retirement benefits not attributable to the individual's
    contributions be fully taxed.

    In 1993, it was estimated that if Social Security benefits received the same
    tax treatment as pensions, on average about 95 percent of benefits would be
    included in taxable income, and that the lowest proportion of benefits that
    would be taxable for anyone entering the work force that year would be 85
    percent of benefits. Because of the administrative complexities involved in
    calculating the proportion of each individual's benefits, and because in theory
    it would ensure that no one would receive less of an exclusion than entitled to
    under other pension plans, a maximum of 85 percent of Social Security
    benefits is currently in taxable income.

    To the extent that Social Security benefits reflect social welfare payments,
    it can be argued that benefits be taxed similar to other general untaxed social
    welfare payments and not like other retirement benefits.   One exception to
    the concept of horizontal equity is social welfare payments -  payments
    made for the greater good (social welfare).  Not all Social Security payments
    have a pension or other retirement income component and, unlike other
    pensions, more than one person may be entitled to benefits for a single
    worker.  In addition, Social Security benefits are based on work earnings
    history and not contributions, with the formula providing additional benefits
    to recipients with lower work earnings histories.

    Because the calculation of provisional income (to determine if benefits are
    taxable) includes a portion of Social Security benefits and certain otherwise
    untaxed income, the provisional income calculation can be compared to the
    income resources concept often used for means testing of various social
    benefits.  Because the taxation increases as the provisional income increases,
    the after-tax Social Security benefits will decline as provisional income
    increases (but not below 15% of pre-tax benefits).  This has resulted in the
    taxation of benefits being viewed as a "back-door" means test.

    Under the current  two level structure, all Social Security beneficiaries have
    some untaxed benefits.  Taxes are imposed on at least half of the benefits for
    middle and upper income beneficiaries, while lower income beneficiaries
    have no benefits taxed.

    	Selected Bibliography

    Brannon, Gerard M.  "The Strange Precision in the Taxation of Social
    Security Benefits,"  Tax Notes.  March 29, 1993.
    Fellows, James A., and Haney, J. Edison.  "Taxing the Middle Class,"
    Taxes.  October, 1993.
    Scott, Christine, Social Security Benefits: Calculation and History of
    Taxing Benefits, Library of Congress, Congressional Research Report
    RL32552.  Washington, DC.
    U.S. Congress, Congressional Budget Office.  Reducing the Deficit:
    Spending and Revenue Options.  March, 1994.
    -, Committee on Ways and Means, 2004 Green Book, Background
    Material and Data on the Programs Within the Jurisdiction of the Committee
    on Ways and Means, WMCP:108-6, March 2004.
    -, House of Representatives.  Omnibus Budget Reconciliation Act of 1993,
    Conference Report No. 103-213.  August 4, 1993.
    Weiner, David.  "Social Security Benefits, Federal Taxation," in The
    Encyclopedia of Taxation and Tax Policy, eds. Joseph J. Cordes, Robert O.
    Ebel, and Jane G. Gravelle.  Washington, DC: Urban Institute Press, 2005.

    Veterans' Benefits and Services

    EXCLUSION OF VETERANS' BENEFITS AND SERVICES

    (1) EXCLUSION OF VETERANS' DISABILITY COMPENSATION
    (2) EXCLUSION OF VETERANS' PENSIONS
    (3) EXCLUSION OF READJUSTMENT BENEFITS

    Estimated Revenue Loss

    [in billions of dollars]

    Individuals

    Fiscal
    Year

    Veterans
    Disability
    Compensation

    Veterans
    Pensions

    Readjustment
    Benefits

    Total

    2006

    3.6

    0.1

    0.2

    3.9

    2007

    3.8

    0.1

    0.3

    4.2

    2008

    3.9

    0.1

    0.3

    4.3

    2009

    4.0

    0.1

    0.3

    4.4

    2010

    4.0

    0.1

    0.3

    4.4

    Authorization

    38 U.S.C. 3101.

    	Description

    All benefits administered by the Department of Veterans Affairs are
    exempt from taxation.  Such benefits include those for veterans' disability
    compensation, veterans' pension payments, and education payments.

    Veterans' service-connected disability compensation payments are related
    to the loss of earnings capacity in civilian occupations resulting from a
    service-related wound, injury, or disease.  Typically, benefits increase with
    the severity of disability.  Veterans whose service-connected disabilities are
    rated at 30 percent or more are entitled to additional allowances for
    dependents.  Veterans with a 60- to 90-percent disability may receive
    compensation at the 100-percent level if they are unemployable.

    Veteran pensions are available to support veterans with a limited income
    who had at least one day of military service during a war period and at least
    90 days of active duty service.  Benefits are paid to veterans over age 65 or to
    veterans with disabilities unrelated to their military service.

    Pension benefits are based on "countable" income (the larger the income,
    the smaller the pension) with no payments made to veterans whose assets may
    be used to provide adequate maintenance.  For veterans coming on the rolls
    after December 31, 1978, countable income includes earnings of the veteran,
    spouse, and dependent children, if any.  Veterans who were on the rolls prior
    to that date may elect coverage under prior law, which excludes from
    countable income the income of a spouse, among other items.

    Veterans' educational assistance is provided under a number of different
    programs for veterans, service persons, and eligible dependents.  These
    programs have varying eligibility requirements and benefits.

    With passage of the Veterans Millennium Health Care Act of 1999,
    veterans received expanded long-term care benefits and increased in home
    care.  The act gave severely disabled veterans and those needing care for
    service-connected conditions higher priority access to long-term care benefits
    and services.  The act also provided higher priority access to veterans
    awarded Purple Hearts and certain military retirees.  It authorized the VA to
    increase co-payments for pharmacy benefits used for treatment of non-
    service-connected conditions, and authorized emergency care coverage for
    certain veterans without health insurance.  Another provision included
    surviving spouses of certain totally disabled former prisoners of war as
    eligible for health care.

    Impact

    Beneficiaries of all three major veterans' programs pay less tax than other
    taxpayers with the same or smaller economic incomes.  Since these exclusions
    are not counted as part of income, the tax savings are a percentage of the
    amount excluded, depending on the marginal tax bracket of the veteran.
    Thus, the exclusion amounts will have greater value for veterans with high
    incomes than for those with lower incomes.

    	Rationale

    The rationale for excluding veterans' benefits from taxation is not clear.
    The tax exclusion of benefits was adopted in 1917, during World War I.
    Many have concluded that the exclusion is in recognition of the extraordinary
    sacrifices made by armed forces personnel, especially during periods of war.

    Assessment

    The exclusion of veterans' benefits alters the distribution of payments and
    favors higher-income individuals.  It is typically argued that the differential
    that exists between veterans' service-connected disability compensation and
    the average salary of wage earners reflects the tax-exempt status of their
    benefits.   Some view veterans' compensation as a career indemnity payment
    owed to those disabled to any degree while serving in the nation's armed
    forces.  If benefits were to become taxable, higher benefit levels would be
    required if lost income were replaced.  Some disabled veterans would find it
    difficult to increase working hours to make up for the loss of expected
    compensation payments.  Some commentors have noted that if veterans with
    new disability ratings below 30 percent were to be made ineligible for
    compensation it would concentrate spending on those veterans most impaired.
     Further, not only would direct expenditures be reduced, but the indirect tax
    expenditure of these payments would be excluded from the tax base.

