    Government Performance and Accountability: Tax Expenditures
    Represent a Substantial Federal Commitment and Need to Be
    Reexamined (23-SEP-05, GAO-05-690).

    Numerous federal programs, policies, and activities are supported
    through the tax code. As described in statute, tax expenditures
    are reductions in tax liabilities that result from preferential
    provisions, such as tax exclusions, credits, and deductions. They
    result in revenue forgone. This report, done under the
    Comptroller General's authority, is part of an effort to assist
    Congress in reexamining and transforming the government to meet
    the many challenges and opportunities that we face in the 21st
    century. This report describes (1) how tax expenditures have
    changed over the past three decades in number, size, and in
    comparison to federal revenue, spending, and the economy, and (2)
    the amount of progress made since our 1994 recommendations to
    improve scrutiny of tax expenditures.
    -------------------------Indexing Terms-------------------------
    REPORTNUM:   GAO-05-690
        ACCNO:   A37958
      TITLE:     Government Performance and Accountability: Tax
    Expenditures Represent a Substantial Federal Commitment and Need
    to Be Reexamined
         DATE:   09/23/2005
      SUBJECT:   Comparative analysis
    	     Productivity in government
    	     Tax administration
    	     Tax expenditures
    	     Performance appraisal
    	     Accountability
    	     Losses
    	     Transparency

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    GAO-05-690

                     United States Government Accountability Office

                             GAO Report to Agency Officials

    September 2005

    GOVERNMENT PERFORMANCE AND ACCOUNTABILITY

    Tax Expenditures Represent a Substantial Federal Commitment and Need to Be
                                       Reexamined

                                           a

    GAO-05-690

    [IMG]

    September 2005

    GOVERNMENT PERFORMANCE AND ACCOUNTABILITY

    Tax Expenditures Represent a Substantial Federal Commitment and Need to Be
    Reexamined

                                     What GAO Found

    Whether gauged in numbers, revenues forgone, or compared to federal
    spending or the size of the economy, tax expenditures have represented a
    substantial federal commitment over the past three decades. Since 1974,
    the number of tax expenditures more than doubled and the sum of tax
    expenditure revenue loss estimates tripled in real terms to nearly $730
    billion in 2004. The 14 largest tax expenditures, headed by the individual
    income tax exclusion for employer-provided health care, accounted for 75
    percent of the aggregate revenue loss in fiscal year 2004. On an
    outlayequivalent basis, the sum of tax expenditure estimates exceeded
    discretionary spending for most years in the last decade. For some budget
    functions, the sum of tax expenditure estimates was of the same magnitude
    as or larger than federal spending. As a share of the economy, the sum of
    tax expenditure outlay-equivalent estimates has been about 7.5 percent of
    gross domestic product since the last major tax reform legislation in
    1986.

    All federal spending and tax policy tools, including tax expenditures,
    should be reexamined to ensure that they are achieving their intended
    purposes and designed in the most efficient and effective manner. The
    nation's current and projected fiscal imbalance serves to reinforce the
    importance of engaging in such a review and reassessment. Although data
    and methodological challenges exist, periodic reviews of tax expenditures
    could establish whether they are relevant to today's needs; if so, how
    well they have worked to achieve their objectives; and whether the
    benefits from specific tax expenditures are greater than their costs. Over
    the past decade, however, the Executive Branch made little progress in
    integrating tax expenditures into the budget presentation, in developing a
    structure for evaluating tax expenditure outcomes or in incorporating them
    under review processes that apply to spending programs, as we recommended
    in 1994. More recently, the Administration has not used its Program
    Assessment Rating Tool process to systematically review tax expenditures
    or promote joint reviews of tax and spending programs sharing common
    goals.

    Sum of Tax Expenditure Estimates Compared with Total Federal Outlays,
    1981-2004 Dollars in billions (in constant 2004 dollars) 1,400

    1,200

    1,000

    800

    600

    400

    200

    0

    1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 Fiscal year

    Mandatory spending Discretionary spending Tax expenditure
    outlay-equivalent estimates Source: GAO analysis of OMB budget reports on
    tax expenditures, fiscal years 1983-2006.

    Note: Summing tax expenditure estimates does not take into account
    interactions between individual provisions.

    United States Government Accountability Office

    Contents

      Letter

    Results in Brief
    Background
    Tax Expenditures Have Represented a Substantial Federal

    Commitment over Time

    Systematic Review of Tax Expenditures Is Integral to Reexamining the
    Federal Base, but Little Progress Has Been Made Since 1994 to Increase
    Scrutiny

    Conclusions
    Recommendations for Executive Action
    Agency Comments and Our Evaluation

    1 4 7

    19

    43 71 73 74

    Appendixes
                    Appendix I:             Scope and Methodology              79
                   Appendix II:  Comments from the Office of Management and    82
                                                   Budget
                  Appendix III:     How Tax Expenditures Are Measured and      92
                                                  Reported
                                 Compilation of Tax Expenditures Reported by
                  Appendix IV:                    Treasury
                                               (1974 to 2004)                 110
                    Appendix V:                   Glossary                    119
                  Appendix VI:         GAO Contact and Acknowledgments        124

    Selected Bibliography

      Related GAO Products

    Tables	Table 1: Table 2:

    Table 3: Table 4:

    Examples of Types of Tax Expenditures Available to
    Taxpayer Groups 10
    Revenue Loss Estimates for the Largest Tax Expenditures
    Reported for Fiscal Year 2004, with Taxpayer Group and
    Budget Function 34
    Comparison of Tax Expenditure Reporting by JCT and
    Treasury 96
    List of Tax Expenditures Reported by the U.S. Department
    of the Treasury and the Joint Committee on Taxation for
    Fiscal Year 2004 100

                                        Contents

    Table 5:	Sum of Revenue Loss Estimates for Tax Expenditures by Budget
    Function Reported by the U.S. Department of the Treasury and Joint
    Committee on Taxation, Fiscal Year 2004 109

    Table 6:	Tax Expenditures Reported by the U.S. Department of the Treasury
    (1974 to 2004) 110

    Figures	Figure 1: Figure 2: Figure 3: Figure 4: Figure 5: Figure 6:

    Figure 7: Figure 8:

    Figure 9:

    Examples of How Each Type of Tax Expenditure Relates
    to the U.S. Individual Income Tax Return (Form 1040)
    Number of Tax Expenditures Reported by Treasury,
    1974-2004
    Duration of Tax Expenditures Reported by Treasury,
    1974-2004
    Sum of Tax Expenditure Revenue Loss Estimates,
    1974-2004
    Sum of Tax Expenditure Revenue Loss Estimates with
    Outlays for Refundable Tax Credits, 1974-2004
    Tax Legislation Enacted From 1974-2004 That May Have
    Influenced the Sum of Revenue Loss Estimates for Tax
    Expenditures
    Sum of Revenue Loss Estimates by Taxpayer Group,
    1974-2004
    Sum of Tax Expenditure Outlay-equivalent Estimates
    Compared with Total Mandatory and Total Discretionary
    Outlays, 1981-2004
    Sum of Tax Expenditure Outlay-Equivalent Estimates
    Compared to Total Mandatory and Discretionary Outlays
    and Receipts as a Percentage of GDP, 1981-2004

    12 22 24 26 27

    30 32

    36

    38 39

    41 45

    46 94 98

    Figure 10: Size of Tax Expenditure Outlay-Equivalent Estimates by Budget
    Function, 1981-2004

    Figure 11: Tax Expenditure Outlay-equivalent Estimates Compared with
    Federal Outlays by Budget Function, Fiscal Year 2004

    Figure 12: Composition of Spending as a Share of GDP under Baseline
    Extended

    Figure 13: Composition of Spending as a Share of GDP Assuming
    Discretionary Spending Grows with GDP after 2005 and All Expiring Tax
    Provisions Are Extended

    Figure 14: Treasury's Supplemental Reporting for Comprehensive Income and
    Consumption Tax Baselines

    Figure 15: Supplemental Estimates Developed by Treasury and JCT

    Contents

    Figure 16: Sum of Revenue Loss Estimates Reported by the Joint Committee
    on Taxation and the U.S. Department of the Treasury (1987-2004) 99

    This is a work of the U.S. government and is not subject to copyright
    protection in the United States. It may be reproduced and distributed in
    its entirety without further permission from GAO. However, because this
    work may contain copyrighted images or other material, permission from the
    copyright holder may be necessary if you wish to reproduce this material
    separately.

    A

    United States Government Accountability Office Washington, D.C. 20548

    September 23, 2005

    The Honorable Joshua Bolten
    Director
    Office of Management and Budget

    The Honorable John W. Snow
    The Secretary of the Treasury

    Over the last decade, a culture of performance has taken root in the
    federal
    government. This culture has placed a greater premium on the importance
    of accountability for the effective use of public resources and
    authorities.
    Periodic reexamination of existing federal policies and operations offers
    the prospect of weeding out ineffective or outdated programs, policies,
    functions, or activities while strengthening and updating those that are
    retained. While inefficient and ineffective programs and policies are
    never
    appropriate, the nation's long-term fiscal imbalance provides an
    additional
    impetus for reexamining all major spending programs and tax provisions.1
    This includes tax incentives and subsidies intended to promote various
    social and economic objectives. Tax preferences-which are legally
    known as tax expenditures-result in forgone revenue for the federal
    government due to preferential provisions in the tax code, such as
    exemptions and exclusions from taxation, deductions, credits, deferral of
    tax liability, and preferential tax rates. These tax expenditures are
    often
    aimed at policy goals similar to those of federal spending programs;
    existing tax expenditures, for example, are intended to encourage
    economic development in disadvantaged areas, finance postsecondary
    education, and stimulate research and development. Tax expenditures
    have a significant effect on overall tax rates-in that, for any given
    level of
    revenue, overall tax rates must be higher to offset the revenue forgone
    through tax expenditures-as well as the budget and fiscal flexibility.
    They
    also contribute to the growing complexity of the federal tax system.
    Regardless of the level of revenue deemed appropriate, tax expenditures-
    like other federal programs or activities-should be reviewed to determine
    their effectiveness and continued relevance. Yet, tax expenditures and
    their relative contributions toward achieving federal missions and goals
    are
    often less visible than spending programs which are subject to more
    systematic review.

    1For more information, see GAO, 21st Century Challenges: Reexamining the
    Base of the Federal Government, GAO-05-325SP (Washington, D.C.: February
    2005).

    A little over a decade ago, GAO examined the growth in tax expenditures
    and opportunities to focus policymakers' attention on them.2 Our review
    found that tax expenditures were not integrated into annual federal budget
    review processes, and most were not subject to reauthorization, even
    though revenues forgone through tax expenditures were substantial. In
    turn, policymakers had few opportunities to make explicit comparisons or
    trade-offs between tax expenditures and federal spending programs.
    Therefore, we made several recommendations to the Office of Management and
    Budget (OMB) intended to encourage more informed policy debate about tax
    expenditures and to stimulate joint reviews of related tax and spending
    programs. OMB agreed that our recommendations were generally reasonable
    and reported that the Executive Branch had initiated efforts to integrate
    tax expenditures in the budget review process and develop performance
    measures for some tax expenditures.

    We have prepared this report under the Comptroller General's authority as
    part of a continuing effort to assist Congress in reexamining the base of
    federal programs, policies, and activities critical to achieving fiscal
    discipline in the budget as a whole. This report updates our 1994 work and
    specifically describes (1) how tax expenditures have changed over the past
    three decades in number and size and in comparison to federal revenue,
    spending, and the economy, and (2) the amount of progress that has been
    made since 1994 in how the Executive Branch scrutinizes tax expenditures.

    This update draws on our previously issued work on tax expenditure trends
    and individual tax provisions as well as results-oriented management and
    performance reporting. We also reviewed relevant literature related to tax
    expenditure measurement and reporting, and trends in the use of tax
    expenditures over time. We interviewed relevant agency officials and tax
    policy experts to obtain a greater understanding of information gained
    through our literature review. To gauge trends in the numbers and size of
    tax expenditures for fiscal years 1974 to 2004, we relied on the
    Department of the Treasury's (Treasury) annual list of tax expenditures
    and estimates for each tax expenditure of the associated revenue loss-the
    amount of revenue that the government forgoes-and the outlay-equivalent
    value-the amount of outlays required to deliver the

    2GAO, Tax Policy: Tax Expenditures Deserve More Scrutiny,
    GAO/GGD/AIMD-94-122 (Washington, D.C.: June 3, 1994).

    same after-tax income as provided through the tax expenditure.3 We added
    the tax expenditure revenue loss estimates for each fiscal year to
    approximate the total revenue forgone through tax expenditure provisions.
    While sufficiently reliable as a gauge of general magnitude, the sum of
    the individual revenue loss estimates has important limitations in that
    any interactions between tax expenditures will not be reflected in the
    sum. In addition, tax expenditure revenue loss estimates for specific
    provisions do not take into account potential behavioral responses to
    changes in these provisions on the part of taxpayers, and, in turn, no
    potential behavioral response would be reflected in the sum of the
    estimates. Thus, the revenue loss from all or several tax expenditures
    together might be greater or less than the sum of the estimated revenue
    losses from the individual tax expenditures, and no measure of the size or
    the magnitude of these potential interactions or behavioral responses to
    all or several tax expenditures is available. Growth in the sum of tax
    expenditure estimates across the three-decade period is presented in
    inflation-adjusted 2004 dollars and measured relative to the economy as a
    share of the gross domestic product (GDP). We compared the sum of tax
    expenditure outlayequivalent estimates to total federal mandatory and
    discretionary spending and spending by budget function. Finally, we used
    Treasury's estimates to examine trends in the size of tax expenditures by
    taxpayer group and identify the largest tax expenditures in 2004.

    To examine progress over the last decade in how the federal government
    scrutinizes tax expenditures, we examined actions taken by the Executive
    Branch to implement our 1994 recommendations for (1) presenting tax
    expenditures in the annual budget, (2) developing a structure for
    conducting reviews of tax expenditures' performance, (3) conducting case
    studies to assess performance review structure, and (4) incorporating tax
    expenditures into the annual budgetary review process. We reviewed efforts
    to include tax expenditures under the Government Performance and Results
    Act's (GPRA) statutory framework for strategic planning,

    3We used revised estimates, which incorporate the most recent changes in
    tax policy and economic activity, developed by the U.S. Department of the
    Treasury and reported in each year's budget in either the Special
    Analyses, Appendixes, or Analytical Perspectives. We chose the tax
    expenditure estimates reported in the budget for our analysis because
    Treasury develops (1) revised estimates based on changes in tax policy and
    economic activity for the year prior to the reported fiscal budget year
    and (2) outlay-equivalent estimates that facilitate comparison to federal
    spending. Although they are the last available estimates reported,
    Treasury's estimates are still projected estimates and may not reflect
    additional policy changes.

    performance measurement, and program reporting and evaluation.4 We also
    considered any related activities to include tax expenditures under OMB's
    Program Assessment Rating Tool (PART)-its current framework for assessing
    the performance of federal programs. (See app. I for details on our scope
    and methodology.)

    Our work was conducted from August 2003 through July 2005, in accordance
    with generally accepted government auditing standards. In July 2005, we
    requested comments on a draft of this report from the Director of the
    Office of Management and Budget, the Secretary of the Department of the
    Treasury, and the Commissioner of the Internal Revenue Service (IRS). We
    received comments from OMB's Associate Director for Economic Policy in a
    letter dated September 2, 2005 (see app. II). Treasury did not provide
    separate comments, instead deferring to OMB. IRS staff provided a
    technical correction that we incorporated.