    	Selected Bibliography

    Cullinane, Danielle.  Compensation for Work-Related Injury and Illness.
    Santa Monica, CA, RAND, 1992.  60 p.  (RAND Publication Series N-3343-
    FMP).
    Ferris, Nancy.  "Serving Those Who Served," Government Executive, v. 30
    (January 1998), pp. 18, 20, 22, 24.
    Ogloblin, Peter K.  Military Compensation Background Papers:
    Compensation Elements and Related Manpower Cost Items, Their Purposes
    and Legislative Backgrounds.  Washington, DC: Department of Defense,
    Office of the Secretary of Defense, U.S. Government Printing Office,
    November 1991, pp. 633-645.
    Poulson, Linda L. and Ananth Seetharaman.  "Taxes and the Armed
    Forces," The CPA Journal, April 1996, pp. 22-26.
    Snook, Dennis William.  "Veterans Issues in the 106th Congress," Library
    of Congress, Congressional Research Service Report RL30099.  Washington,
    DC: March 7, 2001.  31 pp.
    U.S. Congress, Congressional Budget Office.  Disability Compensation:
    Current Issues and Options for Change.  Washington, DC: U.S. Government
    Printing Office, 1982.
    -.  Budget Options.  "End Future Awards of Veterans' Compensation for
    Certain Veterans with Low-Rated Disabilities." and "End Future Awards of
    Veterans' Disability or Death Compensation When a Disability is Unrelated
    to Military Duties."   Washington, DC: February 2001, pp. 347-348.
    U.S. Congress, General Accounting Office.  Major Management
    Challenges and Program Risks: Department of Veterans Affairs, GAO
    Report GAO-03-110, Washington, DC: U.S. General Accounting Office.
    2003. pp. 1-49.

    - .  Military and Veterans' Benefits: Observations on the Concurrent
    Receipt of Military Retirement and VA Disability Compensation, GAO
    Report GAO-03-575T, Washington, DC: U.S. Government Printing Office.
    2003.
    - .  Veterans' Benefits: Quality Assurance for Disability Claims and
    Appeals Processing Can be Further Improved, Washington, DC: U.S.
    Government Printing Office.  2002.
    -.Veterans Compensation: Offset of DOD Separation Pay and VA
    Disability Compensation; Report to Congressional Committees, GAO Report
    GAO/NSIAD-95-123.  Washington, DC: U.S. Government Printing Office.
    1995.
    -.  VA Disability Compensation: Comparison of VA Benefits with Those of
    Workers' Compensation Programs; Report to the Chairman, Subcommittee
    on Benefits, Committee on Veterans' Affairs, House of Representatives, GAO
    Report GAO/HEHS-97-5.  Washington, DC: U.S. Government Printing
    Office. 1997.
    -. VA Disability Compensation: Disability Ratings May Not Reflect
    Veterans' Economic Losses; Report to the Chairman, Subcommittee on
    Compensation, Pension, Insurance and Memorial Affairs, Committee on
    Veterans' Affairs, House of Representatives, GAO Report GAO/HEHS-97-9.
    Washington, DC: U.S. Government Printing Office.  1997.
    U.S.  Congress, House Committee on Ways and Means.  2004 Green
    Book; Background Material and Data on Programs Within the Jurisdiction
    of the Committee on Ways and Means, Committee Print, 108th Congress, 2d
    Session.  March 2004, pp. 15:135-137.
    U.S. Congress, Joint Committee on Veterans' Affairs.  Title 38--United
    States Code: Veterans' Benefits as Amended Through December 31, 1996
    and Related Material.  Prepared by the Committee on Veterans' Affairs of the
    House of Representatives and U.S. Senate.  Washington, DC: March 14,
    1997. (S. Prt. 104-75).
    U.S. Department of the Treasury, Office of the Secretary.  Tax Reform for
    Fairness, Simplicity, and Economic Growth; the Treasury Department
    Report to the President.  Washington, DC: November 1984, pp. 51-57.

    	Veterans' Benefits and Services

    	EXCLUSION OF INTEREST
    	ON STATE AND LOCAL GOVERNMENT BONDS
    FOR VETERANS' HOUSING

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    (1)

    (1)

    (1)

    2007

    (1)

    (1)

    (1)

    2008

    (1)

    (1)

    (1)

    2009

    (1)

    (1)

    (1)

    2010

    (1)

    (1)

    (1)

    (1)Less than $50 million.

    	Authorization

    Sections 103, 141, 143, and 146 of the Internal Revenue Code of 1986.

    	Description

    Veterans' housing bonds are used to provide mortgages at below-market
    interest rates on owner-occupied principal residences of homebuyers who are
    veterans.  These veterans' housing bonds are classified as private-activity
    bonds rather than governmental bonds because a substantial portion of their
    benefits accrues to individuals rather than to the general public.

    Each State with an approved program is subject to an annual volume cap
    related to its average veterans' housing bond volume between 1979 and 1985.
     For further discussion of the distinction between governmental bonds and
    private-activity bonds, see the entry under General Purpose Public
    Assistance: Exclusion of Interest on Public Purpose State and Local Debt.

    	Impact

    Since interest on the bonds is tax exempt, purchasers are willing to accept
    lower before-tax rates of interest than on taxable securities.  These low-
    interest rates enable issuers to offer mortgages on veterans' owner-occupied
    housing at reduced mortgage interest rates.

    Some of the benefits of the tax exemption also flow to bondholders.  For a
    discussion of the factors that determine the shares of benefits going to
    bondholders and homeowners, and estimates of the distribution of tax-exempt
    interest income by income class, see the "Impact" discussion under General
    Purpose Public Assistance: Exclusion of Interest on Public Purpose State
    and Local Debt.

    	Rationale

    Veterans' housing bonds were first issued by the States after World War II,
    when both State and Federal governments enacted programs to provide
    benefits to veterans as a reward for their service to the Nation.

    The Omnibus Budget Reconciliation Act of 1980 required that veterans'
    housing bonds must be general obligations of the State.  The Deficit
    Reduction Act of 1984 restricted the issuance of these bonds to the five States
    that had qualified programs in existence before June 22, 1984, and limited
    issuance to each State's average issuance between 1979 and 1984.

    Loans were restricted to veterans who served in active duty any time before
    1977 and whose application for the mortgage financing occurred before the
    later of 30 years after leaving the service or January 31, 1985, thereby
    imposing an effective sunset date for the year 2007.  Loans were also
    restricted to principal residences.

    The most recent change to the program was enacted by  the Tax Increase
    Prevention and Reconciliation Act (TIPRA; P.L. 109-222), which required
    that payors of state and municipal bond tax-exempt interest begin to report
    those payments to the Internal Revenue Service after December 31, 2005.
    The manner of reporting is similar to reporting requirements for interest paid
    on taxable obligations.

    	Assessment

    The need for these bonds has been questioned, because veterans are
    eligible for numerous other housing subsidies that encourage home ownership
    and reduce the cost of their housing.  As one of many categories of tax-
    exempt private-activity bonds, veterans' housing bonds have been criticized
    because they increase the financing costs of bonds issued for public capital
    stock and increase the supply of assets available to individuals and
    corporations to shelter their income from taxation.

    	Selected Bibliography

    Cooperstein, Richard L.  "Economic Policy Analysis of Mortgage Revenue
    Bonds."  In Mortgage Revenue Bonds: Housing Markets, Home Buyers and
    Public Policy, edited by Danny W. Durning, Boston, MA: Kluwer Academic
    Publishers, 1992.
    -.  "The Economics of Mortgage Revenue Bonds: A Still Small Voice."  In
    Mortgage Revenue Bonds: Housing Markets, Home Buyers and Public
    Policy, edited by Danny W. Durning, Boston, MA: Kluwer Academic
    Publishers, 1992.
    Maguire, Steven.  Private Activity Bonds: An Introduction.  Library of
    Congress, Congressional Research Service Report RL31457.  June 9, 2006.
    -.  Tax-Exempt Bonds: A Description of State and Local Government
    Debt.  Library of Congress, Congressional Research Service Report
    RL30638.  March 10, 2006.
    U.S. Congress, Joint Committee on Taxation.  General Explanation of the
    Revenue Provisions of the Deficit Reduction Act of 1984, Committee Print,
    98th Congress, 2nd session.  December 31, 1984, pp.  903-958.
    Zimmerman, Dennis.  The Private Use of Tax-Exempt Bonds: Controlling
    Public Subsidy of Private Activity.  Washington, DC: The Urban Institute
    Press, 1991.