    Results in Brief	Whether gauged in absolute numbers and revenues forgone
    or in comparison to federal spending or the size of the economy, tax
    expenditures have represented a substantial commitment of federal support
    over the past three decades. Between 1974 and 2004, tax expenditures
    doubled in number from 67 to 146, and while some were repealed or allowed
    to expire, considerably more were added to Treasury's list. Based on our
    analysis of Treasury's estimates, the sum of revenue loss estimates
    associated with tax expenditures, adjusted for inflation, tripled from
    approximately $240 billion to nearly $730 billion over the period.5 The 14
    largest tax expenditures, headed by the largest single tax expenditure-
    the income tax exclusion for employer-provided health care-accounted for
    75 percent of the aggregate revenue loss in fiscal year 2004. The sum of
    the revenue loss estimates for tax expenditures that are used by
    individual taxpayers increased in real terms from approximately $190
    billion to nearly $650 billion. Since 1981 when outlay-equivalent
    estimates were first available, the sum of the outlay-equivalent estimates
    for tax expenditures has been similar in magnitude to discretionary
    spending, and this sum

    4Pub. L. No. 103-62, Aug. 3, 1993.

    5Aggregate tax expenditure estimates must be interpreted carefully because
    of inherent limitations in the meaning of the summed estimates. The sum of
    the individual tax expenditure estimates is useful for gauging the general
    magnitude of revenue forgone through provisions of the tax code but does
    not take into account interactions between individual provisions.

    exceeded total discretionary spending for most years during the last
    decade. As a share of the U.S. economy, the sum of tax expenditure
    outlayequivalent estimates remained relatively stable at about 7.5 percent
    of GDP since the last major tax reform legislation in 1986. Across budget
    functions, the size of tax expenditures varied, and for some budget
    functional areas, such as housing and education, tax expenditures were the
    same magnitude as, or larger than, federal spending.

    Although tax expenditures are substantial in size, little progress has
    been made in the Executive Branch to increase the transparency of and
    accountability for tax expenditures. The entire set of tools the federal
    government can use to address national objectives-including discretionary
    and mandatory spending, tax provisions, and loans and loan
    guarantees-should be subject to periodic reviews and reexamination to
    ensure they are achieving their intended purposes and designed in the most
    efficient and effective manner. The nation's current and projected fiscal
    imbalance serves to reinforce the importance of engaging in such a review
    and reassessment. Tax expenditures may not always be efficient, effective,
    or equitable and, consequently, information on these attributes can help
    policymakers make more informed decisions as they adapt current policies
    in light of our fiscal challenges and other overarching trends. In
    addition, some tax expenditures, at least as currently designed, may serve
    to exacerbate other key private sector and public policy challenges, such
    as controlling health care costs. Although data and methodological
    challenges may impede studies of some tax expenditures, periodic reviews
    of tax expenditures could help establish whether these programs are
    relevant to today's needs; if so, how well tax expenditures have worked to
    achieve their objectives; and whether the benefits from particular tax
    expenditures are greater than their costs. Over the past decade, however,
    the Executive Branch has made little progress in integrating tax
    expenditures into the budget presentation, in developing a structure for
    evaluating the performance of tax expenditures, or in incorporating tax
    expenditures under review processes that apply to spending programs, as we
    recommended in 1994. Also, more recently, OMB has not used its PART
    process to systematically review tax expenditures and promote joint and
    integrated reviews of tax and spending programs sharing common,
    crosscutting goals. One of the key impediments to moving forward in
    evaluating tax expenditures' performance is the continuing lack of clarity
    about the roles of OMB, Treasury, IRS, and departments or agencies with
    outlay program responsibilities.

    We are recommending that the Director of OMB, in consultation with the
    Secretary of the Treasury, take several steps to ensure greater
    transparency of and accountability for tax expenditures by reporting
    better information on tax expenditures' performance and more fully
    incorporating tax expenditures into federal performance management and
    budget review processes.

    In providing comments on a draft of this report, OMB's Associate Director
    for Economic Policy disagreed with our recommendations, raised concerns
    about our use of tax expenditure estimates developed by Treasury and
    reported in the annual federal budget, and implied that increasing the
    attention paid to tax expenditures due to the severity of the nation's
    longterm fiscal imbalance would lead to tax increases. Pursuant to the
    Congressional Budget Act of 1974, the term tax expenditure, as our draft
    stated, has been used in the federal budget for three decades, and the tax
    expenditure concept-while not precisely defined-is a valid representation
    of one tool that the federal government uses to allocate resources. In
    addition, OMB's implication that focusing more attention on tax
    expenditures would automatically lead to increased taxes is unfounded. Our
    report states that the revenues forgone through tax expenditures reduce
    revenues available to fund other federal activities or they require higher
    tax rates to obtain a given amount of revenue. Thus, if the evaluations of
    tax expenditures we call for lead to reducing or eliminating some tax
    expenditures, the net change after rate adjustments could, depending on
    overall congressional priorities and preferences, result in tax reductions
    for many taxpayers. Furthermore, although specific tax expenditures, such
    as the earned income tax credit (EITC) and Liberty Zone tax benefits, have
    received varying degrees of scrutiny, efforts to date have not provided
    the Congress and others with an integrated perspective on the extent to
    which programs and tools-including tax expenditures- contribute to
    national goals and position the government to successfully meet 21st
    century demands. The lack of a requirement to disclose tax expenditures in
    agencies' annual performance and accountability reports may result in
    important performance and cost related data not being fully considered
    with other federal resources allocated to achieve similar objectives.
    Although challenges must be overcome to provide systematic reviews of tax
    expenditures, these challenges cannot be addressed absent effective
    leadership within the Executive Branch. For these reasons, we believe our
    recommendations, if fully implemented, will ensure that policymakers and
    the public have the necessary information to make informed decisions and
    to improve the progress toward greater scrutiny of tax expenditures.

    Background	To understand the trends in the size of tax expenditures, it is
    helpful to understand how tax expenditures are defined and how the
    different types affect taxpayer liability. For this report, we also
    provide an overview of the broad purposes of tax expenditures-one method
    the federal government can use to achieve national objectives-and a
    discussion of how tax expenditures interact with the federal budget.

    Tax Expenditures Defined	Tax expenditures are revenue losses-the amount of
    revenue that the government forgoes-resulting from federal tax provisions
    that grant special tax relief for certain kinds of behavior by taxpayers
    or for taxpayers in special circumstances. These provisions may, in
    effect, be viewed as spending programs channeled through the tax system
    and are classified in the U.S. budget by the same functional categories as
    other spending, such as energy and health. Tax expenditures are provisions
    that are exceptions to the "normal structure" of the individual and
    corporate income tax necessary to collect government revenues.6 Deciding
    whether an individual provision should be characterized as a tax
    expenditure is a matter of judgment, and disagreements about
    classification stem from different views about what should be included in
    the income tax base.7 As a practical matter, the term tax expenditure has
    been used in the federal budget for three decades, and the tax expenditure
    concept-while not precisely defined-is a valid representation of one tool
    that the federal government uses to allocate resources.

    Both the congressional Joint Committee on Taxation (JCT) and Treasury's
    Office of Tax Analysis annually compile a list of tax expenditures and
    estimates of their cost.8 (App. III provides additional information on how

    6The concept of tax expenditures extends beyond the income tax. Tax
    expenditures also exist for other types of taxes such as excise and
    payroll taxes; however, this report considers only tax expenditures for
    the federal income tax system.

    7Some object that the distinction between those tax provisions labeled tax
    expenditures and those that are not is arbitrary and, that the very notion
    of labeling these provisions expenditures implies that all income could be
    taxed and thus, all income inherently belongs to the government. See, for
    example, Joint Economic Committee, Tax Expenditures: A Review and Analysis
    (Washington, D.C.: August 1999).

    8Office of Management and Budget, Analytical Perspectives, Budget of the
    United States Government, Fiscal Year 2006 (Washington, D.C.: 2005); and
    Joint Committee on Taxation, Estimates of Federal Tax Expenditures for
    Fiscal Years 2005-2009, JCS-1-05, (Washington, D.C.: Jan. 12, 2005).

    tax expenditures are measured and reported and perspective on differences
    among the lists of tax expenditures reported by JCT and Treasury.)
    Treasury's tax expenditure estimates are included as an informational
    supplement to the annual federal budget by the OMB. The revenue loss is
    estimated for each tax expenditure separately by comparing the revenue
    raised under current law with the revenue that would have been raised if
    the single provision did not exist, assuming all other parts of the tax
    code remain constant and taxpayer behavior is unchanged. Revenue loss
    estimates are intended to provide information about the value of tax
    expenditures. However, tax expenditure estimates do not incorporate any
    behavioral responses and thus do not necessarily represent the exact
    amount of revenue that would be gained if a specific tax expenditure were
    repealed.9 For example, when the consumer interest deduction was phased
    out gradually beginning in 1987, some taxpayers shifted to
    interest-deductible home equity loans to finance consumption, thereby
    affecting the revenue gain from eliminating the consumer interest
    deduction.

    In addition to estimating revenue loss, Treasury also measures tax
    expenditures on an outlay-equivalent basis. Outlay-equivalent estimates
    represent the amount of budget outlays that would be required if the
    government were to provide taxpayers with the same after-tax income they
    receive through the tax expenditure. Outlay-equivalent estimates are often
    higher than revenue loss estimates to reflect that a comparable outlay
    program could result in additional taxable income to recipients.10
    Outlayequivalent estimates are useful to compare tax expenditures and
    other parts of the federal budget. For example, the outlay-equivalent
    estimate for the tax exclusion for housing and meal allowances for
    military personnel reflects the additional pretax income that military
    personnel would have to be paid to raise their income after federal taxes
    by the amount of the tax expenditure. The outlay-equivalent estimate can
    be used to compare this tax expenditure with other outlays for defense
    compensation on a more consistent basis.

    9Changes in taxpayer behavior are taken into account when JCT and Treasury
    prepare revenue estimates for proposed legislation.

    10Although outlay-equivalent estimates are often higher than revenue loss
    estimates, the net estimated revenue loss for the government is unchanged.
    For more information on how outlay-equivalent estimates are measured, see
    app. III.

    Types of Tax Expenditures	The Congressional Budget and Impoundment Control
    Act of 197411 lists six types of tax expenditures: exclusions, exemptions,
    deductions, credits, preferential tax rates, and deferral of tax
    liability. Some tax expenditures apply only to individual taxpayers, such
    as deductions and exclusions for employer-provided contributions for
    medical insurance, and some only to corporate taxpayers, such as a tax
    credit for corporations doing business in U.S. possessions. Other tax
    expenditures, such as accelerated depreciation, apply both to corporations
    and to individual taxpayers with income from businesses such as sole
    proprietorships or partnerships.12 Table 1 shows examples of each type of
    tax expenditure and the taxpayer group that may claim a particular type.

    11Pub. L. No. 93-344, Sec. 3, 88 Stat. 299 (July 12, 1974) (codified at 2
    U.S.C. sec. 622(3)).

    12Tax expenditures have been described by some analysts as being directed
    toward social or business interests. A social tax expenditure provides
    transfer payments related to old age, education, occupational and health
    benefits. A business tax expenditure has as its central goal the provision
    of financial support to corporations, partnerships, or individuals in any
    industry. See Eric Toder, The Changing Composition of Tax Incentives:
    1980-99, (Washington, D.C.: The Urban Institute, March 1999).

      Table 1: Examples of Types of Tax Expenditures Available to Taxpayer Groups
                                    Taxpayer groups

    Both corporate and Types of tax expendituresa Individual taxpayersb
    Corporate taxpayers individual taxpayers

    Exclusion from taxable income	Exclusion of employer Extraterritorial
    income exclusion Exclusion of interest on contributions to medical
    insurance public purpose state and premiums and medical care local bond

    Exemption from taxable income	Parent personal exemption for Exemption of
    credit union income Special employer stock student age 19 and over
    ownership plan rules

    Deduction from  Deductibility of       Special Blue       Deductibility of
    taxable income  mortgage interest      Cross/Blue Shield        charitable
                         on owner-occupied        deduction       contributions
                               homes
           Credit                                                Credit for
    subtracted from    Child tax credit    Employer-provided  low-income
            taxes                                 child care
         ordinarily                                 credit           housing
          computed                                                 investments

    Preferential tax rate for all or Averaging previous period taxable
    Graduated corporation income tax N/A part of taxable income income for
    farmers rate

    Deferral of tax liability	Carryover basis of capital gains on Deferral of
    income from controlled Accelerated depreciation of gifts foreign
    corporations machinery and equipment

    Source: GAO.

    aTypes of tax expenditures that are identified in the U.S. Congressional
    Budget and Impoundment Act of 1974.

    b Individual tax expenditures include those available to non-corporate
    forms of business such as sole proprietorships.

    Figure 1 illustrates how tax expenditures appear on the U.S. Individual
    Income Tax Return (Form 1040). Exclusions are those items of income that
    would otherwise constitute a part of the taxpayer's gross income, but are
    excluded under a specific provision of the tax code. Exclusions generally
    do not appear on the Form 1040, and excluded income is not reflected in
    total reported income. For example, the income tax exclusion of employer
    contributions to medical insurance premiums and medical care is not
    reported in a taxpayer's wages or salaries. An exemption, such as the
    parent personal exemption for students over age 19 but under age 24, is a
    reduction in taxable income offered to taxpayers because of their status
    or circumstances. Deductions are adjustments from adjusted gross income.13
    Deductions claimed before the adjusted gross income line on the Form 1040,
    such as the tuition and fees deduction (this appears on line 27 in fig.
    1), are sometimes called "above-the-line" deductions. Taxpayers may

    13Adjusted gross income is equal to gross income less qualifying
    adjustments to income, including some deductions.

    also claim "below-the-line" deductions after the adjusted gross income
    line; to do so, taxpayers must itemize their deductions.14

    14Taxpayers list their itemized deductions on the U.S. Individual Income
    Tax Return Form 1040 Schedule A-Itemized Deductions. In 2001, we reported
    that less than one-third of individual taxpayers itemize their deductions;
    in lieu of itemizing their deductions, most taxpayers take the standard
    deduction, which is considered part of the individual income tax
    structure. See GAO, Tax Deductions: Estimates of Taxpayers Who May Have
    Overpaid Federal Taxes by Not Itemizing, GAO-01-529 (Washington, D.C.:
    Apr. 12, 2001).

    Figure 1: Examples of How Each Type of Tax Expenditure Relates to the U.S.
    Individual Income Tax Return (Form 1040)

    Exemption

    An example of an exemption is the

    parent personal exemption for

    students over age 19 but under age

    24 (appears on line 6c).

    Exclusion

    Excluded income generally does not

    appear on the tax form, but can still

    cause the income line to be lower

    than it otherwise would be. For

    example, the exclusion of employer

    contributions to medical insurance

    premiums and medical care causes

    the reported amount of wages and

    salaries to be less than it would be

    otherwise (see line 7).

    Deferral

    An example of a deferral is the

    accelerated depreciation of

    machinery and equipment for a

    sole proprietorship (appears on

    line 12 via Schedule C-Profit or

    Loss from Business and Form

    4562-Depreciation and

    Amortization.

    Preferential tax rate

    An example of this tax expenditure

    type is the preferential tax rate on

    capital gains of certain income

    (appears on line 13 via the

    Schedule D-Capital Gains and

    Losses form).