    	General Purpose Fiscal Assistance

    	EXCLUSION OF INTEREST ON PUBLIC PURPOSE
    STATE AND LOCAL GOVERNMENT DEBT

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    18.7

    7.3

    26.0

    2007

    20.1

    7.8

    27.9

    2008

    21.1

    8.2

    29.3

    2009

    22.1

    8.6

    30.7

    2010

    23.1

    9.0

    32.1

    Authorization

    Sections 103 and 141.

    	Description

    Certain obligations of State and local governments qualify as
    "governmental" bonds.  The interest income earned by individual and
    corporate purchasers of these bonds is excluded from taxable income.  This
    interest income is not taxed because the bond proceeds generally are used to
    build capital facilities that are owned and operated by governmental entities
    and serve the general public interest, such as highways, schools, and
    government buildings.  These bonds can be issued in unlimited amounts,
    although State governments do have self-imposed debt limits.  The revenue
    loss estimates in the above table for general fiscal assistance are based on the
    difference between excluded interest income on these governmental bonds
    and taxable bonds.

    Other obligations of State and local governments are classified as "private-
    activity" bonds.  The interest income earned by individual and corporate
    purchasers of these bonds is included in taxable income.  This interest income
    is taxed because the bond proceeds are believed to provide substantial
    benefits to private businesses and individuals and the bonds are repaid with
    revenue generated by the project, e.g., tolls or service charges.  Tax
    exemption is available for a subset of these otherwise taxable private-activity
    bonds if the proceeds are used to finance an activity included on a list of
    activities specified in the Code.  Unlike governmental bonds, however, these
    tax-exempt, private-activity bonds may not be issued in unlimited amounts.
    All governmental entities within each State currently are subject to a federally
    imposed State volume cap on new issues of these tax-exempt, private-activity
    bonds equal to the greater of $80 per resident or $246.6 million in 2006.
    Some qualified private activities, such as qualified public educational
    facilities, are subject to national caps and are not subject to the State volume
    cap.  Still other facilities, such as government owned airports, docks, and
    wharves, are not capped.

    Each activity included in the list of private activities eligible for tax-exempt
    financing is discussed elsewhere in this document under the private activity's
    related budget function.

    	Impact

    The distributional impact of this interest exclusion can be viewed from two
    perspectives: first, the division of tax benefits between State and local
    governments and bond purchasers; and second, the division of the tax benefits
    among income classes.  The direct benefits of the exempt interest income
    flow both to State and local governments and to the purchasers of the bonds.
    The exclusion of interest income causes the interest rate on State and local
    government obligations to be lower than the rate paid on comparable taxable
    bonds.  In effect, the Federal Government pays part of State and local interest
    costs.  For example, if the market rate on tax-exempt bonds is 8.5 percent
    when the taxable rate is 10 percent, there is a 1.5-percentage-point interest
    rate subsidy to State and local governments.

    The interest exclusion also raises the after-tax return for some bond
    purchasers.  A taxpayer facing a 15 percent marginal tax rate is equally well
    off purchasing either the 8.5 percent tax-exempt bond or the 10-percent
    taxable bond (both yield an 8.5 percent after-tax interest rate).  But a taxpayer
    facing a 35 percent marginal tax rate is better off buying a tax-exempt bond,
    because the after-tax return on the taxable bond is 6.5 percent, and on the tax-
    exempt bond, 8.5 percent.  These "inframarginal" investors receive what have
    been characterized as windfall gains.

    The allocation of benefits between the bondholders and State and local
    governments (and, implicitly, its taxpayer citizens) depends on the spread in
    interest rates between the tax-exempt and taxable bond market, the share of
    the tax-exempt bond volume purchased by individuals with marginal tax rates
    exceeding the market-clearing marginal tax rate, and the range of the marginal
    tax rate structure.  The reduction of the top income tax rate of bond
    purchasers from the 70 percent individual rate that prevailed prior to 1981 to
    the 35 percent individual rate that prevails in 2006 has increased substantially
    the share of the tax benefits going to State and local governments.

    The table below provides an estimate of the distribution by income class of
    tax-exempt interest income (including interest income from both
    governmental and private-activity bonds).  In 2004, approximately 69 percent
    of individuals' tax-exempt interest income is earned by returns with adjusted
    gross income in excess of $100,000, although these returns represent only 9.6
    percent of all returns.  Returns below $30,000 earn only 12.2 percent of tax-
    exempt interest income, although they represent 50.5 percent of all returns.

    The revenue loss is even more concentrated in the higher income classes
    than the interest income because the average marginal tax rate (which
    determines the value of the tax benefit from the nontaxed interest income) is
    higher for higher-income classes.

    Distribution of Tax-Exempt Interest
    Income, 2004

    Income Class
    (in thousands of $)

    Percentage
    Distribution

    Below $10

    3.8

    $10 to $20

    2.9

    $20 to $30

    3.1

    $30 to $40

    3.5

    $40 to $50

    3.1

    $50 to $75

    7.5

    $75 to $100

    6.9

    $100 to $200

    17.5

    $200 to $500

    16.7

    $500 to $1,000

    9.8

    $1,000 to $1,500

    4.7

    $1,500 to $2,000

    2.9

    $2,000 to $5,000

    6.9

    $5,000 to $10,000

    3.9

    $200 and over

    6.8

    Source: IRS, Statistics of Income Division, July 2006

    	Rationale

    This exemption has been in the income tax laws since 1913, and was based
    on the belief that state and local interest income had constitutional protection
    from Federal Government taxation.  The argument in support of this
    constitutional protection was rejected by the Supreme Court in 1988, South
    Carolina v. Baker (485 U.S. 505, [1988]).  In spite of this loss of protection,
    many believe the exemption for governmental bonds is still justified on
    economic grounds, principally as a means of encouraging State and local
    governments to overcome a tendency to underinvest in public capital
    formation.

    Bond issues whose debt service is supported by State and local tax bases
    have been left largely untouched by Federal legislation, with a few exceptions
    such as arbitrage restrictions, denial of Federal guarantee, and registration.
    The reason for this is that most of these bonds have been issued for the
    construction of public capital stock, such as schools, highways, sewer
    systems, and government buildings.

    This has not been the case for revenue bonds without tax-base support and
    whose debt service is paid from revenue generated by the facilities built with
    the bond proceeds.  These bonds were the subject of almost continual
    legislative scrutiny, beginning with the Revenue and Expenditure Control Act
    of 1968 and peaking with a comprehensive overhaul by the Tax Reform Act
    of 1986.  This legislation focused on curbing issuance of the subset of tax-
    exempt revenue bonds used to finance the quasi-public investment activities
    of private businesses and individuals that are characterized as "private-
    activity" bonds.  Each private activity eligible for tax exemption is discussed
    elsewhere in this document under the private activity's related budget
    function.

    	Assessment

    This tax expenditure subsidizes the provision of State and local public
    services.  A justification for a Federal subsidy is that it encourages State and
    local taxpayers to provide public services that also benefit residents of other
    states or localities.  The form of the subsidy has been questioned because it
    subsidizes one factor of public sector production, capital, and encourages
    State and local taxpayers to substitute capital for labor in the public
    production process.  Critics maintain there is no evidence that any
    underconsumption of State and local public services is isolated in capital
    facilities and argue that, to the extent a subsidy of State and local public
    service provision is needed to obtain the service levels desired by Federal
    taxpayers, the subsidy should not be restricted only to capital.

    The efficiency of the subsidy, as measured by the Federal revenue loss that
    shows up as reduced State and local interest costs rather than as windfall
    gains for purchasers of the bonds, has also been the subject of considerable
    controversy.  The State and local share of the benefits (but not the amount)
    depends to a great extent on the number of bond purchasers with marginal tax
    rates higher than the marginal tax rate of the purchaser who clears the market.
     The share of the subsidy received by State and local governments was
    improved considerably during the 1980s as the highest statutory marginal
    income tax rate on individuals was reduced from 70 percent to 31 percent and
    on corporations from 46 percent to 34 percent.  (The highest current rate on
    individuals and corporations is now 35 percent.)

    The open-ended structure of the subsidy affects Federal control of its
    budget and the amount of the Federal revenue loss on governmental bonds is
    entirely dependent upon the decisions of State and local officials.

    	Selected Bibliography

    Fortune, Peter.  "Tax-Exempt Bonds Really Do Subsidize Municipal
    Capital!"  National Tax Journal, v. 51, March 1998, pp. 43-54.
    -.  "The Municipal Bond Market, Part II: Problems and Policies," New
    England Economic Review.  May/June, 1992, pp. 47-64.
    Gordon, Roger H., and Gilbert E. Metcalf.  "Do Tax-Exempt bonds Really
    Subsidize Municipal Capital?"  National Tax Journal, v. 44, December 1991,
    pp. 71-79.
    Maguire, Steven.  Private Activity Bonds: An Introduction.  Library of
    Congress, Congressional Research Service Report RL31457, June 9, 2006.
    -. Tax-Exempt Bonds: A Description of State and Local Government Debt.
     Library of Congress, Congressional Research Service Report RL30638,
    March 10, 2006.
    Ott, David J., and Allan H. Meltzer.  Federal Tax Treatment of State and
    Local Securities.  Washington, DC: The Brookings Institution, 1963.
    Poterba, James M. and Andrew A. Samwick.  "Taxation and Household
    Portfolio Composition: US Evidence from the 1980s and 1990s, Journal of
    Public Economics, v. 87, January 2003, pp. 5-38.
    Shaul, Marnie.  "The Taxable Bond Option for Municipal Bonds."
    Columbus, Ohio: Academy for Contemporary Problems, 1977.
    Temple, Judy.  "Limitations on State and Local Government Borrowing for
    Private Purposes."  National Tax Journal, v. 46, March 1993, pp. 41-53.
    U.S. Congress, Congressional Budget Office.  Statement of Donald B.
    Marron before the Subcommittee on Select Revenue Measures Committee on
    Ways and Means U.S. House of Representatives.  "Economic Issues in the
    Use of Tax-Preferred Bond Financing," March 16, 2006.
    U.S. Congress,  Joint Committee on Taxation, Present Law and
    Background Related to State and Local Government Bonds, Joint Committee
    Print JCX-14-06, March 16, 2006.
    U.S. Department of Treasury,  Internal Revenue Service.  Tax-Exempt
    Private Activity Bonds, Publication 4078, June 2004.
    Zimmerman, Dennis.  The Private Use of Tax-Exempt Bonds: Controlling
    Public Subsidy of Private Activity.  Washington, DC: The Urban Institute
    Press, 1991.
    Zimmerman, Dennis.  "Tax-Exempt Bonds," in The Encyclopedia of
    Taxation and Tax Policy, edited by Joseph J. Cordes, Robert D. Ebel, and
    Jane G. Gravelle.  Washington, DC: The Urban Institute Press, 2005.

    	General Purpose Fiscal Assistance

    	DEDUCTION OF NONBUSINESS
    	STATE AND LOCAL GOVERNMENT
    	INCOME, SALES, AND PERSONAL PROPERTY TAXES

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    36.8

    -

    36.8

    2007

    27.3

    -

    27.3

    2008

    27.3

    -

    27.3

    2009

    28.1

    -

    28.1

    2010

    28.9

    -

    28.9

    H.R. 6111 (December 2006) increased the loss by $3.0 billion in
    FY2007, $2.1 billion in FY2008 and $0.4 billion in FY2009.

    	Authorization

    Section 164.

    	Description

    State and local income, sales, and personal property taxes paid by
    individuals are deductible from adjusted gross income.  For the 2004 through
    2007 tax years, however, taxpayers chose between deducting sales or income
    taxes.  Business income, sales, and property taxes are deductible as business
    expenses, but their deduction is not a tax expenditure because deduction is
    necessary for the proper measurement of business economic income.

    	Impact

    The deduction of State and local individual income, sales, and personal
    property taxes increases an individual's after-Federal-tax income and reduces
    the individual's after-Federal-tax price of the State and local public services
    provided with these tax dollars.  Some of the benefit goes to the State and
    local governments (because individuals are willing to pay higher taxes) and
    some goes to the individual taxpayer.

    There may be an impact on the structure of state and local tax systems.
    Economists have theorized that if a particular state and local tax or revenue
    source is favored by deductibility in the federal tax code, then state and local
    governments may rely more upon that tax source.  In effect, local
    governments and taxpayers recognize that residents are only paying part of
    the tax, and that the federal government, through federal deductibility, is
    paying the remainder.

    The distribution of tax expenditures from State and local income, sales, and
    personal property tax deductions is concentrated in the higher income classes.
     Over 88% of the tax benefits are taken by families with adjusted gross
    income in excess of $75,000 in 2005.  As with any deduction, it is worth
    more as marginal tax rates increase.  Personal property tax deductions
    (typically for cars and boats) are but a small fraction of state and local taxes
    paid deduction, and are less concentrated in higher income classes.

    Distribution by Income Class of
    Tax Expenditure for State and Local Income and
    Personal Property Tax Deductions, 2005

    Income Class
    (in thousands of $)

    Percentage
    Distribution

    Below $10

    0.0

    $10 to $20

    0.1

    $20 to $30

    0.4

    $30 to $40

    0.9

    $40 to $50

    1.9

    $50 to $75

    8.3

    $75 to $100

    10.2

    $100 to $200

    33.5

    $200 and over

    44.7

    	Rationale

    Deductibility of State and local taxes was adopted in 1913 to avoid taxing
    income that was obligated to expenditures over which the taxpayer had little
    or no discretionary control.  User charges (such as for sewer and water
    services) and special assessments (such as for sidewalk repairs), however,
    were not deductible.  The Revenue Act of 1964 eliminated deductibility for
    motor vehicle operators' licenses, and the Revenue Act of 1978 eliminated
    deductibility of the excise tax on gasoline.  These decisions represent
    congressional concern that differences among States in the legal specification
    of taxes allowed differential deductibility treatment for taxes that were
    essentially the same in terms of their economic incidence.

    The Tax Reform Act of 1986 eliminated deductibility of sales taxes, partly
    due to concern that these taxes were estimated and therefore did not perfectly
    represent reductions of taxable income, and partly due to concerns that some
    portion of the tax reflects discretionary decisions of State and local taxpayers
    to consume services through the public sector that might be consumed
    through private (nondeductible) purchase.  The Omnibus Budget
    Reconciliation Act (OBRA) of 1990 curtailed the tax benefit from State and
    local income and real property tax deductions for higher income taxpayers
    (those whose AGI exceeds the applicable threshold amount--$150,500 for
    2006).  OBRA 1990 requires that itemized deductions be reduced by a
    percentage of the amount by which adjusted gross income exceeds the
    threshold amount.  The phaseout is scheduled to gradually phase-out
    beginning in the 2006 tax year and be completely eliminated beginning with
    the 2010 tax year.