    Deduction

    An example of a deduction above the

    adjusted gross income line is the tuition

    and fees deduction (appears on

    line 27). An example of an itemized

    deduction below-the-line is the deduction

    for mortgage interest on owner-occupied

    homes (appears on line 39 as an

    itemized deduction via the Schedule

    A-Itemized Deductions form).

    Note: Adjusted gross income is equal to gross income less qualifying
    adjustments to income, including some deductions.

    Credit

    An example of a credit is the tax credit for the elderly or disabled
    (appears on line 48). An example of a refundable credit is the child tax
    credit (appears on line 51 with the refundable portion on line 67 via Form
    8812-Additional Child Tax Credit).

                                      Source: GAO.

    Each type of tax expenditure creates tax savings in different ways and,
    consequently, reduces federal revenues in different ways. The amount of
    tax relief per dollar that a taxpayer receives using an exclusion,
    exemption, or deduction depends on the taxpayer's marginal tax rate.15
    Generally, the higher the taxpayer's marginal tax rate, the greater the
    tax savings from these tax expenditure types.16 Tax credits reduce tax
    liability dollar-fordollar, so the value of a credit is the same
    regardless of the taxpayer's marginal tax rate. A nonrefundable tax credit
    can be used to reduce current year tax liability to zero, and a refundable
    credit in excess of tax liability results in a cash refund. For
    preferential tax rates which reduce the tax rate on some forms of income
    such as capital gains, the tax savings depend on the difference between
    the preferential rate and a taxpayer's marginal tax rate. By allowing
    taxpayers to reduce current tax liability by delaying recognition of some
    income or accelerating some deductions otherwise attributable to future
    years, a tax deferral shifts the timing of tax payments and, in effect,
    provides an interest-free "loan" to the taxpayer. The benefit from a
    deferral is even greater if the taxpayer expects to face a lower tax
    bracket in the future. A lower-income taxpayer-with no net annual income
    or with no current tax liability after claiming the standard deduction and
    any personal exemptions-would not directly benefit from most tax
    expenditures other than refundable credits.

    Some techniques have been used to limit the benefits that taxpayers may
    receive from individual tax expenditures or groups of them. Congress has
    controlled the amount of revenue forgone for some tax expenditures by
    adopting provisions to restrict taxpayers' eligibility for benefits. For
    example, the mortgage interest deduction is limited to interest on debt up
    to $1 million to buy, build, or improve first and second homes and up to
    $100,000 in home equity debt. Aggregate itemized deductions are reduced by
    3 percent of the amount of a taxpayer's adjusted gross income that exceeds
    a certain threshold, eliminating 3 cents of itemized deductions for each
    dollar of income above the threshold for higher-income taxpayers.17 Some
    tax expenditures, such as tax-exempt private-activity bonds issued by each
    state, are subject to volume caps limiting the aggregate amount of

    15A marginal tax rate is the tax rate that applies to an additional dollar
    of income.

    16Marginal individual tax rates for 2004 taxes were 10 percent, 15
    percent, 25 percent, 28 percent, 33 percent, and 35 percent.

    17The reduction in itemized deductions for higher-income taxpayers may
    also be viewed as a hidden tax rate.

    benefits available. The alternative minimum tax (AMT) also affects tax
    expenditures and the amount of the revenue loss for the federal
    government.18 The AMT is intended to ensure that taxpayers with income
    over certain thresholds pay some income tax, no matter how much they claim
    in certain deductions and credits. Under the AMT, taxpayers may have to
    add back some tax expenditures that they could otherwise claim under the
    regular tax system, such as deductions for state and local taxes and home
    equity loan interest, and they may have to include as income certain
    tax-exempt bond interest that is excluded under the regular tax system.

        Objectives of Tax Expenditures

    In addition to raising revenue, the federal income tax has long been used
    as a tool for accomplishing social and economic objectives. The general
    objectives of tax expenditures are to encourage particular types of
    activities (such as saving for retirement, promoting home ownership,
    investing in certain sectors, or funding research and development) and
    provide economic relief to selected groups of taxpayers (such as the
    elderly, the blind, and those with children). Another objective of tax
    expenditures may also be to adjust for differences in individuals' ability
    to pay taxes. For example, if two taxpayers have the same income, but one
    has a catastrophic illness and costly medical bills (or large casualty and
    theft losses), the other taxpayer is judged better able to pay income
    taxes. Some tax expenditures may be enacted to compensate for other
    provisions of the tax code. For example, advocates of reduced tax rates on
    capital gains often explain the special treatment of capital gains income
    as offsetting, in part, the assessment of taxes on the nominal, rather
    than the real, value of capital gains. The rationale and reasons for a
    particular tax expenditure may change over time. For example, according to
    the Congressional Research Service (CRS), the income tax code instituted
    in 1913 contained a deduction for all interest paid. No distinction was
    made between business and personal interest expenses, although most
    interest payments at that time represented business expenses. The
    legislative history does not indicate that the deductibility of mortgage
    interest was originally intended to encourage home ownership or subsidize
    the housing industry. However, over time, encouraging home ownership,
    stimulating

    18The AMT is a separate tax system that applies to both individual and
    corporate taxpayers. It parallels the regular individual income tax system
    but with different rules for determining taxable income, different tax
    rates for computing tax liability, and different rules for allowing the
    use of tax credits.

    residential construction and maintenance, and encouraging families to save
    and invest in a major financial asset have all been offered as
    justifications for the mortgage interest deduction.19

    The tax expenditure tool may substitute for a federal spending program in
    that the federal government "spends" some of its revenue on subsidies by
    forgoing taxation on some income.20 Certain activities may be cheaper and
    simpler to subsidize through the tax code than by setting up a separate
    program using a different tool. For example, the incremental
    administrative and compliance costs to deliver the tax credit for child
    and dependent care expenses may be relatively low compared to the costs of
    setting up a separate system for processing child care applications and
    sending vouchers to those eligible. The administrative infrastructure
    already exists for the government to collect and remit money to over 131
    million individual tax filers and 6 million corporations via the tax
    system administered by the IRS. In concept, the costs to implement an
    incomebased benefit program through the existing tax system could be lower
    than to set up separate spending programs to deliver these benefits.

    In some circumstances, tax expenditures may not be the best policy choice
    to deliver timely benefits or reach intended populations. For programs
    that seek to provide benefits within a given year, the annual income
    measure relevant for income tax purposes may not be the best way to target
    benefits. Relative to spending programs, tax expenditures are limited in
    their ability to directly provide benefits to nontaxpayers. For example,
    tax credits must be refundable to reach low-income individuals who do not
    pay taxes and otherwise would not be required to file tax returns. Tax
    expenditures generally do not deliver federal resources directly to state
    and local governments and tax-exempt nonprofit organizations. The
    charitable contribution deduction provides an incentive for individual and
    corporate taxpayers to donate to charitable, religious, educational, and

    19For more information on the history of the mortgage interest deduction,
    see Pamela J. Jackson, Fundamental Tax Reform: Options for the Mortgage
    Interest Deduction, Library of Congress, Congressional Research Service
    Report RL33025 (Washington, D.C.: Aug. 8, 2005).

    20For more discussion of administering programs using tax expenditures,
    see OMB, Analytical Perspectives, Budget of the United States Government,
    Fiscal Year 2006

    (Washington, D.C.: 2005); Eric J. Toder, "Tax Cuts or Spending-Does It
    Make a Difference?" National Tax Journal, Vol. LIII, No. 3, September
    2000); and Joel Slemrod and Jon Bakija, Taxing Ourselves: A Citizen's
    Guide to the Debate Over Taxes, 3rd Edition (Cambridge, Mass.: The MIT
    Press, 2004).

    health nonprofit organizations. The deduction, in effect, is a federal
    grant to the donor that reduces the out-of-pocket cost of giving. The
    itemized deduction for state and local taxes directly increases an
    individual taxpayer's after-tax income and thus reduces the after-tax
    price of state and local taxes. State and local governments receive some
    of the benefit to the extent that taxpayers may be more willing to pay
    state and local taxes.

    Tax expenditures are not necessarily an either/or alternative to federal
    spending and may be used in combination with federal spending and
    strategies to achieve national objectives. For example, the HOPE and
    Lifetime Learning tax credits are used with federal education assistance,
    such as student loans, all of which help individuals fund higher
    education. Many tax expenditures are comparable to entitlement programs
    for which spending is determined by rules for eligibility, benefit
    formulas, and other parameters rather than by Congress appropriating
    specific dollar amounts each year.21 With some exceptions, tax
    expenditures typically make funds (through reduced taxes) available to all
    qualified claimants, regardless of how many taxpayers claim the tax
    expenditures, how much they claim collectively, or how much federal
    revenue is reduced by these claims. Some tax expenditures resemble other
    policy tools, such as grants or direct loans. A few tax expenditures are
    administered like grant programs, allowing for some administrative
    discretion over who receives funds. For the New Markets Tax Credit (NMTC),
    those seeking the credit must apply to the Community Development Financial
    Institutions (CDFI) Fund within Treasury and be chosen by a group of
    evaluators to receive the tax credit. Like a grant program, the NMTC has a
    maximum amount that can be allocated by CDFI.22 Tax expenditures in the
    form of deferrals resemble loans, because they allow taxpayers to postpone
    the time when income is recognized for tax purposes or to accelerate the
    deduction of expenses, both of which effectively lower the amount of
    income currently subject to tax. Deferrals can result in higher taxes in
    later years when taxpayers recognize deferred income in later tax years or
    have fewer deductions to claim than they otherwise would have had; the
    amount of the deferral is, in effect, analogous to a government loan.

    21Entitlement statutes provide the authority to make payments to any
    person or government if, under the provisions of the law containing that
    authority, the United States is obligated to make such payments to persons
    or governments who meet the requirements established by that law.

    22The NMTC legislation limits the allocation of equity eligible for tax
    credits from 2001 through 2007 from $1 billion to $3.5 billion per year,
    totaling $15 billion over the 7 years.

        Tax Expenditures and the Federal Budget

    Tax expenditures, by definition, reduce federal revenue and thus have
    implications for income tax rates, federal spending, and the federal
    budget. To obtain a given amount of revenue, tax expenditures require
    overall statutory tax rates to be higher. Otherwise, revenues forgone
    through tax expenditures reduce the revenue base available for funding
    federal spending programs. From a budgetary perspective, most tax
    expenditures are comparable to mandatory spending for entitlement
    programs, in that no further action is required to provide resources for
    tax expenditures. Tax expenditures do not compete overtly in the annual
    budget process and, in effect, receive a higher funding priority than
    discretionary spending subject to the annual appropriations process.
    Revenues forgone through tax expenditures-unless offset by increased taxes
    or lower spending- increase the unified budget deficit and federal
    borrowing from the public (or reduce the unified budget surplus available
    to reduce debt held by the public).

    As noted previously, both the executive and legislative branches-by
    Treasury and JCT, respectively-publish annual lists of tax expenditures
    and the associated revenue loss, but budgetary decisions generally are not
    based on these lists. Like any spending program, newly proposed tax
    expenditures and those subject to expiration, to some extent, are subject
    to scrutiny, but most tax expenditures are not subject to reauthorization.
    Tax expenditures may be indirectly controlled to the extent that the
    Congress aims to achieve any revenue target. The tax committees consider
    tradeoffs between tax expenditures, tax rates, and other parts of the tax
    code.

    In concept, eliminating or limiting an existing tax expenditure-like an
    existing spending program-would free up resources to reduce tax rates,
    increase federal spending or other tax expenditures, reduce the deficit,
    or produce some combination thereof. Conversely, adding a new tax
    expenditure, expanding an existing tax expenditure, or extending an
    expiring tax expenditure reduces the resources available to reduce tax
    rates, fund federal spending and tax expenditures, or reduce the deficit.
    The overall effect on the unified budget position would depend on the
    extent to which any change in tax expenditures is offset by adjustments to
    the tax code or other spending programs.

      Tax Expenditures Have Represented a Substantial Federal Commitment over Time

    Whether gauged in absolute numbers, by revenues forgone, or in comparison
    to federal spending or the size of the economy, tax expenditures have been
    substantial over the last three decades. Between fiscal years 1974 and
    2004, tax expenditures doubled in number, and the sum of estimated revenue
    losses associated with tax expenditures tripled, most of which was
    accounted for by tax expenditures that were used by individual taxpayers.
    Since 1981 when outlay-equivalent estimates were first available, the sum
    of the outlay-equivalent estimates for tax expenditures has been similar
    in magnitude to discretionary spending, and this sum exceeded total
    discretionary spending for most years during the last decade. As a share
    of the U.S. economy, the sum of tax expenditure outlay-equivalent
    estimates remained relatively stable at about 7.5 percent of GDP since the
    last major tax reform legislation.

        Sums of Tax Expenditure Estimates Are Useful for Gauging Magnitude of Tax
        Spending but Need to Be Interpreted Carefully

    Summing the individual tax expenditure estimates is useful for gauging the
    general magnitude of the federal revenue involved, but it does not take
    into account possible interactions between the individual tax code
    provisions. Because of this limitation, sums of tax expenditure estimates
    must be interpreted carefully. The JCT and Treasury estimate the revenue
    loss from each tax expenditure separately, assuming that the rest of the
    tax code remains unchanged. Neither JCT nor Treasury adds tax expenditure
    estimates, because summing them does not take into account possible
    interaction effects among the provisions. If two or more tax expenditures
    were estimated simultaneously, the total change in federal revenue could
    be smaller or larger than the sum of the amounts shown for each item
    separately as a result of interactions among the tax expenditure
    provisions. For example, the repeal of an itemized deduction tax
    expenditure might cause more taxpayers to take the standard deduction
    instead of itemizing. However, the revenue loss estimate for any single
    tax expenditure among the itemized deductions does not reflect this
    potentially sizeable interaction with the standard deduction. Eliminating
    several itemized deductions at the same time could cause significant
    numbers of taxpayers to take the standard deduction, and thus, the
    decrease in revenue could be less than the sum of the estimated revenue
    loss estimates for each itemized deduction. To demonstrate the magnitude
    of possible interactions and the potential implications for summing tax
    expenditures, Treasury's Office of

    Tax Analysis illustrated for us the repeal of five itemized deductions.23
    Based on tax year 2002 data, the sum of the five separate tax expenditure
    estimates, each calculated assuming the rest of the tax code was
    unchanged, was over $175 billion.24 Assuming the simultaneous repeal of
    all five provisions, Treasury estimated the revenue loss after interaction
    totaled $131 billion-about 25 percent less than the sum of the separate
    estimates. According to Treasury, this example cannot be generalized given
    that some groups of tax provisions have substantial interactions and
    others do not. For all tax expenditures, the magnitude of the difference
    between the sum of the estimates and an estimate for all tax expenditures
    simultaneously is not known.

    Additionally, tax expenditure estimates developed by Treasury and JCT do
    not take into account possible behavioral responses by taxpayers if a tax
    expenditure were repealed. For example, if the HOPE scholarship tax
    credit-a tax credit for the first 2 years of post-secondary education-were
    eliminated, taxpayers who would have used that tax credit may instead opt
    for the Lifetime Learning tax credit or other tax subsidies aimed at
    higher education. In contrast, certain kinds of behavioral responses, such
    as changes in the timing of transactions, income recognition, or shifts
    between sectors of the economy, are taken into account when JCT and
    Treasury prepare revenue estimates for proposed legislation. Potential
    macroeconomic effects, such as changes to GDP, are not reflected in tax
    expenditure revenue loss estimates or in revenue estimates for proposed
    legislation.