    In 2004, sales tax deductibility was reinstated for the 2004 and 2005 tax
    years by the "American Jobs Creation Act of 2004," (P.L. 108-357).  In
    contrast to pre-1986 law, State sales and use taxes can only be deducted in
    lieu of State income taxes, not in addition to.  Taxpayers who itemize and live
    in States without a personal income tax will benefit the most from the new
    law.  The rationale behind the in lieu of is the more equal treatment for
    taxpayers in states that do not levy an income tax.  In December 2006, H.R.
    6111 extended the deduction through 2007.

    	Assessment

    Modern theories of the public sector discount the "don't tax a tax"
    justification for State and local tax deductibility, emphasizing instead that
    taxes represent citizens' decisions to consume goods and services collectively.
     In that sense, State and local taxes are benefit taxes and should be treated the
    same as expenditures for private consumption--not deductible against Federal
    taxable income.

    Deductibility can also be seen as an integral part of the Federal system of
    intergovernmental assistance and policy.  Modern theories of the public sector
    also suggest that:

    (1) deductibility does provide indirect financial assistance for the State and
    local sector and should result in increased State and local budgets, and

    (2) deductibility will influence the choice of State and local tax instruments
    if deductibility is not provided uniformly.

    In theory, there is an incentive for sub-federal governments to rely upon the
    taxes that are deductible from federal income, such as personal property taxes,
    because the tax "price" to the taxpayer is lower than the "price" on taxes that
    are not deductible.

    	Selected Bibliography

    Feldstein, Martin, and Gilbert Metcalf.  "The Effect of Federal Tax
    Deductibility on State and Local Taxes and Spending," Journal of Political
    Economy.  1987, pp. 710-736.
    Gade, Mary and Lee C. Adkins.  "Tax Exporting and State Revenue
    Structures," National Tax Journal.  March 1990, pp. 39-52.
    Holtz-Eakin, D. and H. Rosen.  "Tax deductibility and Municipal Budget
    Structure," National Bureau of Economic Research, Working Paper No.
    2224, 1987.
    -.  "Federal Deductibility and Local Property Tax Rates," Journal of
    Urban Economics, v. 27, 1990, pp. 269-284.
    Kenyon, Daphne.  "Federal Income Tax Deductibility of State and Local
    Taxes: What Are Its Effects? Should It Be Modified or Eliminated?"
    Strengthening the Federal Revenue System.  Advisory Commission on
    Intergovernmental Relations Report A-97.  1984, pp. 37-66.
    Lindsey, Lawrence B. "Federal Deductibility of State and Local Taxes: A
    Test of Public Choice by Representative Government," in Fiscal Federalism:
    Quantitative Studies, edited by Harvey Rosen, (Chicago: University of
    Chicago Press), pp. 137-176.
    Maguire, Steven .  "Federal Deductibility of State and Local Taxes,"
    Library of Congress, Congressional Research Service Report RL32781.
    September 28, 2006.
    Noto, Nonna A., and Dennis Zimmerman.  "Limiting State-Local Tax
    Deductibility: Effects Among the States,"  National Tax Journal.  December
    1984, pp. 539-549.
    -.  Limiting State-Local Tax Deductibility in Exchange for Increased
    General Revenue Sharing: An Analysis of the Economic Effects.  U.S.
    Congress, Subcommittee on Intergovernmental Relations, Committee on
    Governmental Affairs, 98th Congress, 1st session, Committee Print S. Prt 98-
    77.  August 1983.

    General Purpose Fiscal Assistance

    TAX CREDIT FOR PUERTO RICO AND POSSESSION INCOME
    AND PUERTO RICO ECONOMIC ACTIVITY

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    -

    0.3

    0.3

    2007

    -

    -

    -

    2008

    -

    -

    -

    2009

    -

    -

    -

    2010

    -

    -

    -

    	Authorization

    Sections 936, 30A.

    	Description

    In general, corporations chartered in the United States are subject to U.S.
    taxes on their worldwide income.  However, prior to 2005, the possessions
    tax credit provided by section 936 of the Internal Revenue Code and the
    Puerto Rican economic activity tax credit provided by section 30A permitted
    qualified U.S. corporations that operate in Puerto Rico, the U.S. Virgin
    Islands, and other U.S. possessions a tax credit that offset some or all of their
    U.S. tax liability on income from business operations and certain types of
    financial investment in the possessions.  The credits had the effect of
    exempting  some or all of qualified income from tax at the Federal level.  The
    possessions enacted their own complementary set of tax incentives.  However,
    under the terms of the Small Business Job Protection Act of 1996 (Public
    Law 104-188), the Federal credits were scheduled to end after 2005, and have
    thus expired.  A substitute economic development credit has been allowed for
    American Samoa for 2006 through 2007.

    To qualify for either credit, a firm was required to have derived 80 percent
    of its gross from the possessions.  Also, 75 percent of a qualified corporation's
    income was required to be from the active conduct of a business in a
    possession rather than from passive (financial) investment.  The amount of
    the tax credit was generally equal to a firm's tax liability on possession-source
    income, subject to one of two alternative caps enacted in 1993.  Under one
    cap-that applicable under section 30A's economic activity credit-the credit
    was limited to a specified portion of wages and depreciation.  The alternative
    cap in effect provided a flat 40% tax exemption.  The Small Business Job
    Protection Act of 1996 also provided for an additional limit that phases the
    credit out in the case of Puerto Rico and the U.S. Virgin Islands (but not the
    other possessions).  Under this additional cap, the amount of income eligible
    for the credit was linked to a firm's average possessions earnings during a
    base period.

    Impact

    The most direct effect of the possessions tax credit was to reduce the cost
    of qualified investment in Puerto Rico, the Virgin Islands, and the other U.S.
    possessions.  In addition, changes introduced by the Omnibus Budget
    Reconciliation Act of 1993 (OBRA93) reduced the effective cost of qualified
    wages paid in the possessions.

    The largest user of the credit was the pharmaceuticals industry.  In 2001,
    for example, it accounted for 49 percent of all credits claimed under sections
    936 and 30A.  In the long run, however, the burden of the corporate income
    tax (and the benefit from reductions in it) probably spreads beyond corporate
    stockholders to owners of capital in general.  Also--particularly since
    enactment of OBRA93 and its caps linked to economic activity in the
    possessions--it is likely that part of the benefit of the tax credits was shared by
    labor in the possessions.

    It is probable that the end of the tax benefit will reduce investment in
    Puerto Rico from what would otherwise occur. This will likely be
    accompanied by a decline in labor earnings.  However, an alternative (albeit,
    less generous) tax benefit remains available for investment in Puerto Rico and
    the possessions: the "deferral" benefit under which U.S. firms that operate
    abroad through foreign-chartered subsidiaries can indefinitely postpone
    federal tax on income reinvested abroad.  Since firms chartered in the
    possessions are treated as foreign corporations, such firms can defer taxes.  In
    the years since the possessions tax credit's phase-out began, evidence
    indicates that many firms that formerly used the possessions credit continue to
    operate in the possessions while using the deferral benefit.

    Rationale

    A Federal tax exemption for firms earning income in the possessions has
    been in effect since the Revenue Act of 1921, although its precise nature has
    undergone several changes.  However, the credit was not heavily used in
    Puerto Rico until the years following World War II, when the Puerto Rican
    Government integrated the Federal tax exemption into its "Operation
    Bootstrap" development plan; the plan was designed, in part, to attract
    investment from the mainland United States.