    To some extent, the same kinds of challenges in interpreting tax
    expenditure estimates also exist in projecting the costs of spending
    programs. Budget line items generally do not reflect the actual budget
    savings to be gained by abolishing specific programs or groups of
    programs. For instance, eliminating all veterans' benefits would reduce
    the federal budget by less than the amount currently spent on those
    programs because spending likely would increase in food stamps, Medicaid,
    and other entitlement programs. Although interaction effects also occur
    for

    23The 2002 estimates for the five itemized deductions were: (1) charitable
    contributions, $33.8 billion; (2) home mortgage interest expenses, $69.2
    billion; (3) state and local income taxes, $43.0 billion; (4) state and
    local property taxes, $24.2 billion; and (5) medical expenses, $5.5
    billion.

    24The sum of Treasury's 2004 revenue loss estimates for the five itemized
    deductions was about $168 billion; see app. III.

    spending programs, Treasury officials responsible for developing tax
    expenditure estimates told us that the bias in summing tax expenditure
    revenue loss estimates likely is greater than the bias for outlay
    projections. Whereas historical data are reported for federal budget
    receipts and outlays, the last available values for tax expenditures
    remain estimates. Treasury's last reported re-estimates for past fiscal
    years reflect legislation enacted, prevailing economic conditions, and the
    latest taxpayer data available at the time of estimation.25 Projections of
    the future costs of tax expenditures are more uncertain than projections
    for future tax receipts or outlays because it is not known with certainty,
    even after the fact, how much was spent for any given tax expenditure.

    Despite the limitations in summing separate tax expenditure revenue loss
    and outlay-equivalent estimates, these are the best available data to
    measure the value of tax expenditures and make comparisons to other
    spending programs. Summing the estimates provides perspective on the use
    of tax expenditures as a policy tool and represents a useful gauge of the
    general magnitude of government subsidies carried out through the tax
    code. The estimates also can be used to compare tax expenditures to
    federal spending overall and by budget function. Other researchers also
    have summed tax expenditure estimates to help gain perspective on the use
    of this policy tool and examine trends in the aggregate growth of tax
    expenditure estimates over time.26

    Tax Expenditures Have More Between 1974 and 2004, tax expenditures
    reported by Treasury more than

    Than Doubled in Number and doubled in overall number from 67 to 146, and
    while some were dropped,

    Tripled in Size	considerably more were added. For 1974, Treasury listed 67
    separate exclusions, exemptions, deductions, credits, preferential tax
    rates, and

    25Treasury's fiscal year 2004 re-estimates were published in February
    2005, still months before 2004 tax returns would be filed. JCT projects
    the revenue loss for future years and does not re-estimate tax
    expenditures for past fiscal years.

    26See for example: Eric Toder, The Changing Composition of Tax Incentives:
    1980-1999. (Washington, D.C.: The Urban Institute, 1999); Dhammika
    Dharmapala, Tax Expenditures Versus Direct Subsidies: A Review of the
    Issues. (Austin, Tex.: National Tax Association, 91st Annual Conference,
    1998); Christopher Howard, "Tax Expenditures," The Tools of Government: A
    Guide to the New Governance, edited by Lester M. Salamon (New York, N.Y.:
    Oxford University Press, 2002), pp. 410-444; Congressional Research
    Service, Overview of the Federal Tax System (Washington, D.C.: 2005).

    deferral of tax liability as tax expenditures.27 In 1986, Treasury
    reported 115 tax expenditures, and by 2004 Treasury's list grew to 146 tax
    expenditures. Figure 2 shows the rise of the overall number of tax
    expenditures over the last three decades. (App. IV contains a compilation
    of all tax expenditures reported by Treasury between 1974 and 2004.)

    Figure 2: Number of Tax Expenditures Reported by Treasury, 1974-2004

    Number 160

    140

    120

    100

    80

    60

    40

    20

    0 19741975

                      19761977197819791980198119821983198419851986
        198719881989199019911992199319941995199619971998199920002001200220032004

    Fiscal year

    Source: GAO analysis of OMB budget reports on tax expenditures, Fiscal
    Years 1976-2006.

    Note: The number of tax expenditures reflects all provisions reported by
    Treasury, including those enacted but effective for future fiscal years.
    For example, Treasury's last available list included eight new tax
    expenditures enacted in 2004 that will be effective in fiscal year 2005
    and later. In addition, fluctuations in the trend lines from year-to-year
    may reflect changes in OMB's methodology. For example, the exclusion of
    scholarship and fellowship income and several other tax expenditures were
    excluded for fiscal year 1982, but included in prior and post years,
    because of changes in Treasury's income tax baseline that defines a tax
    expenditure.

    Of the 146 tax expenditures listed by Treasury in the President's fiscal
    year 2006 budget, 32 percent were on the first list in 1974, 23 percent
    were added between 1975 and 1986, and 45 percent were added since 1986.
    Figure 3 shows the duration of tax expenditures listed by Treasury. Of the
    67 tax expenditures listed in 1974, 21 had been dropped over the period,
    leaving

    27The revenue loss estimates for fiscal year 1974 were reported in the
    President's Budget for fiscal year 1976, published in 1975. The list has
    been required by the Congressional Budget Act of 1974 in the budget
    thereafter.

    46 remaining on the list in 2004. Since 1974, 143 tax expenditures were
    added to Treasury's list, although 43 of them have since dropped from the
    list over the period. Of the 100 added since 1974 and still reported in
    fiscal year 2004, 66 were first reported for 1986 or later.

    Figure 3: Duration of Tax Expenditures Reported by Treasury, 1974-2004

    Duration of tax expenditures

                                           1

                                          1 5

                                           7

                                           2

                                           9

                                          2 1

                                          1 6

    11 3

                                           1

                                           3

    5 1 1 9

                    197419751976197719781979198019811982198319841985
      1986198719881989199019911992199319941995199619971998199920002001200220032004

    Fiscal year

    Source: GAO.

    Note: The number of tax expenditures reflects all provisions reported by
    Treasury, including those enacted but effective for future fiscal years.
    For example, Treasury's last available list included eight new tax
    expenditures enacted in 2004 that will be effective in fiscal year 2005
    and later. Fluctuations in

    the trend lines from year-to-year may reflect changes in OMB's
    methodology. For example, the exclusion of scholarship and fellowship
    income and several other tax expenditures were excluded for fiscal year
    1982, but included in prior and post years, because of changes in
    Treasury's income tax baseline that defines a tax expenditure.

    The number of tax expenditures reported by Treasury has changed over time
    for several reasons. Some provisions expired or were repealed; others were
    merged with another tax expenditure. For example, until expiration on
    December 31, 1984, state and local governments were allowed to issue
    tax-exempt obligations to finance the purchase of mass-commuting vehicles
    for lease to government transit agencies; the Tax Reform Act of 198628
    repealed the investment tax credit; and the tax expenditure that provided
    5-year amortization for pollution control was merged into the investment
    tax credit by the Tax Reform Act of 1976.29 Legislation also added new tax
    expenditures over time, such as the child tax credit created by the
    Taxpayer Relief Act of 1997.30 Some tax expenditures split into additional
    listings to reflect legislation expanding existing tax expenditures. For
    example, Treasury began listing the net exclusion of pension contributions
    and earnings with separate estimates for employersponsored defined-benefit
    and 401(k) pension plans following 2001 legislation increasing the
    contribution limits for 401(k) accounts. Finally, changes in the baseline
    used by Treasury to identify tax expenditures may have caused some tax
    expenditures to drop off its list, while adding new tax expenditure
    listings.31 For example, Treasury briefly dropped the exclusion of
    scholarship and fellowship income from its fiscal year 1982 list because
    it was not considered a tax expenditure under the baseline that Treasury
    used that year.

    As the overall number reported by Treasury doubled, the sum of the
    estimated revenue loss due to tax expenditures, adjusted for inflation,
    tripled from approximately $243 billion for 1974 to $728 billion for
    2004.32 Figure 4 shows the sum of Treasury's revenue loss estimates over
    the past

    28Pub. L. No. 99-514, October 2, 1986.

    29Pub. L. No. 94-455, October 4, 1976.

    30Pub. L. No. 105-34, August 5, 1997.

    31To determine the tax code provisions that satisfy the definition of a
    tax expenditure, the existing tax law must be compared or measured against
    an alternative set of tax rules that represent a baseline. App. III
    discusses in more detail the baselines used by Treasury as well as how
    Treasury measures and reports tax expenditures.

    32The tax expenditure revenue loss estimates take into account the AMT
    liability.

    three decades. From 1974 to 1986, revenue losses increased by nearly two
    and one-half times from approximately $243 billion for 1974 to $598
    billion for 1986 (in 2004 dollars). Over the next 2 years, the sum of the
    revenue losses decreased by about 28 percent to approximately $433 billion
    for 1988. From 1989 through 1997, however, revenue losses increased by
    approximately 16 percent to approximately $547 billion. From 1998 to 2002,
    the sum of the estimated revenue loss increased by an average of about $41
    billion per year, peaking at about $783 billion for 2002. The sum of the
    revenue loss estimates declined to approximately $728 billion in 2004.

    Figure 4: Sum of Tax Expenditure Revenue Loss Estimates, 1974-2004

    Dollars in billions (in constant 2004 dollars) 900

    800

    700

    600

    500

    400

    300

    200

    100

    0

                  1974197519761977197819791980198119821983198419851986
        198719881989199019911992199319941995199619971998199920002001200220032004

    Fiscal year

    Source: GAO Analysis of OMB budget reports on tax expenditures, Fiscal
    Years 1976-2006.

    Note: Summing the revenue loss estimates does not take into account
    possible interaction effects among the tax expenditures that we mentioned
    earlier in the report. Changes in economic conditions and estimation
    techniques can affect revenue loss estimates for tax expenditures, making
    them differ from year to year. Changes to the number of tax expenditures
    reported by Treasury would also affect the amount of revenue loss reported
    if some tax expenditures were eliminated or added. Finally, revenue loss
    estimates include the effect of certain tax credits on receipts only and
    not the effect of the credits on outlays.

    The revenue loss estimates do not reflect the outlays for the refundable
    portion for certain tax credits.33 Summing these outlays along with the
    sum of the revenue loss estimates provides a more complete picture of the
    aggregate cost of tax expenditures throughout the period, as shown in
    figure 5. The sum of the estimated revenue losses and outlays associated
    with tax expenditures totaled about $770 billion for fiscal year 2004.

        Figure 5: Sum of Tax Expenditure Revenue Loss Estimates with Outlays for
                           Refundable Tax Credits, 1974-2004

                     Dollars in billions (in constant 2004 dollars)
    1974197519761977197819791980198119821983198419851986198719881989199019911992199319941995199619971998199920002001200220032004

    Fiscal year

    Tax expenditure revenue loss estimates

    Tax expenditure revenue loss estimates plus outlays for refundable tax
    credits

    Source: GAO analysis of OMB budget reports on tax expenditures, fiscal
    years 1976-2006.

    Note: Reflects refundable amounts for the EITC from 1976 to 2004, the
    child tax credit for 1997 to 2004, the child insurance medical premium
    credit for 1992 to1993, and the tax credit for health insurance purchased
    by certain displaced and retired individuals for 2004. Summing the revenue
    loss estimates does not take into account possible interaction effects
    among the tax expenditures that we mentioned earlier in the report.
    Changes in economic conditions and estimation techniques can affect
    revenue loss estimates for tax expenditures, making them differ from year
    to year. Changes to the number of tax expenditures reported by Treasury
    would also affect the amount of revenue loss reported if some tax
    expenditures were eliminated or added. Finally, revenue loss estimates
    include the effect of certain tax credits on receipts only and not the
    effect of the credits on outlays.

    33In fiscal year 2004, the associated outlays were $33.1 billion for the
    EITC, $8.9 billion for the child tax credit, and $0.7 billion for the
    health insurance tax credit for certain displaced and retired individuals.

    Trends in the sum of tax expenditures are due, at least in part, to
    legislation affecting the number or scope of tax expenditures or modifying
    tax rates or other basic structural features of the tax code. During this
    period, tax legislation directly influenced the sum of tax expenditure
    estimates by repealing or limiting some tax expenditures, enacting new
    ones, and extending the life of expiring tax expenditures. Even without
    changes to tax expenditures, legislation affecting tax rates or the tax
    structure affects the sum of the tax expenditure estimates. When a
    taxpayer uses a tax expenditure, his or her effective tax rate34 is
    reduced, because some part of his or her income remains untaxed or is
    taxed at a lower rate. When statutory rates increase, a taxpayer's ability
    to avoid tax on a portion of income is worth more; consequently, tax
    expenditures are worth more. Likewise, when rates decrease, tax
    expenditures are worth relatively less.

    Figure 6 highlights tax legislation enacted since 1974 that likely
    influenced the aggregate revenue losses due to tax expenditures. The sum
    of estimated revenue losses declined following the Tax Reform Act of
    1986,35 primarily because of individual and corporate marginal tax rate
    reductions which indirectly scaled back the value of all but a few tax
    credits. The 1986 act, which created the last major tax reform, also
    eliminated or limited the scope of various tax expenditures directly, for
    example, by repealing the investment tax credit, phasing out the interest
    deduction for consumer credit over 5 years, and limiting the expensing of
    the intangible drilling costs for oil and gas to successful, domestic
    wells. While materially reducing the number and scope of tax expenditures
    broadened the tax base, the act resulted in no net change in federal
    revenue because of the lower tax rates. In contrast, the sum of estimated
    revenue losses increased following the Omnibus Budget Reconciliation Act
    of 1993,36 which directly increased several tax expenditures-for example,
    extending the EITC to single workers with no children earning $9,000 or
    less-and indirectly increased the value of other tax expenditures by
    increasing the top individual income tax rates and adding a third rate.
    The sum of estimated revenue losses accelerated following the Taxpayer
    Relief Act of 1997, which expanded several tax expenditures-for example,
    increasing eligibility for traditional individual retirement accounts-and
    created an assortment of new tax expenditures, including the child tax
    credit and

    34The effective tax rate is the ratio of taxes paid to a taxpayer's total
    income.
    35Pub. L. No. 99-514, October 21, 1986.
    36Pub. L. No. 103-66, August 10, 1993.

    postsecondary education tax incentives. The Economic Growth and Tax Relief
    Reconciliation Act of 200137 reduced tax rates again and also increased
    the individual AMT exemption. The influence on the aggregate trend is less
    apparent for legislation expanding or adding tax expenditures while also
    reducing tax rates.

    37Pub. L. No. 107-16, June 7, 2001.

    Figure 6: Tax Legislation Enacted From 1974-2004 That May Have Influenced
    the Sum of Revenue Loss Estimates for Tax Expenditures

    900 Billions of dollars (in constant 2004 dollars)

    7419197519

        76197719781979198019811982198319841985198619871988198919901991199219931

    99419

                                          951

    99619

                              9719981999200020012002200320

    40Fiscal year

    The Revenue Act of 1978: P.L. 95-600, November 6, 1978, made the EITC a
    permanent provision of the Internal Revenue Code and reduced individual
    and corporate tax rates.

    The Economic Recovery Tax Act of 1981: P.L. 9734, August 13, 1981, enacted
    several new tax expenditures, expanded existing tax expenditures for
    individuals and businesses, and phased in a 23 percent cut in individual
    tax rates.

    The Economic Growth and Tax Relief Reconciliation Act of 2001: P.L.
    107-16, June 7, 2001, expanded several tax expenditures, lowered tax
    rates, and created an increase in the individual alternative minimum tax
    exemption amount.

    individuals.	August 5, 1997, expanded The Jobs and Growth Tax Relief
    several tax expenditures Reconciliation Act of 2003: P.L. 108-27,and
    created many new May 28, 2003, increased the child tax credit,

    The Omnibus Budget provisions, such as the and accelerated reductions in
    the regular
    Reconciliation Act of child, HOPE, and Lifetime income tax rates that were
    scheduled for
    1990: P.L. 101-508, Learning education 2004 through 2006.

    November 5, 1990, credits.
    expanded family eligibility
    for the EITC and replaced American Jobs Creation Act of 2004: P.L.
    108-357, October 22, 2004,
    the top three marginal tax extended several tax provisions that expired in
    2003 or were scheduled
    rate brackets of the Tax to expire in 2004, including the research and
    development tax credit;
    Reform Act of 1986 with two simplified the rules for utilizing foreign tax
    credits; and reduced the
    brackets. corporate tax rate from 35 percent for domestic manufacturers,

                      producers, farmers, and small corporations.

    Source: GAO analysis of OMB budget reports on tax expenditures, fiscal
    years 1976-2005.

    Note: The effects of legislative changes on tax expenditure estimates
    might not have occurred within the same year that the legislation was
    enacted. Summing the revenue loss estimates does not take into account
    possible interaction effects among the tax expenditures that we mentioned
    earlier in the report. Changes in economic conditions and estimation
    techniques, can affect revenue loss estimates

    for tax expenditures, making them differ from year to year. Changes to the
    number of tax expenditures reported by Treasury would also affect the
    amount of revenue loss reported if some tax expenditures were eliminated
    or added. Finally, revenue loss estimates include the effect of certain
    tax credits on receipts only and not the effect of the credits on outlays.

    Changes in economic conditions and in the baseline tax system can also
    affect revenue loss estimates for tax expenditures, making them differ
    from year to year. For example, rising housing prices may cause the
    estimated cost of the mortgage interest deduction to increase as
    homeowners finance larger mortgages or take out equity with home equity
    loans. In addition, changes in tax expenditure baselines could also cause
    estimates to differ from year to year. For example, for fiscal years 2003
    and 2004, Treasury redefined accelerated depreciation tax expenditures so
    that they are calculated relative to a replacement cost basis baseline
    rather than the historic cost basis previously used. This redefinition had
    the effect of reducing the estimated size of the accelerated depreciation
    tax expenditures.38

        Tax Expenditures for Individual Taxpayers Accounted for Most of the Sum of
        Tax Expenditure Revenue Losses

    The sum of estimated revenue losses due to tax expenditures for individual
    income taxpayers accounted for substantially more of the revenue loss
    between 1974 and 2004 than corporate tax expenditures, as shown in figure

    7. The sum of revenue loss estimates for tax expenditures that arise under
    the individual income tax increased from approximately $187 billion for
    1974 to $487 billion for 1987 (in 2004 dollars). After decreasing to
    approximately $363 billion for 1988, the sum gradually increased to a high
    of approximately $688 billion for 2002 and then declined in 2003 and 2004.
    On average over the entire period, revenue loss estimates for individual
    income taxpayers accounted for about 83 percent of the sum of revenue loss
    estimates per year. While estimated revenue losses for all tax
    expenditures tripled, the sum of revenue loss estimates for corporate tax
    expenditures increased from approximately $57 billion for fiscal year 1974
    to a high of about $116 billion in 1984 (in 2004 dollars). After 1984, the
    sum dropped back to approximately $57 billion in 1992 and increased
    slightly over the rest of the period, with some fluctuation between years.
    In 2004, revenue loss estimates for tax expenditures that arise under the
    corporate income tax accounted for 11 percent of the sum of revenue losses
    due to all

    38This is one of the reasons why the sum of tax expenditure revenue loss
    estimates by Treasury and JCT, which had been tracking each other rather
    closely since 1987, diverged in 2003 and 2004. While Treasury has changed
    its tax expenditure baselines over time, JCT's tax expenditure baseline
    has changed little over time. See app. III for additional information on
    how JCT and Treasury measure tax expenditures.

    tax expenditures. At about 10 percent of total federal receipts, corporate
    income taxes also accounted for a smaller share than individual income
    taxes.

          Figure 7: Sum of Revenue Loss Estimates by Taxpayer Group, 1974-2004

                     Dollars in billions (in constant 2004 dollars)

                                        N/A N/A

    197419751976 1977 197819791980 1981 1982 1983198419851986 198719881989 1990 1991
        199219931994 1995 1996 19971998 1999 2000 20012002 20032004 Fiscal year

    Individual Corporate

    Source: GAO analysis of OMB budget reports on tax expenditures, fiscal
    years 1976-2006.

    Note: Treasury did not report separate estimates for the individual and
    corporate income tax expenditures for fiscal years 1981 and 1982. Total
    revenue loss estimates for fiscal years 1981 and 1982 were approximately
    $410 and $448 billion (in 2004 dollars). The location of tax expenditure
    estimates under the individual and corporate tax expenditure headings does
    not imply that these categories of filers benefit from the special tax
    provisions in proportion to the respective tax expenditure amounts shown.
    For instance, the ultimate beneficiaries of corporate tax expenditures
    could be shareholders, employees, customers, or other providers of
    capital, depending on economic forces. In addition, summing the revenue
    loss estimates does not take into account possible interaction effects
    among the tax expenditures that we mentioned earlier in the report.
    Changes in economic conditions and estimation techniques, can affect
    revenue loss estimates for tax expenditures, making them differ from year
    to year. Changes to the number of tax expenditures reported by Treasury
    would also affect the amount of revenue loss reported if some tax
    expenditures were eliminated or added. Finally, revenue loss estimates
    include the effect of certain tax credits on receipts only and not the
    effect of the credits on outlays.

    The sum of revenue loss estimates due to individual income tax
    expenditures is primarily attributable to a small number of large tax
    expenditures. The fourteen tax expenditures listed in table 2-each with an
    annual revenue loss estimated at $20 billion or more-accounted for

    about 75 percent of the sum of revenue losses for fiscal year 2004. Ten of
    the 14 largest tax expenditures focused entirely on individual taxpayers,
    and the other 4 were available for individuals and corporations. Most of
    the largest tax expenditures are long-standing ones, and only 2 of the 14
    were added to the tax code since 1986.39 The child tax credit, enacted in
    1997, is among the largest tax expenditures based on its estimated revenue
    losses alone, not counting associated outlays of $8.9 billion in fiscal
    year 2004. With revenue losses estimated at $4.9 billion, the EITC does
    not appear on this list; if $33.1 billion in associated outlays were
    included, this refundable credit ranks among the largest tax expenditures.

    39The exclusion of net imputed rental income on owner-occupied homes is a
    long-standing feature of the income tax system. It was first listed as a
    tax expenditure by Treasury in the 2006 budget; JCT does not list this tax
    expenditure.

    Table 2: Revenue Loss Estimates for the Largest Tax Expenditures Reported
    for Fiscal Year 2004, with Taxpayer Group and Budget Function

                                          Revenue loss
                             Revenue loss estimate as
                                          a
                                 estimate   percentage
          Tax expenditure    (Billions $)       of sum Taxpayer        Budget
                                                       group          function
    Income tax exclusion        $102.3        14.0% Individual      Health
            of employer
         contributions to
         medical insurance
             premiums
         and medical carea
         Deductibility of
    mortgage interest on          61.5         8.4% Individual    Commerce and
               owner                                                      housing
          occupied homesa                                              credit
         Net exclusion of
    pension contributions         47.7         6.6% Individual      Income
                and                                                   security
         earnings: 401(k)
         Net exclusion of
    pension contributions         47.0         6.5% Individual      Income
                and                                                   security
        earnings: employer
              plansa
         Deductibility of
    nonbusiness state and         45.3         6.2% Individual  General
               local                                               purpose fiscal
    taxes (other than on
          owner-occupied                                             assistance
              homes)a
            Accelerated
          depreciation of            44.7         6.1%  Corporate    Commerce and
           machinery and                                   and            housing
             equipment                                 Individual      credit
           Capital gains
         exclusion on home           29.7         4.1% Individual    Commerce and
               sales                                                      housing
                                                                       credit
         Deductibility of
            charitable               27.4         3.8%  Corporate    Education,
        contributions other                                and       training,
        than education and                             Individual   employment,
              healtha                                                  social
                                                                      services
    Exclusion of interest
         on public purpose           26.2         3.6%  Corporate  General
               state                                       and     purpose fiscal
         and local bondsa                              Individual    assistance
    Capital gains (other
         than agriculture,           25.2         3.5% Individual    Commerce and
              timber,                                                     housing
    iron ore, and coal)a                                            credit
         Exclusion of net
    imputed rental income         24.6         3.4% Individual    Commerce and
                on                                                        housing
    owner-occupied homes                                            credit
         Step-up basis of
         capital gains at            24.2         3.3% Individual    Commerce and
               death                                                      housing
                                                                       credit
    Child credit (effect          22.4         3.1% Individual    Education,
         on receipts only)                                           training,
                                                                      employment,
                                                                       and social
                                                                      services
    Exclusion of interest
         on life insurance           20.1        2.98%  Corporate    Commerce and
             savingsa                                      and            housing
                                                       Individual      credit

    Source: GAO analysis of OMB budget report on tax expenditures, fiscal year
    2006.

    aDenotes tax expenditures that have been reported by Treasury since 1974.

    Note: Some tax expenditures split into additional listings to reflect
    legislation expanding existing tax expenditures. For example, Treasury
    began listing the net exclusion of pension contributions and earnings with
    separate estimates for employer-defined benefits and 401(k) pension plans
    following 2001 legislation increasing the contribution limits for 401(k)
    accounts. From year to year, revenue loss estimates may change because
    Treasury updates their estimates for each new budget to reflect
    legislation enacted, prevailing economic conditions, and the latest
    taxpayer data available. Although there are substantial revenues forgone
    for these 14 large tax expenditures, the estimated amount of

    federal spending that would be required to provide equivalent assistance
    is frequently larger than the revenue forgone because this spending could
    be subject to income tax. For example, the outlayequivalent estimate for
    the income tax exclusion of employer contributions for medical insurance
    premiums and medical care is $126.7 billion for fiscal year 2004.
    Outlay-equivalent estimates for tax expenditures are discussed in more
    detail in app. III.

    Tax expenditure revenue loss estimates reflect federal income tax revenue
    forgone and do not account for provisions that exclude certain earnings
    from payroll taxes. For example, the income tax exclusion for health care
    not only permits the value of health insurance premiums to be excluded
    from the calculation of employees' taxable earnings for income taxes but
    also excludes the value of the premiums from the calculation of Social
    Security and Medicare payroll taxes for both employees and employers.40
    Some researchers have estimated that these payroll tax revenue losses
    amount to more than half of the income tax revenue losses. 41 If payroll
    tax revenue losses were 50 percent of the $102.3 billion in income tax
    revenue loss estimated by Treasury, the combined revenue loss associated
    with the exclusion of employer contributions for health insurance premiums
    would be $153.5 billion in 2004.

        While Tax Expenditures Have Exceeded Discretionary Spending in Some Years,
        They Have Remained Relatively Stable as a Share of the U.S. Economy

    The sum of tax expenditure outlay-equivalent estimates exceeded the amount
    of discretionary spending for most years during the last decade, as shown
    in figure 8.42 Outlay-equivalent estimates, introduced by Treasury in
    1981, allow the value of a tax expenditure to be compared with a direct
    federal outlay. The sum of the outlay-equivalent estimates reported by
    Treasury was approximately $853 billion in 2004.43 Until 1987, the sum of
    outlay-equivalent estimates for tax expenditures was roughly the same
    magnitude as discretionary spending. From 1988 through 1995, the sum of
    tax expenditure outlay-equivalent estimates averaged about $104 billion
    (in

    40Employers may deduct their premium payments as a business expense in
    calculating their net taxable income; this deduction, like those for other
    labor costs, is not a tax benefit for employers.

    41John Sheils and Randall Haught, "The Cost of Tax-Exempt Health Benefits
    in 2004," Health Affairs (Feb. 25, 2004 ); and Leonard E. Burman and
    Jonathan Gruber, "Tax Credits for Health Insurance," Tax Policy Center
    Discussion Paper No. 19 (Washington, D.C.: The Tax Policy Center, June
    2005).

    42When measured in terms of sum of revenue loss estimates, tax
    expenditures also exceeded discretionary spending in some years.

    43The sum of tax expenditure outlay-equivalent estimates plus outlays
    associated with refundable credits amounted to $896 billion in fiscal year
    2004.

    2004 dollars) less than annual discretionary spending. Beginning in 1996,
    the sum of tax expenditure outlay-equivalent estimates surpassed
    discretionary spending and averaged about $114 billion (in 2004 dollars)
    more than annual discretionary spending through 2003. However, in 2003,
    the sum of Treasury's tax expenditure estimates declined markedly, and the
    sum of tax expenditure outlays fell below discretionary spending in fiscal
    year 2004. This decline may be due, at least in part, to changes in the
    way Treasury defined and measured several tax expenditures in these years.
    Just as the sum of tax expenditure outlay-equivalent estimates increased
    since the late 1990s, discretionary spending also increased over this
    period. Between 1996 and 2002, the sum of tax expenditure estimates
    increased by an average of approximately $46 billion annually, while
    discretionary spending increased by an average of $21 billion annually (in
    2004 dollars). Mandatory spending-larger than the sum of tax expenditure
    estimates or discretionary spending-consistently rose over the period
    shown by an average of $43 billion annually (in 2004 dollars).

    Figure 8: Sum of Tax Expenditure Outlay-equivalent Estimates Compared with
    Total Mandatory and Total Discretionary Outlays,

    1981-2004

    Dollars in billions (in constant 2004 dollars)

    1,500 1,400

    1,300

    1,200

    1,100

    1,000

    900

    800

    700

    600

    500 400 300 200 100

    0 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994
    1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

    Fiscal year

                                   Mandatory spending

                                 Discretionary spending

                      Tax expenditure outlay equivalent estimates

      Source: GAO analysis of OMB budget reports on tax expenditures, fiscal years
                                       1983-2006

    Note: Mandatory spending includes net interest. Summing the
    outlay-equivalent estimates does not take into account possible
    interaction effects among the tax expenditures. In addition, tax
    expenditure estimates developed in different years generally use different
    economic, demographic, and other assumptions. Finally, changes to the
    number of tax expenditures reported by Treasury would also affect the
    amount of outlay-equivalent estimates reported if some tax expenditures
    were eliminated or added.