    The Tax Reform Act of 1976 implemented several changes designed to
    strengthen the provision's incentive effect and to tie it more closely to the
    possessions.  The Act also instituted the credit-cum-exemption mechanism
    that is currently in place.  In keeping the essential elements of the tax
    exemption intact, Congress indicated that the provision's purpose was to keep
    Puerto Rico and the possessions competitive with low-wage, low-cost foreign
    countries as a location for investment.

    Changes in the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA)
    imposed tighter rules on mainland parent firms that used transfers of
    intangible assets (e.g., patents) to possessions subsidiaries as a means of
    sheltering mainland-source income from taxes.  The Tax Reform Act of 1986
    also sought to link the tax credit more tightly to tangible investment in the
    possessions by increasing the portion of income that must be from active
    business investment.  The Omnibus Budget Reconciliation Act of 1993 scaled
    back the credit by limiting each firm's maximum credit to a specified portion
    of wage and depreciation costs incurred in the credit.  While the Act's change
    likely reduced the tax benefit for some firms, the cap's link with wages and
    depreciation probably increased the incentive for other companies to employ
    labor and tangible investment in the possessions, thus focusing the credit
    more tightly on the possessions themselves.  When repeal was subsequently
    proposed, Congress expressed concern about the provision's revenue cost and
    stated that the benefit is "enjoyed by only the relatively small number of U.S.
    corporations that operate in the possessions" while the revenue costs is "borne
    by all U.S. taxpayers."

    The possessions tax credit is also intertwined with the issue of Puerto
    Rico's political status, and whether Puerto Rico should retain its current
    Commonwealth status, become a U.S. State, or become independent.  The
    link exists because both independence and statehood may require repeal of
    the tax credits.

    H.R. 6111 (December 2006) provided a substitute economic development
    credit for American Samoa for 2006 through 2007.

    Assessment

    Because it reduced the cost of investment in Puerto Rico and the Virgin
    Islands, the possessions tax credit encouraged firms to divert investment from
    the mainland and foreign countries to the possessions.  The measure probably
    played an important role in attracting a large flow of investment to Puerto
    Rico in the years following World War II.  The investment may have, in turn,
    helped transform Puerto Rico's economy from one based on agriculture to one
    heavily dependent on manufacturing.  The inflow of investment probably also
    increased the earnings of Puerto Rican labor by increasing the capital/labor
    ratio in Puerto Rico.

    The tax credits' supporters maintain that the provision was critical to the
    well-being of Puerto Rico's economy.  However, the credit's critics have
    pointed out that prior to enactment of the credit's wage-related cap in 1993,
    the exemption was an incentive to invest rather than a direct incentive to
    employ labor, and to the extent it increased employment in Puerto Rico, it did
    so only as a by-product of its increase in investment.  In addition, some
    questioned the measure's cost-effectiveness, arguing that the measure's cost in
    terms of foregone tax collections is high compared to the number of jobs the
    provision creates in Puerto Rico.

    	Selected Bibliography

    Brumbaugh, David L.  The Possessions Tax Credit:  Economic Analysis of
    the 1993 Revisions.  Library of Congress, Congressional Research Service
    Report 94-650 E.  Washington, DC: 1994.
    - .  The Puerto Rican Economic Activity Credit: Current Proposals and
    Scheduled Phaseout.  Library of Congress, Congressional Research Service
    Report RS20695.  Washington, DC: 2000.  October 4, 2000.
    -.  U.S. Federal Taxes in Puerto Rico.  Library of Congress, Congressional
    Research Service Report RS20718.  Washington, DC: October 20, 2000.
    Grubert, Harry, and Joel Slemrod.  The Effect of Taxes on Investment and
    Income Shifting to Puerto Rico.  NBER Working Paper No. 4869.
    Cambridge, MA: National Bureau of Economic Research, 1994.
    Holick, Daniel S.  "U.S. Possessions Corporation Returns, 2003."
    Statistics of Income Bulletin 23 (Summer 2006), 113-127.
    Martin, Gary D.  "Industrial Policy by Accident: the United States in
    Puerto Rico." Journal of Hispanic Policy 4 (1989-90), pp. 93-115.
    Sierra, Ralph J., Jr. "Puerto Rico Seeks New Incentives Under Section
    956." Tax Notes International 22  (June 18, 2001), pp. 3167-3170.
    Swanick, Michael F.  "Going, Going, Gone: Section 936." Tax
    Management International Journal 25 (November 8, 1996), pp. 749-751.
    U.S. Congress.  Joint Committee on Taxation.  An Overview of the Special
    Tax Rules Related to Puerto Rico and an Analysis of the Tax and Economic
    Policy Implications of Recent Legislative Options.  JCX-24-06.  Washington:
    June 23, 2006.
    U.S. Congressional Budget Office.  Potential Economic Impacts of
    Changes in Puerto Rico's Status under S. 712.  Washington, DC: 1990.
    U.S. Department of the Treasury.  The Operation and Effect of the
    Possessions Corporation System of Taxation. Sixth Report.  Washington,
    DC: 1989.

    U.S. General Accounting Office.  Fiscal Relations with the Federal
    Government and Economic Trends During the Phaseout of the Possessions
    Tax Credit.  Report GAO-06-541.  Washington, DC: May 19, 2006.
    U.S. President (1981-1989: Reagan).  "Replace Possessions Tax Credit
    With a Wage Credit."  In The President's Tax Proposals to the Congress for
    Fairness, Growth, and Simplicity.  Washington, DC: U.S. Government
    Printing Office, 1985, pp. 307-312.

    	Interest

    DEFERRAL OF INTEREST ON SAVINGS BONDS

    Estimated Revenue Loss

    [In billions of dollars]

    Fiscal year

    Individuals

    Corporations

    Total

    2006

    1.1

    -

    1.1

    2007

    1.1

    -

    1.1

    2008

    1.2

    -

    1.2

    2009

    1.2

    -

    1.2

    2010

    1.2

    -

    1.2

    	Authorization

    Section 454(c) of the Internal Revenue Code of 1992.

    	Description

    Owners of U.S. Treasury Series E, Series EE, and Series I savings bonds
    have the option of either including interest in taxable income as it accrues or
    excluding interest from taxable income until the bond is redeemed.
    Furthermore, before September 1, 2004, EE bonds could be exchanged for
    current income HH savings bonds with the accrued interest deferred until the
    HH bonds are redeemed.  As of September 1, 2004, the U.S. Treasury ended
    the sale and exchange of HH savings bonds.  On September 1, 1998, the
    Treasury began issuing Series I bonds, which guarantee the owner a real rate
    of return by indexing the yield for changes in the rate of inflation.  The
    revenue loss shown above is the tax that would be due on the deferred interest
    if it were reported and taxed as it accrued.

    	Impact

    The deferral of tax on interest income on savings bonds provides two
    advantages.  First, payment of tax on the interest is deferred,  delivering the
    equivalent of an interest-free loan of the amount of the tax.  Second, the
    taxpayer often is in a lower income bracket when the bonds are redeemed.
    This is particularly common when the bonds are purchased while the owner is
    working and redeemed after the owner retires.

    Savings bonds appeal to small savers because of such financial features as
    their small denominations, ease of purchase, and safety.  Furthermore, there
    are currently annual cash purchase limits of $15,000 per person in terms of
    issue price for both EE bonds and I bonds (for a total of $30,000 per year).
    Because poor families save little and do not pay Federal income taxes, the tax
    deferral of interest on savings bonds primarily benefits middle income
    taxpayers.