    Figure 9 compares tax expenditures and federal outlays as a share of GDP
    as a way to measure the amount of federal spending through the tax code
    and other programs relative to the economy.44 As a share of the U.S.
    economy, the sum of tax expenditure outlay-equivalent estimates peaked at
    10.9 percent of GDP in 1986. Since 1988, the sum of tax expenditure
    outlays has remained relatively stable at about 7.5 percent of GDP. Over
    the period shown, mandatory spending also was fairly constant as a share
    of the economy, at an average of 12.7 percent of GDP. As a share of the
    economy, discretionary spending declined from 10.1 percent of GDP in 1981
    to 6.3 percent in 1999 and 2000, with some fluctuation between the years.
    In recent years, discretionary spending has grown faster than the economy,
    increasing to 7.8 percent of GDP in fiscal year 2004. Averaging about 18.0
    percent of GDP in the 1980s through the early 1990s, federal receipts
    steadily rose to 20.9 percent of GDP in 2000 and since declined to 16.3
    percent of GDP in fiscal year 2004. With total federal outlays- including
    mandatory and discretionary spending plus net interest- reaching 19.9
    percent of GDP, the federal unified budget deficit amounted to 3.6 percent
    of GDP ($412 billion) in fiscal year 2004. The on-budget deficit in fiscal
    year 2004 amounted to 4.9 percent of GDP ($567 billion).45

    44Expressing tax expenditures as a share of the nation's economy provides
    the context for assessing trends in federal revenue and spending. GDP is a
    commonly used measure of domestic national income. GDP is the value of all
    goods and services produced within the United States in a given year and
    is conceptually equivalent to incomes earned in production. It is a rough
    indicator of the economic earnings base from which the government draws
    its revenues.

    45Whereas the unified budget is a consolidated measure of federal
    activity, the on-budget deficit excludes Social Security and the Postal
    Service which are off-budget under current law. In fiscal year 2004, the
    off-budget surplus included a $151 billion Social Security surplus and a
    $4 billion surplus for the Postal Service.

    Figure 9: Sum of Tax Expenditure Outlay-Equivalent Estimates Compared to
    Total Mandatory and Discretionary Outlays and Receipts as a Percentage of
    GDP, 1981-2004

    Percent of GDP

                                           25

                                           20

                                           15

                                           10

                                           5

                                           0

    1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995
    1996 1997 1998 1999 2000 2001 2002 2003 2004 Fiscal year

    Receipts

    Mandatory spending

    Discretionary spending

    Tax expenditure outlay equivalent estimates

    Source: GAO analysis of OMB budget reports on tax expenditures, fiscal
    years 1983-2006.

    Note: Mandatory spending includes net interest. Whereas the mandatory and
    discretionary numbers represent actual money that was spent by the federal
    government, tax expenditure figures are estimates. In addition, summing
    the outlay-equivalent estimates does not take into account possible
    interaction effects among the tax expenditures that we mentioned earlier
    in the report. Tax expenditure estimates developed in different years
    generally use different economic, demographic, and other assumptions.
    Changes to the number of tax expenditures reported by Treasury would also
    affect the amount of outlay-equivalent estimates reported if some tax
    expenditures were eliminated or added.

    Tax expenditures span almost all federal mission areas, but their relative
    size differs across budget functions. To gauge the relative role of tax
    expenditures, the sum of tax expenditure outlay-equivalent estimates and
    federal outlays can be compared to total spending by budget function. For
    2004, Treasury reported tax expenditures for 16 of 20 budget functions.
    Five of the functions accounted for 91 percent of the sum of the tax
    expenditure outlay-equivalent estimated dollar amounts in 2004- commerce
    and housing credit; education, training, employment and social services;
    income security; health; and general government, as shown in figure 10.
    (See app. III for a list of tax expenditures reported for 2004 by budget
    function.) For the most part, these same five budget functions accounted
    for the largest percentage of total outlay-equivalent estimates

    over time, although the relative size of the estimated outlay-equivalent
    dollar amounts for the five budget functions varied somewhat over the
    period shown. For example, the health and the education, training,
    employment and social services budget functions more than doubled between
    1986 and 2002 (in 2004 dollars).

    Figure 10: Size of Tax Expenditure Outlay-Equivalent Estimates by Budget
    Function, 1981-2004 Dollars in billions (in constant 2004 dollars)

    1000 900 800 700 600 500 400 300 200 100 0 1981 1982 1983 1984 1985 1986
    1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
    2002 2003 2004

    Other

    Education, training, employment, and social services

    General government

    Health

    Income security

    Commerce and housing

    Source: GAO Analysis of OMB Budget Reports on Tax Expenditures, Fiscal
    Years 1983-2006.

    Note: The other budget functions that Treasury lists tax expenditures
    under are national defense; international affairs; general science, space,
    and technology; energy; natural resources and environment; agriculture;
    transportation; community and regional development; social security;
    veterans' benefits and services; and net interest. The general government
    budget function includes tax expenditures listed by Treasury under the
    general purpose fiscal assistance budget subfunction. For two budget
    functions-commerce and housing credit; and education, training,
    employment, and social services-tax expenditures are listed by
    subfunction. In addition, summing the outlayequivalent estimates by budget
    function does not take into account possible interaction effects among the
    expenditures. Tax expenditure estimates developed in different years
    generally use different economic, demographic, and other assumptions.
    Changes to the number of tax expenditures reported by Treasury would also
    affect the amount of outlay-equivalent estimates reported if some tax
    expenditures were eliminated or added.

    The sum of the tax expenditure outlay-equivalent estimates was greater
    than what the federal government spends in discretionary and mandatory
    spending for some budget functions. As shown in figure 11, the sum of the
    tax expenditure outlay-equivalent estimates exceeded federal outlays for
    three budget functions: energy, 46 commerce and housing credit, and
    general government. Outlay-equivalent estimates for tax expenditures in
    the commerce and housing credit budget function totaled $300 billion for
    2004, while budget outlays for that function totaled $5 billion.47 Seven
    of the 14 largest tax expenditures, listed in table 2 with revenue losses
    exceeding $20 billion in 2004, were reported under the commerce and
    housing credit budget function. The mortgage interest deduction-the second
    largest single tax expenditure in fiscal year 2004-had an outlayequivalent
    estimate of $61.5 billion, compared to $45 billion in outlays for the
    Department of Housing and Urban Development, which is responsible for,
    among other things, mortgage credit and housing assistance programs.48
    Various tax expenditures for accelerated depreciation and capital gains
    listed under the commerce and housing credit budget function also provide
    incentives for a wide range of different investments that can affect other
    federal mission areas. The general government budget function included two
    of the largest tax expenditures-the deduction of state and local income
    and sales tax, and the exclusion of interest on public purpose state and
    local bonds-which together accounted for about $71.5 billion in tax
    expenditures outlays.49

    46Total outlays for the energy budget function were negative in fiscal
    year 2004; energy discretionary outlays were $3.4 billion and energy
    mandatory outlays were negative $3.6 billion. For more information on the
    major federal energy-related tax and spending programs, see GAO, National
    Energy Policy: Inventory of Major Federal Energy Programs and Status of
    Policy Recommendations, GAO-05-379 (Washington, D.C.: June 10, 2005).

    47Within the commerce and housing credit budget function, outlays in
    fiscal year 2004 by subfunction were: $ 2.7 billion for mortgage credit,
    negative $4.1 billion for the Postal Service, negative $2 billion for
    deposit insurance, and $8.7 billion for other advancement of commerce.

    48Housing assistance is a subfunction under the income security budget
    function.

    49The deduction for property taxes on owner-occupied homes is listed under
    the commerce and housing credit budget function. Estimated at $19.9
    billion in outlay-equivalent value, this deduction was one of the 15
    largest tax expenditures in fiscal year 2004. Including this deduction,
    the sum of the outlay-equivalent estimates for tax expenditures related to
    state and local governments amounted to $102.7 billion in fiscal year
    2004. The outlay-equivalent value of the exclusion for state-and local
    private purpose bonds totaled $9.4 billion in fiscal year 2004. These
    amounts are reflected across the related budget functions.

    Figure 11: Tax Expenditure Outlay-equivalent Estimates Compared with
    Federal Outlays by Budget Function, Fiscal Year 2004 Dollars in billions
    National defense

    International affairs

    General science, space and technology

    Energy

    Natural resources and environment

    Agriculture

    Commerce and housing credit

    Transportation

    Community and regional development

                             Education, training, employment, and social services

    Health

    Medicare

    Income security

    Social security

    Veterans benefits and services

    Administration of justice

    General government

    Net interest

    0 50 100 150 200 250 300 350 400 450 500

    Budget function

    Tax expenditure outlay equivalent estimates Federal outlays

      Source: GAO analysis of OMB budget reports on tax expenditures, fiscal year
                                         2006.

    Note: Federal outlays for the energy budget function were negative because
    revenues for this function exceeded spending in 2004. Summing the
    outlay-equivalent estimates by budget function does not

    take into account possible interaction effects among the expenditures.
    Outlays associated with the refundable child credit and EITC are shown in
    the outlay bars.

    As figure 11 shows, the sum of outlay-equivalent estimates for tax
    expenditures was nearly the same magnitude as outlays in two budget
    functions: international affairs and education, training, employment, and
    social services. Within the education, training, employment, and social
    services budget function, the sum of outlay-equivalent estimates of the
    tax expenditures represented 49 percent of the total federal support.50
    This budget function includes two of the largest tax expenditures-the
    child tax credit and charitable contributions other than for health. The
    sum of the outlay-equivalent estimates for tax expenditures was
    substantially less than total outlays in the health and income security
    budget functions.51 The income tax exclusion for employer-provided health
    care-the largest single tax expenditure-accounted for 12 percent of the
    sum of tax expenditure outlay-equivalent estimates and represented about
    27 percent of total federal support in the health function, which includes
    Medicaid. Outlays in the income security function include mandatory
    outlays refunded under the EITC and child tax credit. No tax expenditures
    are reported by Treasury for two budget functions: administration of
    justice and Medicare.52

    50Total federal support includes federal outlays and tax expenditure
    outlay-equivalent amounts within the same budget function.

    51Treasury and JCT list the EITC tax expenditure under the income security
    budget function and the child tax credit under the education, training,
    employment and social services budget function.

    52JCT does not list any tax expenditures under the administration of
    justice budget function but does list exclusions for Medicare benefits as
    a tax expenditure under the Medicare budget function.

      Systematic Review of Tax Expenditures Is Integral to Reexamining the Federal
      Base, but Little Progress Has Been Made Since 1994 to Increase Scrutiny

    Although tax expenditures represent a substantial federal commitment of
    resources, little progress has been made in the Executive Branch to
    increase the transparency of and accountability for tax expenditures. The
    entire set of tools the federal government can use to address national
    objectives-including discretionary and mandatory spending, tax provisions,
    loans and loan guarantees-should be subject to periodic reviews and
    reexamination to ensure that they are achieving their intended purposes
    and designed in the most efficient and effective manner. The nation's
    current and projected fiscal imbalance provides an additional impetus for
    engaging in such a review and reassessment. Tax expenditures may not
    always be efficient, effective, or equitable, and consequently,
    information on these attributes can help policymakers make more informed
    decisions as they adapt current policies in light of our fiscal challenges
    and other overarching trends. In addition, some tax expenditures, at least
    as currently designed, may serve to exacerbate other key private sector
    and public policy challenges (e.g., controlling health care costs). To
    review tax expenditures, information is needed to assess economic
    efficiency, effectiveness, distributional equity, and administration and
    compliance costs, although data and methodological challenges may impede
    studies of some tax expenditures. Over the past decade, the Executive
    Branch made little progress to integrate tax expenditures in the budget
    presentation and review processes that apply to spending programs, as we
    recommended in 1994.

        Long-Term Fiscal Challenge Provides Additional Impetus to Reexamine Federal
        Spending and Tax Policies, Including Tax Expenditures

    Simply put, our nation's fiscal policy is on an unsustainable course.
    Longterm simulations by GAO, the Congressional Budget Office (CBO), and
    others show that over the long term we face large, escalating, and
    persistent deficits due primarily to known demographic trends and rising
    health care costs.53 This unsustainable fiscal path will gradually erode
    the nation's economy and increasingly constrain the federal government's
    capacity to address emerging challenges and opportunities. The long-term
    fiscal challenge is too big to be solved by economic growth alone or by
    making modest changes to existing spending and tax policies, including tax

    53For additional information on our long-term fiscal modeling, see GAO,
    Our Nation's Fiscal Outlook: The Federal Government's Long-Term Budget
    Imbalance, http://www.gao.gov/special.pubs/longterm/. See also U.S.
    Congressional Budget Office, The Long-Term Budget Outlook (Washington,
    D.C.: December 2003), and the Office of Management and Budget, Analytical
    Perspectives, Budget of the United States Government, Fiscal Year 2006
    (Washington, D.C.: 2005).

    expenditures. In addition, the long-term fiscal challenge makes it all the
    more important to ensure all major federal spending and tax programs and
    policies-including tax expenditures-are efficient, effective, and
    relevant. The revenues forgone through tax expenditures either reduce
    resources available to fund other federal activities or require higher tax
    rates to raise a given amount of revenue.

    Our long-term simulations illustrate the magnitude of fiscal challenges we
    will face in the future.54 Figures 12 and 13 present these simulations
    under two different sets of assumptions. In figure 12, we begin with CBO's
    August 2005 baseline-constructed according to the statutory requirements
    for that baseline.55 Consistent with these requirements, this simulation
    assumes that discretionary spending grows with inflation for the first 10
    years, and that tax cuts which are currently scheduled to expire will
    expire. After 2015, discretionary spending is assumed to grow with the
    economy, and revenue is held constant as a share of GDP at the 2015 level.
    In figure 13, only two assumptions are changed: (1) discretionary spending
    is assumed to grow with the economy rather than merely with inflation for
    the entire period (not just after 2015), and (2) all tax cuts which are
    currently scheduled to expire are made permanent. For both simulations,
    Social Security and Medicare spending is based on the 2005 Trustees'
    intermediate projections, and we assume that benefits continue to be paid
    in full after the trust funds are exhausted. Medicaid spending is based on
    CBO's December 2003 long-term projections under mid-range assumptions.

    54Long-term simulations illustrate the relative fiscal and economic
    outcomes associated with alternative policy paths and should not be viewed
    as precise forecasts.

    55 Congressional Budget Office, The Budget and Economic Outlook: An Update
    (Washington, D.C.: August 2005).

    Figure 12: Composition of Spending as a Share of GDP under Baseline
    Extended Percent of GDP 50

    40

    30

    20

    10

    0 2004 2015 2030 2040 Fiscal year

    All other spending
    Medicare & Medicaid
    Social Security
    Net interest
    Source: GAO's August 2005 analysis.

    Notes: In addition to the expiration of tax cuts, revenue as a share of
    GDP increases through 2015 due to (1) real bracket creep, (2) more
    taxpayers becoming subject to the AMT, and (3) increased revenue from
    tax-deferred retirement accounts. After 2015, revenue as a share of GDP is
    held constant.

    Figure 13: Composition of Spending as a Share of GDP Assuming
    Discretionary Spending Grows with GDP after 2005 and All Expiring Tax
    Provisions Are Extended

    Percent of GDP 50

    40

    30

    20

    10

    0 2004 2015 2030 2040 Fiscal year

    All other spending Medicare & Medicaid Social Security

    Net interest

    Source: GAO's August 2005 analysis.

    Notes: Although expiring tax provisions are extended, revenue as a share
    of GDP increases through 2015 due to (1) real bracket creep, (2) more
    taxpayers becoming subject to the AMT, and (3) increased revenue from
    tax-deferred retirement accounts. After 2015, revenue as a share of GDP is
    held constant.