    	Rationale

    Prior to 1951, a cash-basis taxpayer generally reported interest on U.S.
    Treasury original issue discount bonds in the year of redemption or maturity,
    whichever came first.  In 1951, when provision was made to extend Series E
    bonds past their dates of original maturity, a provision was enacted to allow
    the taxpayer either to report the interest currently, or at the date of
    redemption, or upon final maturity.  The committee reports indicated that the
    provision was adopted to facilitate the extension of maturity dates.

    On January 1, 1960, the Treasury permitted owners of E bonds to exchange
    these bonds for current income H bonds with the continued deferment of
    Federal income taxes on accrued interest until the H bonds were redeemed.
    The purpose was to encourage the holding of U.S. bonds.  This tax provision
    was carried over to EE bonds, HH bonds, and I bonds.

    	Assessment

    The savings bond program was established to provide small savers with a
    convenient and safe debt instrument and to lower the cost of borrowing to the
    taxpayer.  The option to defer taxes on interest  increases sales of bonds.  But
    there is no empirical study that has determined whether or not the cost savings
    from increased bond sales more than offset the loss in tax revenue from the
    accrual.

    	Selected Bibliography

    U.S. Department of the Treasury.  A History of the United States Savings
    Bond Program.  Washington, DC: September 1984.

    -,Treasury Direct,
     [http://www.treasurydirect.gov/indiv/products/products.htm], updated
    October 6, 2006.
    - , Bureau of the Public Debt Online, The Savings Bonds Owner's Manual,
    [http://www.publicdebt.treas.gov/mar/marsbomintrogeneral.htm], updated
    April 4, 2005.

    Appendix A

    FORMS OF TAX EXPENDITURES

    EXCLUSIONS, EXEMPTIONS, DEDUCTIONS, CREDITS,
    PREFERENTIAL RATES, AND DEFERRALS

    Tax expenditures may take any of the following forms:

    (1) special exclusions, exemptions, and deductions, which reduce taxable
    income and, thus, result in a lesser amount of tax;

    (2) preferential tax rates, which reduce taxes by applying lower rates to part
    or all of a taxpayer's income;

    (3) special credits, which are subtracted from taxes as ordinarily computed;
    and

    (4) deferrals of tax, which result from delayed recognition of income or
    from allowing in the current year deductions that are properly attributable to a
    future year.

    	Computing Tax Liabilities

    A brief explanation of how tax liability is computed will help illustrate the
    relationship between the form of a tax expenditure and the amount of tax
    relief it provides.

    	CORPORATE INCOME TAX

    Corporations compute taxable income by determining gross income (net of
    any exclusions) and subtracting any deductions (essentially costs of doing
    business).

    The corporate income tax eventually reaches an average rate of 35 percent
    in two steps.  Below $10,000,000 taxable income is taxed at graduated rates:
    15 percent on the first $50,000, 25 percent on the next $25,000, and 34
    percent on the next $25,000.  The limited graduation provided in this
    structure was intended to furnish tax relief to smaller corporations.  The value
    of these graduated rates is phased out, via a 5 percent income additional tax,
    as income rises above $100,000.  Thus the marginal tax rate, the rate on the
    last dollar, is 34 percent on income from $75,000 to $100,000, 39 percent on
    taxable income from $100,000 to $335,000, and returns to 34 percent on
    income from $335,000 to $10,000,000.  The rate on taxable income in excess
    of $10,000,000 is 35 percent, and there is a second phase-out, of the benefit
    of the 34-percent bracket, when taxable income reaches $15,000,000.  An
    extra tax of three percent of the excess above $15,000,000 is imposed (for a
    total of 38 percent) until the benefit is recovered, which occurs at
    $18,333,333 taxable income.  Above that, income is taxed at a flat 35 percent
    rate.  Most corporate income is taxed at the 35 percent marginal rate.

    Any credits are deducted directly from tax liability.  The essentially flat
    statutory rate of the corporation income tax means there is very little
    difference in marginal tax rates to cause variation in the amount of tax relief
    provided by a given tax expenditure to different corporate taxpayers.
    However, corporations without current tax liability will benefit from tax
    expenditures only if they can carry back or carry forward a net operating loss
    or credit.

    	INDIVIDUAL INCOME TAX

    Individual taxpayers compute gross income which is the total of all income
    items except exclusions.  They then subtract certain deductions (deductions
    from gross income or "business" deductions) to arrive at adjusted gross
    income.  The taxpayer then has the option of "itemizing" personal deductions
    or taking the standard deduction.  The taxpayer then deducts personal
    exemptions to arrive at taxable income.  A graduated tax rate structure is
    applied to this taxable income to yield tax liability, and any credits are
    subtracted to arrive at the net after-credit tax liability.

    The graduated tax structure is currently applied at rates of 10, 15, 25, 28,
    33, and 35 percent, with brackets varying across types of tax returns.  These
    rates enacted in the 2001 and 2003 tax bills are technically temporary
    (expiring in 2010).  At that time the 10% rate will return to the 15% rate and
    the four top rates will return to 28, 31, 36, and 39.6 percent, with brackets
    varying across types of tax returns. For joint returns, in 2005, rates on taxable
    income are 10 percent on the first $14,600, 15 percent for amounts from
    $14,600 to $59,400, 25 percent for amounts from $59,400 to $119,950, 28
    percent for incomes from $119,950 to $182,800, 33 percent for taxable
    incomes of $182,800 to $326,450, and 35 percent for amounts over $326,450.
     These amounts are indexed for inflation. There are also phase-outs of
    personal exemptions and excess itemized deductions so that marginal tax
    rates can be higher at very high income levels. These phase are scheduled to
    be eliminated in 2005.

    	Exclusions, Deductions, and Exemptions

    The amount of tax relief per dollar of each exclusion, exemption, and
    deduction increases with the taxpayer's marginal tax rate.  Thus, the exclusion
    of interest from State and local bonds saves $35 in tax for every $100 of
    interest for the taxpayer in the 35-percent bracket, whereas for the taxpayer in
    the 15-percent bracket the saving is only $15.  Similarly, the increased
    standard deduction for persons over age 65 or an itemized deduction for
    charitable contributions are worth almost twice as much in tax saving to a
    taxpayer in the 28-percent bracket as to one in the 15-percent bracket.

    In general, the following deductions are itemized, i.e., allowed only if the
    standard deduction is not taken: medical expenses, specified State and local
    taxes, interest on nonbusiness debt such as home mortgage payments, casualty
    losses, certain unreimbursed business expenses of employees, charitable
    contributions, expenses of investment income, union dues, costs of tax return
    preparation, uniform costs and political contributions.  (Certain of these
    deductions are subject to floors or ceilings.)

    Whether or not a taxpayer minimizes his tax by itemizing deductions
    depends on whether the sum of those deductions exceeds the limits on the
    standard deduction.  Higher income individuals are more likely to itemize be-
    cause they are more likely to have larger amounts of itemized deductions
    which exceed the standard deduction allowance.  Homeowners often itemize
    because deductibility of mortgage interest and property taxes leads to larger
    deductions than the standard deduction.

    	Preferential Rates

    The amount of tax reduction that results from a preferential tax rate (such
    as the reduced rates on the first $75,000 of corporate income) depends on the
    difference between the preferential rate and the taxpayer's ordinary marginal
    tax rate.  The higher the marginal rate that would otherwise apply, the greater
    is the tax relief from the preferential rate.

    	Credits

    A tax credit (such as the dependent care credit) is subtracted directly from
    the tax liability that would accrue otherwise; thus, the amount of tax reduction
    is the amount of the credit and is not contingent upon the marginal tax rate.  A
    credit can (with one exception) only be used to reduce tax liabilities to the
    extent a taxpayer has sufficient tax liability to absorb the credit.  Most tax
    credits can be carried backward and/or forward for fixed periods, so that a
    credit which cannot be used in the year in which it first applies can be used to
    offset tax liabilities in other prescribed years.