    Both of these simulations illustrate that, absent policy changes on the
    spending or revenue side of the budget, the growth in federal retirement
    and health entitlements will encumber an escalating share of the
    government's resources. Indeed, when we assume that recent tax reductions
    are made permanent and discretionary spending keeps pace with the economy,
    our long-term simulations suggest that by 2040 federal revenue may be
    adequate to pay little more than interest on the federal debt. Neither
    slowing the growth in discretionary spending nor allowing the tax
    provisions to expire-nor both combined-would eliminate the imbalance.
    Although revenues will be part of the debate about our fiscal future,
    making no changes to Social Security, Medicare, Medicaid, and

    other drivers of the long-term fiscal gap would require at least a
    doubling of federal taxes in the future and that seems both unrealistic
    and inappropriate. Accordingly, substantive reform of Social Security and
    the major health programs remains critical to recapturing our fiscal
    flexibility.

    While Social Security and Medicare dominate the long-term outlook, they
    are not the only federal programs or activities that bind the future. The
    federal government undertakes a wide range of programs, responsibilities,
    and activities that may explicitly or implicitly expose it to future
    spending. These "fiscal exposures" range from explicit liabilities, such
    as environmental cleanup and disposal, to the implicit promises embedded
    in current policy or public expectations, such as assistance following a
    major disaster.56 Policymakers may benefit from a better understanding of
    the long-term costs of decisions when they are made. For large and
    significant spending programs and tax provisions, consideration of
    estimates of present values for the long-term commitments implied could
    facilitate analysis and decisionmaking.57 While the fiscal exposure
    concept focuses only on items that may expose the government to future
    spending, some new or existing tax expenditures may have uncertain or
    accelerating future growth paths with long-term implications. These would
    need to be considered concurrently with long-term spending exposures in
    addressing long-term fiscal sustainability.

    Confronting the nation's fiscal challenge will require a fundamental
    reexamination and reprioritization of the entire set of tools the federal
    government can use to address national objectives, including major
    spending and tax policies and programs. To effectively respond to social,
    economic, and security changes and challenges emerging in the 21st
    century, the federal government cannot accept what it does, how it does
    it, who does it, and how it is financed as "givens." To assist Congress in
    reexamining the base of government, we issued a report that provides
    examples of the kinds of difficult choices the nation faces with regard to
    discretionary spending; mandatory spending, including entitlements; as

    56GAO, Fiscal Exposures: Improving the Budgetary Focus on Long-Term Costs
    and Uncertainties, GAO-03-213 (Washington, D.C.: Jan. 24, 2003).

    57See app. III for information about Treasury's supplemental discounted
    present value estimates for select tax expenditures that involve deferrals
    or other long-term revenue effects.

    well as tax policies and compliance activities.58 The tax policies and
    programs financing the federal budget can be reviewed with an eye toward
    the overall level of revenue needed to fund federal operations and
    commitments, the mix of taxes that should be used, and the extent to which
    the tax code is being used to promote certain societal objectives.59

        Some Tax Expenditures May Not Be Efficient, Effective, or Equitable

    Some tax expenditures may not always be efficient, effective, or
    equitable, and consequently, information on these attributes can help
    policymakers make more informed decisions as they adapt current policies
    in light of our fiscal challenges and other overarching trends. Periodic
    reviews of tax expenditures could help to establish whether these programs
    are relevant to today's needs; if so, how well tax expenditures have
    worked to achieve their objectives; and whether the benefits from
    particular tax expenditures are greater than their costs. To measure
    benefits and costs, information is needed concerning their effects on
    economic efficiency, effectiveness, distributional equity, and
    administration and compliance costs. To the extent that periodic reviews
    show that specific tax expenditures are not effective, efficient, or
    equitable, those tax expenditures might be eliminated or redesigned,
    perhaps at a lower cost in revenue forgone. Coordinated reviews of tax
    expenditures with related federal spending programs could assess the
    relationships and interactions of programs within similar mission areas
    and identify which strategies are effective. Policymakers could use such
    evaluations to reduce overlap and inconsistencies and direct scarce
    resources to the most effective or least costly methods to deliver federal
    support.

    Tax expenditures, if well designed and effectively implemented, can be an
    effective tool and appropriate to further some federal goals and
    objectives. For those activities that merit a subsidy (where too little of
    the activity would otherwise be undertaken), subsidies through the tax
    code are one option. For example, a tax expenditure for medical insurance
    would improve economic efficiency if, absent a subsidy, too few workers
    would purchase insurance and the tax expenditure encouraged workers to
    insure

    58GAO-05-325SP.

    59For background information, criteria, and key questions for assessing
    the pros and cons of tax reform proposals, both proposals for a major
    overhaul of the current federal tax system and incremental changes to the
    system, see GAO, Understanding the Tax Reform Debate: Background,
    Criteria, and Questions, GAO-05-1009SP (Washington, D.C.: September 2005).

    in a cost-effective manner. Because the benefits from research may not
    fully accrue to the firms that bear the costs of research, a tax
    expenditure aimed at spurring private-sector investment in research and
    development may be an appropriate response assuming it stimulates
    additional research whose benefits exceed the social costs associated with
    the forgone revenues.

    However, studies we and others have done raise concerns about the
    efficiency, effectiveness, or equity of some tax expenditures and about
    how tax expenditures relate to other federal activities aimed at the same
    mission area.

    o 	While tax expenditures may be intended to improve economic efficiency,
    poor targeting or design may introduce additional economic inefficiencies.
    For example, the income tax exclusion of employer-paid health insurance
    premiums, by shifting a portion of the costs to all taxpayers, reduces the
    after-tax cost of insurance for the beneficiary.60 The income tax
    exclusion is credited with increasing health care coverage for employees,
    and the risk pooling under group health insurance generally allows
    employees to obtain insurance at lower costs than in the individual
    insurance market. However, this tax benefit also leads people to obtain
    more coverage than they would otherwise and increases the demand for
    health care by enabling those insured to obtain services at discounted
    prices. Some researchers believe that the unlimited availability of the
    exclusion for employer-provided health insurance has led to excessive use
    of health care services, which, in turn, has helped to drive up health
    care prices faster than the overall price level.61 Capping the exclusion
    at the average premium cost has been suggested as one option to improve
    the economic efficiency of this tax expenditure and reduce the associated
    revenue loss; another option suggested is replacing the tax exclusion with
    a tax credit to improve equity since the tax savings per dollar of premium
    would be the same for all taxpayers. In another example, the mortgage
    interest deduction encourages home ownership by lowering the costs of
    borrowing for taxpayers who itemize their deductions. However, by doing
    so, the deduction encourages households to invest more in housing and less
    in

    60This tax-free benefit is not reported on the employee's W-2 form as the
    amount is not considered wages subject to federal and state income taxes
    or federal payroll taxes.

    61Bob Lyke, Tax Benefits for Health Insurance and Expenses: Current
    Legislation. Congressional Research Service Issue Brief IB98037
    (Washington, D.C.: February 2005).

    other assets that might contribute more to the nation's productivity and
    economic capacity. According to CBO's Budget Options, limiting the
    deductibility of interest to $500,000 of mortgage debt might still provide
    taxpayers with a sizable incentive to become homeowners and could boost
    investment in businesses and education.62

    o 	Tax expenditures may not be an effective way to achieve federal goals
    if targeting them to entities or activities meant to receive the benefits
    is difficult, if they subsidize activities that would have been undertaken
    without their stimulus, or if they serve to exacerbate other key private
    sector and public policy challenges. For example, the income tax exclusion
    of employer-paid health insurance premiums reduces the after-tax cost of
    insurance for the beneficiary. However, the exclusion offers no benefit to
    workers whose employers do not offer health benefits or who purchase their
    own insurance. Further, this tax benefit also leads people to obtain more
    comprehensive coverage than they would otherwise and could increase the
    demand for health care to the extent that it shields those insured from
    the full costs of health care, complicating efforts to moderate health
    care spending. The exclusion also tends to favor higher-income workers
    more likely to have employersponsored coverage. In another example,
    individual retirement accounts (IRAs) also receive preferential tax
    treatment with $7.5 billion in estimated revenue losses in fiscal year
    2004. Contributions may be tax-deductible depending on the IRA type, and
    earnings generally are not taxable until distribution and not taxable at
    all in some cases.63 Although the tax benefits indeed seem to encourage
    individuals to contribute to these kinds of accounts, the amounts
    contributed may not be totally new saving. Some contributions may
    represent amounts that would have occurred without the tax incentives or
    amounts shifted from taxable assets or financed by borrowing. In a 1996
    symposium examining universal deductible IRAs available in the early
    1980s, researchers reached three widely divergent conclusions: (1) yes,
    most contributions represented new saving, (2) no, most IRAs contributions
    were not new saving; and (3) maybe, about 26 cents of each dollar

    62Congressional Budget Office, Budget Options (Washington, D.C.: February
    2005).

    63For more information on the types of IRAs as well as the rules and limit
    on contributions and distributions, see Department of the Treasury,
    Internal Revenue Service, Individual Retirement Accounts (IRAs),
    Publication 590.

    contributed may have represented new saving.64 More recent research
    examining the universal IRA experience estimated that at most 9 cents of
    each dollar contributed represented new saving.65 Since 1986, Congress has
    restricted IRA eligibility for higher-income taxpayers and increased the
    contribution limits, and the overall effect of IRAs on personal saving
    remains subject to considerable debate.

    o 	Although tax expenditures, by design, result in individuals with
    similar incomes and expenses paying differing amounts of tax depending on
    whether they engage in tax-subsidized activities, tax expenditures still
    may raise equity concerns. Some tax expenditures benefit mainly
    upperincome taxpayers because they are most likely to itemize and because
    the value of tax expenditures is generally greatest for those in higher
    tax brackets.

    Tax expenditures also can contribute to mission fragmentation and program
    overlap,66 and this, in turn, creates the potential for duplication and
    service gaps. Though sometimes necessary to meet federal priorities,
    mission fragmentation and program overlap can create an environment in
    which programs do not serve participants as efficiently and effectively as
    possible. Like spending programs, tax expenditures may reduce government
    effectiveness to the extent that they duplicate or interfere with other
    federal programs. For example, in the higher education mission area, the
    federal government helps students and families save and pay for the costs
    of postsecondary education through tax expenditures and longerstanding
    federal financial aid programs, consisting of grants, loans, and
    work-study income. Since the 1990s, the federal government has offered
    multiple tax incentives to help families pay for post-secondary education,
    including the nonrefundable Lifetime Learning and HOPE tax credits,
    deductions for qualifying post-secondary expenses and interest on student
    loans, and two tax-preferred ways to save for future education expenses.
    The tax-preferred saving vehicles interact with the traditional federal
    aid

    64GAO, National Saving: Answers to Key Questions, GAO-01-591SP
    (Washington, D.C.: June 2001).

    65Orazio P. Attanasio and Thomas DeLeire, "The Effect of Individual
    Retirement Accounts on Household Consumption and National Saving," The
    Economic Journal, Vol. 112, July 2002, pp. 504-538.

    66We define mission fragmentation as the involvement of multiple agencies
    in a similar programmatic area and program overlap as providing the same
    services to the same target groups.

    system and can affect the net federal assistance received. Further, some
    tax filers do not appear to make the most effective use of certain
    educationrelated tax incentives, and we have found that some people who
    appear eligible for the tuition deduction and/or the tax credits did not
    claim them.67 One reason may be that the differing income phaseouts and
    interactions among the tax credits and deductions are difficult for
    taxpayers to understand; CBO, JCT, IRS's National Taxpayer Advocate,
    Treasury, and others have suggested ways to consolidate the education tax
    credits and deductions.

    Others have also questioned the efficiency, effectiveness, and equity of
    other tax expenditures and suggested ways to design and better target
    specific provisions.

    o 	In December 2004, the IRS National Taxpayer Advocate designated the
    complexity of the Internal Revenue Code, including the complexity of
    reporting requirements related to tax expenditures, as the most serious
    problem facing taxpayers and the IRS.68 The IRS National Taxpayer Advocate
    also recommended consolidating the various types of retirement saving
    vehicles and creating uniform rules regarding early withdrawals, plan
    loans, and portability.

    o 	In its January 2005 report to the Senate Finance Committee, JCT staff
    presented various options to improve tax compliance and reform tax
    expenditures.69 Options include repealing some tax expenditures and
    restructuring others to simplify the law or achieve the intended purpose
    in a more fair or efficient way.

    o 	In its February 2005 budget options compendium prepared for the House
    and Senate Budget Committees, CBO listed several options to

    67GAO, Student Aid and Postsecondary Tax Preferences: Limited Research
    Exists on Effectiveness of Tools to Assist Students and Families Through
    Title IV Student Aid and Tax Preferences, GAO-05-684 (Washington, D.C.:
    July 29, 2005).

    68IRS, Taxpayer Advocate Service, National Taxpayer Advocate 2004 Annual
    Report to Congress, (Washington, D.C.: December 2004).

    69Joint Committee on Taxation, Options to Improve Tax Compliance and
    Reform Tax Expenditures, JCS-2-05. Prepared by the staff of the Joint
    Committee on Taxation. (Washington, D.C.: Jan. 27, 2005).

    eliminate or restructure tax expenditures.70 Options include further
    limiting the tax benefit of itemized deductions to the 15 percent rate for
    higher-bracket taxpayers and capping itemized deductions for state and
    local taxes and charitable contributions to the amount exceeding 2 percent
    of adjusted gross income.

    o 	Finally, in December 2004 for the Senate Budget Committee, CRS updated
    its biennial compendium on tax expenditures. 71 This volume includes for
    each tax expenditure: JCT's revenue loss estimate, the legal
    authorization, a description of the tax provision, its impact including
    distribution of benefits when available, the rationale at the time of
    adoption, assessment summarizing the arguments for and against the
    provision, citations to relevant research. According to CRS, congressional
    budget decisions will take into account the full spectrum of federal
    programs only when tax expenditures are considered in conjunction with
    direct spending programs.

        Assessing the Efficiency, Effectiveness, or Equity of Tax Expenditures Can
        Be Challenging

    Inadequate or missing data and difficulties in quantifying the benefits of
    some tax expenditures can impede studies of their efficiency,
    effectiveness, and equity. 72 A key challenge is that data necessary to
    assess how often a tax expenditure is used and by whom generally would not
    be collected on tax returns unless IRS needs the information to know the
    correct amount of taxes owed or is legislatively mandated to collect or
    report the information. For example, tax exclusions-including those for
    employerprovided health insurance and pensions which are among the largest
    tax expenditures-generally are not reported on individual taxpayers'
    returns. In some cases, IRS may combine reporting requirements to minimize
    its workload and taxpayer burden, and as a result, the information
    collected may not identify specific beneficiaries or activities targeted
    by a tax expenditure. For example:

    70Congressional Budget Office, Budget Options. (Washington, D.C.: February
    2005).

    71U.S. Congress, Senate Committee on the Budget, Tax Expenditures:
    Compendium of Background Material on Individual Provisions, S. Prt.
    108-54. Prepared by the Congressional Research Service (Washington, D.C.:
    December 2004).