    The earned income credit and child credit are the only tax credits which are
    now refundable.  That is, a qualifying individual will obtain in cash the entire
    amount of the refundable credit even if it exceeds tax liability.  Child credits
    are not fully refundable, however, for certain very low income families.

    Deferrals

    Deferral can result either from postponing the time when income is
    recognized for tax purposes or from accelerating the deduction of expenses.
    In the year in which a taxpayer does either of these, his taxable income is
    lower than it otherwise would be, and because of the current reduction in his
    tax base, his current tax liability is reduced.  The reduction in his tax base
    may be included in taxable income at some later date.  However, the
    taxpayer's marginal tax rate in the later year may differ from the current year
    rate because either the tax structure or the applicable tax rate has changed.

    Furthermore, in some cases the current reduction in the taxpayer's tax base
    may never be included in his taxable income.  Thus, deferral works to reduce
    current taxes, but there is no assurance that all or even any of the deferred tax
    will be repaid.  On the other hand, the tax repayment may even exceed the
    amount deferred.

    A deferral of taxes has the effect of an interest-free loan for the taxpayer.
    Apart from any difference between the amount of "principal" repaid and the
    amount borrowed (that is, the tax deferred), the value of the interest-free loan-
    -per dollar of tax deferral--depends on the interest rate at which the taxpayer
    would borrow and on the length of the period of deferral.  If the deferred
    taxes are never paid, the deferral becomes an exemption.  This can occur if, in
    succeeding years, additional temporary reductions in taxable income are
    allowed.  Thus, in effect, the interest-free loan is refinanced; the amount of
    refinancing depends on the rate at which the taxpayer's income and deductible
    expenses grow and can continue in perpetuity.

    The tax expenditures for deferrals are estimates of the difference between
    tax receipts under the current law and tax receipts if the provisions for
    deferral had never been in effect.  Thus, the estimated revenue loss is greater
    than what would be obtained in the first year of transition from one tax law to
    another.  The amounts are long run estimates at the level of economic activity
    for the year in question.

    	Appendix B

    	RELATIONSHIP BETWEEN TAX EXPENDITURES AND
    LIMITED TAX BENEFITS SUBJECT TO LINE ITEM VETO

    Description

    The Line Item Veto Act (P.L. 104-130) enacted in 1996 gave the President
    the authority to cancel "limited tax benefits."  A limited tax benefit was
    defined as either a provision that loses revenue and that provides a credit,
    deduction, exclusion or preference to 100 or fewer beneficiaries, or a
    provision that provides temporary or permanent transition relief to 10 or fewer
    beneficiaries in any fiscal year.  The act was found unconstitutional in 1998,
    but there have been subsequent proposals to provide veto authority for certain
    limited benefits.

    Items falling under the revenue losing category did not qualify if the
    provision treated in the same manner all persons in the same industry,
    engaged in the same activity, owning the same type of property, or  issuing
    the same type of investment instrument.

    A transition provision did not qualify if it simply retained current law for
    binding contracts or was a technical correction to a previous law (that had no
    revenue effect).

    When the beneficiary was a corporation, partnership, association, trust or
    estate, the stockholders, partners, association members or beneficiaries of the
    trust or estate were not counted as beneficiaries.   The beneficiary was the
    taxpayer who is the legal, or statutory, recipient of the benefit.

    The Joint Committee on Taxation was responsible for identifying limited
    tax benefits subject to the line item veto (or indicating that no such benefits
    exist in a piece of legislation);  if no judgment was made, the President could
    identify such a provision.

    The line item veto took effect on January 1, 1997.

    	Similarities to Tax Expenditures

    Limited tax benefits resemble tax expenditures in some ways, in that they
    refer to a credit, deduction, exclusion or preference that confers some benefit.
     Indeed, during the debate about the inclusion of tax provisions in the line
    item veto legislation, the term "tax expenditures" was frequently invoked.
    The House initially proposed limiting these provisions to a fixed number of
    beneficiaries (originally 5, and eventually 100).  The Senate bill did not at
    first include tax provisions, but then included provisions that provided more
    favorable treatment to a taxpayer or a targeted group of taxpayers.

    Such provisions would most likely be considered as tax expenditures, at
    least conceptually, although they might not be included in the official lists of
    tax expenditures because of de minimis rules (that is, some provisions that are
    very small are not included in the tax expenditure budget although they would
    qualify on conceptual grounds), or they might not be separately identified.
    This is particularly true in the case of transition rules.

    	Differences from Tax Expenditures

       Most current tax expenditures would probably not qualify as limited tax
    benefits even if they were newly introduced (the line item veto applied only to
    newly enacted provisions).

    First, many if not most tax expenditures apply to a large number of
    taxpayers.  Provisions benefitting individuals, in particular, would in many
    cases affect millions of individual taxpayers.  Most of these tax expenditures
    that are large revenue losers are widely used and widely available (e.g.
    itemized deductions, fringe benefits, exclusions of income transfers).

    Provisions that only affect corporations may be more likely to fall under a
    beneficiary limit;  even among these, however, the provisions are generally
    available for all firms engaged in the same activity.

    These observations are consistent with a draft analysis of the Joint
    Committee on Taxation during consideration of the legislation which
    included examples of provisions already in the law that might have been
    classified as limited tax benefits had the line item veto provisions been in
    effect.  Some of these provisions had at some time been included in the tax
    expenditure budget, although they were not currently included: the orphan
    drug tax credit, which is very small, and an international provision involving
    the allocation of interest, which has since been repealed.  ( The orphan drug
    tax credit is currently included in the tax expenditure budget.)  Some
    provisions modifying current tax expenditures might also have been included.
     But, in general, tax expenditures, even those that would generally be seen as
    narrow provisions focusing on a certain limited activity, would probably not
    have been deemed limited tax benefits for purposes of the line item veto.

    	Bibliographic Reference

    U.S. Congress.  Joint Committee on Taxation.  Draft Analysis of Issues
    and Procedures for Implementation of Provisions Contained in the Line Item
    Veto Act (Public Law 104-130) Relating to Limited Tax Benefits, (JCX-48-
    96), November 12, 1996.
          U.S. Congress, Joint Committee on Taxation. Estimates of Federal Tax
    Expenditures for Fiscal Years 2006-2010, April 25, 2006.  They also include
    temporary items that were reinstated during the remainder of 2006.
          For a discussion of the conceptual problems involved in defining tax
    expenditures and some of the differences between the Administration and Joint
    Committee approaches, see The Budget of the United States Government, Fiscal
    Year 2005, Analytical Perspectives, "Tax Expenditures," pp. 285-325.  See also
    Linda Sugin, "What is Happening to the Tax Expenditure Budget?"  Tax Notes,
    August 16, 2004, pp. 763-766, and Thomas L. Hungerford, Tax Expenditures:
    Trends and Critiques, Library of Congress, Congressional Research Service Report
    RL33641, September 13, 2006.
          See Jane G. Gravelle, Distributional Effects of Taxes on Corporate Profits,
    Investment Income, and Estates, Library of Congress, Congressional Research
    Service Report RL32517, August 9,2004.
          U.S. Congress, Congressional Budget Office.  Effective Federal Tax Rates for
    1979-2001, April 2004, Table 1B.
             These data were released by the Democratic staff of the Ways and
    Means Committee, June 7, 2006.
            Released by the Democratic staff of the Ways and Means Committee,
    June 7, 2006.