    72We have also noted limitations in the quality of agency performance and
    evaluation information and agency capacity to produce rigorous evaluations
    of effectiveness for federal spending programs. See GAO, Performance
    Budgeting: Current Developments and Future Prospects, GAO-03-595T
    (Washington, D.C.: Apr. 1, 2003).

    o 	In our 2002 report on three tax expenditures meant to encourage
    employment of the disabled among other economically disadvantaged workers,
    we could not determine the amounts used to hire, retain, and accommodate
    workers with disabilities.73 We found that information on the work
    opportunity and disabled access credits was not available from tax data
    because tax returns provided only the total amount of credits reported,
    and employers could claim the work opportunity credit for employing other
    types of workers and claim the disabled access credit for expenditures
    made to accommodate customers with disabilities. Also, information
    regarding use of the barrier removal deduction for providing
    transportation or architectural accommodations was not available in IRS
    databases.

    o 	As we reported in 2003, for one of the seven Liberty Zone tax benefits,
    the business employee credit, IRS was in the process of collecting but was
    not planning to report information about the number of taxpayers claiming
    the credit and the amount of credit claimed.74 IRS was also not planning
    to collect or report information about the use of the other six benefits,
    and taxpayers do not report these benefits as separate items on the
    existing returns. For example, taxpayers added the amount of depreciation
    they are allowed under the Liberty Zone special depreciation allowance
    benefit to other depreciation expenses and report their total depreciation
    expenses on their returns. IRS officials said that they do not need
    information on each specific benefit claimed to properly target their
    enforcement efforts.

    Further, IRS's financial management system does not currently have cost
    accounting capabilities. As a result, comparisons of the costs of
    administering existing or proposed tax expenditures with similar
    administrative costs for spending programs may be impossible. Regarding
    taxpayer compliance costs, although IRS is working to develop improved
    estimates of taxpayer compliance burden, it is not yet clear whether this
    modeling effort will provide estimates of additional compliance costs that
    may result from particular tax expenditures.

    73GAO, Business Tax Incentives: Incentives to Employ Workers with
    Disabilities Receive Limited Use and Have an Uncertain Impact, GAO-03-39
    (Washington, D.C.: Dec. 11, 2002).

    74GAO, Tax Administration: Information Is Not Available to Determine
    Whether $5 Billion in Liberty Zone Tax Benefits Will Be Realized,
    GAO-03-1102 (Washington, D.C.: Sept. 30, 2003).

    According to IRS officials, IRS seeks to collect information necessary to
    determine whether taxpayers have accurately reported their income and
    calculated the correct amount of tax liability. By focusing on information
    essential to administering the tax code, IRS aims to ensure that taxpayers
    are not burdened unnecessarily by record keeping and reporting, and IRS
    can minimize its own administrative costs for data collection and
    processing. For tax expenditures recorded on particular lines on tax
    forms, such as deductions and credits for individual taxpayers, data on
    the use of these tax expenditures are available. IRS Statistics of Income
    Division publications detail the number of individual tax returns on which
    taxpayers claimed each deduction or credit, the total amounts claimed, and
    the distribution of claims among taxpayers by income level.

    If policymakers conclude that additional data would facilitate reexamining
    a particular tax expenditure, decisions would be required on what data are
    needed, who should provide the data, who should collect the data, how to
    collect the data, what it would cost to collect the data, and whether the
    benefits of collecting additional data warrant the cost of doing so.
    Another factor to consider is how to facilitate data sharing and
    collaborative evaluation efforts. For example:

    o 	Limited data are available on the prevalence and use of business-owned
    life insurance, and GAO has reported that more comprehensive data could be
    useful in assessing the tax-favored treatment of this investment.75 Data
    on the amount of tax-free income that businesses received from death
    benefits could help explain the potential effect of changes to the tax
    treatment of policies on tax revenues. Businesses holding the policies or
    insurance companies that sold them could provide this and other data.
    Several agencies, including Treasury and the Securities and Exchange
    Commission, already collect some financial information from businesses and
    insurers and could be tasked to collect additional data for tax policy
    purposes.

    o 	In the higher education area, the Department of Education (Education)
    is unable to analyze the use of higher education tax credits or their
    effects because it lacks access to individual taxpayer data needed to
    identify users of the credits. Treasury has access to taxpayer data but
    has not used these data for evaluating the education tax credits since

    75GAO, Business-Owned Life Insurance: More Data Could Be Useful in Making
    Tax Policy Decisions, GAO-04-303, (Washington, D.C.: May 13, 2004).

    their implementation in 1998. In 2002, GAO recommended that Education and
    Treasury collaborate in studying the impact of tax credits and student aid
    programs on postsecondary attendance, choice, completion, and costs.76 A
    key first step would be identifying opportunities for, and limits to, data
    sharing and develop a plan to address data needs, but little action has
    been taken.

    o 	In the case of the empowerment zone, enterprise community, and renewal
    community programs, the lack of tax benefit data limits the ability of the
    Department of Housing and Urban Development (HUD) and the Department of
    Agriculture (USDA) to administer and evaluate the overall programs.77 We
    recommended that HUD, USDA, and IRS collaborate to (1) identify the data
    needed to assess the use of the tax benefits and the various means of
    collecting such data; (2) determine the cost-effectiveness of collecting
    these data, including the potential impact on taxpayers and other program
    participants; (3) document the findings of their analysis; and, if
    necessary, (4) seek the authority to collect the data, if a cost-effective
    means is available.

    When data on the cost and use of tax expenditures are available or can be
    reasonably estimated and other relevant data are available, economic
    analysis can be useful in evaluating whether a tax expenditure is
    efficient, effective, or equitable. Econometric modeling analysis can
    estimate how a tax expenditure affects the prices and quantities of
    targeted goods and services and determine how taxpayers' incomes are
    affected. Although isolating and quantifying the outcomes associated with
    tax expenditures is challenging-just as it is for spending programs,
    research results are useful in demonstrating how particular tax
    expenditures work or providing insight on ways to refine their design. For
    example, research has generally shown that the EITC effectively increases
    recipients' participation in the labor force, particularly for single
    parents, and lifts millions of recipients out of poverty. Some tax
    expenditures are enacted on a temporary basis, specifically to provide an
    opportunity for evaluating their effects before they are extended. For
    example, the research tax credit, enacted on a

    76 GAO, Student Aid and Tax Benefits: Better Research and Guidance Will
    Facilitate Comparison of Effectiveness and Student Use, GAO-02-751
    (Washington, D.C.: Sept. 13, 2002).

    77GAO, Community Development: Federal Revitalization Programs are Being
    Implemented, but Data on the Use of Tax Benefits Are Limited, GAO-04-306
    (Washington, D.C.: Mar. 5, 2004).

    temporary basis in 1981 and extended 11 times as of 2004, was
    substantially modified in 1989 after researchers showed the original
    credit formula undercut the incentive it was intended to provide to
    undertake additional research spending.

    In some cases, economic research has not yielded definitive results or was
    limited by data and methodological issues. For example, although the
    various tax expenditures aimed at encouraging saving for, among other
    things, retirement, education, and health care have resulted in
    substantial sums being placed in these tax preferred accounts, economists
    disagree about whether tax incentives, such as for IRAs, are effective in
    increasing the overall level of personal saving. In the case of the
    research credit, GAO reported in 1996 that studies done at that time
    provided mixed evidence on the amount of spending stimulated and used
    publicly available data that were not a suitable proxy for tax return
    data.78 To fully assess the value to society of the research tax credit,
    researchers need to look at more than just the amount of spending
    stimulated per dollar of revenue cost. Comparisons should include (1) the
    total benefits gained by society from research stimulated by the credit
    and (2) the estimated costs to society resulting from the collection of
    taxes required to fund the credit. The social benefits of the research
    conducted by individual companies include any new products, productivity
    increases, or cost reductions that benefit other companies and consumers
    throughout the economy. Although most economists agree that research
    spending can generate social benefits, the effects of the research on
    other companies and consumers are difficult to measure.

    Ultimately, evaluation results could be used to identify how well tax
    expenditures are working, to both identify ways to better manage
    individual tax expenditures and decide how best to ensure prudent
    stewardship of taxpayers' resources. Whether in time of deficit or
    surplus, reexamining both the spending and tax sides of the budget is
    essential to ensure the reasonableness, relevancy, and sustainability of
    existing programs and position the nation for the future. In the case of
    the EITC, Treasury and IRS are using evaluation results to identify ways
    of reducing erroneous claims, while maintaining participation among
    eligible claimants and minimizing taxpayer and IRS's administrative
    burden. Additional evaluations of other tax expenditures may identify
    opportunities to retarget

    78GAO, Tax Policy and Administration: Review of Studies of the
    Effectiveness of the Research Tax Credit, GAO/GGD-96-43 (Washington, D.C.:
    May 21, 1996).

    or eliminate ineffective or outdated tax expenditures. Tax expenditures,
    unless well designed to correct market failures, can distort economic
    decisions in ways that reduce economic performance from what it otherwise
    could be and thereby lower our future economic well-being. If a tax
    expenditure or group of tax expenditures is reduced or eliminated, any
    resulting increase in tax revenues could be offset if policymakers deem
    that to be appropriate fiscal policy. In any event, in order to raise a
    given amount of federal revenue, tax rates must be raised higher than they
    otherwise need to be due to revenue losses from tax expenditures. Thus,
    the net change after tax rate adjustments could, depending on overall
    congressional priorities and preferences, result in tax reductions for
    many taxpayers in place of the preferential treatment for some taxpayers.
    According to a recent estimate, a broad-based income tax system-
    eliminating basically all credits, deductions, special rates, exclusions
    for employer-provided fringe benefits and employee contributions to
    retirement account as well as eliminating the AMT--could raise about the
    same amount of revenue as the current income tax system while lowering tax
    rates by about one-third.79

        The Executive Branch Has Made Little Progress Since 1994 to Improve Scrutiny
        of Tax Expenditures

    Although OMB and Treasury in 1994 supported expanding federal reviews of
    tax expenditures, the Executive Branch made little progress over the past
    decade to integrate tax expenditures in the budget presentation and to
    incorporate tax expenditures under review processes that apply to spending
    programs, as we recommended in 1994. Even though the sum of tax
    expenditure outlay-equivalent estimates is about the same magnitude as
    discretionary spending overall and greater than outlays in some budget
    functions, this is not readily visible to policymakers and the public
    because tax expenditures are not integrated in the budget presentation.
    Since their initial efforts to outline a framework for evaluating tax
    expenditures and preliminary performance measures, OMB and Treasury have
    largely ceased to make progress and have retreated from setting a schedule
    for evaluating tax expenditures. One of the key impediments to moving
    forward in conducting reviews of tax expenditures' performance is the
    continuing lack

    79See the President's Advisory Panel on Federal Tax Reform, "Understanding
    Tax Bases: Staff Presentation," (presentation before the Panel's public
    meeting, Washington, D.C., July 20, 2005,
    http://taxreformpanel.gov/meetings/docs/understanding_tax_bases.ppt
    (downloaded September 13, 2005). The calculations for the presentation
    were produced by the U.S. Department of the Treasury, Office of Tax
    Analysis, at the request of the Panel. The broad income tax base scenario
    assumes integration of individual and corporate income taxes with the
    corporate tax rate set equal to the top individual rate.

    of clarity about the roles of OMB, Treasury, IRS, and departments or
    agencies with outlay program responsibilities. So far, GPRA plans and
    reports are underutilized as a way to provide more information about the
    performance of tax expenditures and their contributions relative to
    spending programs. Tax expenditures are not subject to annual budget
    reviews, and OMB has not generally subjected them to scrutiny under PART
    in tandem with spending programs sharing common, crosscutting goals.

    Tax Expenditures Are Not Integrating tax expenditure costs in the annual
    budget presentation is Integrated in the Annual Budget crucial to
    providing a comprehensive picture of federal resources to

    Presentation or Financial Statement Reporting

    facilitate reexamining the base. As a start in acting on our 1994
    recommendation, OMB began presenting revenue loss sums for tax
    expenditures alongside outlays and credit activity for each budget
    function in the fiscal year 1998 budget. These summary tables were a
    useful starting point in highlighting the relative magnitude of tax
    expenditures across mission areas. However, OMB discontinued the reporting
    practice after the fiscal year 2002 budget, and instead, the Analytical
    Perspectives contains Treasury's list of tax expenditures with associated
    revenue loss estimates for each one. Isolating tax expenditure cost
    information in a supplemental volume, however, provides a less
    comprehensive picture for policymakers and the public to compare all of
    the policy tools used within a mission area, such as health care or
    energy, because all the tools are not displayed together in the budget.
    OMB has demonstrated that it is feasible to display tax expenditure totals
    alongside spending programs in each budget function. Such a display is a
    first step in providing the public and policymakers with a more useful and
    accurate picture of the extent of federal support and activities.

    GAO also recommended in 1994 that the budget presentation include, to the
    extent possible, information to highlight for policymakers and the public
    the effectiveness, distributional equity, and economic efficiency for all
    federal resources allocated in a mission area. In the tax expenditure
    chapter in Analytical Perspectives, OMB added a section outlining possible
    performance measures developed by Treasury, which could be used to present
    information about the performance of tax expenditures. Although this
    overview was initially introduced in the 1997 budget and expanded in the
    1999 budget, no performance information is actually displayed. OMB states
    that the measure examples provided are "illustrative" in nature,
    acknowledges that the performance measure discussion "although broad, is
    nonetheless incomplete," and noted that many tax expenditures are not
    explicitly cited.

    The Chief Financial Officers Act,80 as expanded by the Government
    Management Reform Act of 1994,81 required federal agencies to prepare
    annual audited financial statements beginning in fiscal year 1996. OMB
    Circular A-136 Financial Reporting Requirements requires agencies to
    combine the annual GPRA program performance report with the financial
    statements and other information in a combined performance and
    accountability report. In accordance with generally accepted accounting
    principles, the basis on which federal agencies are required to prepare
    their financial statements, tax expenditures may be presented as other
    accompanying information. The Federal Accounting Standards Advisory Board
    (FASAB), which promulgates federal accounting standards, recognized that
    tax expenditures, which can be large in relation to spending programs that
    are measured under federal accounting standards, may not be fully
    considered in entity reporting. FASAB based its views, in part, on the
    fact that, in some cases, the association of tax expenditures with
    particular programs is not clear and the information is available
    elsewhere. The Board agreed to permit reporting entities to present, as
    other accompanying information, information on tax expenditures that the
    reporting entity considers relevant to its programs, if suitable
    explanations and qualifications are provided. As a result, tax expenditure
    amounts, which in some cases are larger than similar spending programs,
    are not required to be disclosed to the public as part of federal
    agencies' financial statements nor are they disclosed in the consolidated
    financial statements of the federal government. Similarly, OMB's guidance
    for the performance and accountability reports does not require reporting
    of tax expenditure information in agencies' reports. Reporting such
    information would ensure greater transparency of and accountability for
    tax expenditures.

    Progress on Developing OMB has not designed and implemented a structure
    for conducting reviews

    Structure for Reviewing Tax of tax expenditures' performance, as we
    recommended in 1994. Our

    Expenditures' Performance Has recommendation was consistent with language
    in the Senate Committee on

    Stalled Government Affairs' Report82 on GPRA, which specified that the
    Director of OMB was to establish an appropriate framework for periodic
    analyses of the effects of tax expenditures in achieving performance
    goals. To

    80Pub. L. No. 101-576, Nov. 15, 1990. 81Pub. L. No. 103-356, Oct. 13,
    1994. 82S. Rep. No. 103-58, p. 29 (1993).

    significantly increase the oversight and analysis of tax expenditures, the
    committee report also called for a schedule for periodic tax expenditure
    evaluations.

    The ultimate goal of designing a structure for conducting performance
    reviews of tax expenditures was to begin developing and presenting
    performance information in the federal budget that would help demonstrate
    the relative effectiveness, efficiency, and equity of federal outlays and
    tax expenditure efforts within a mission area. In our 1994 report, we
    emphasized that in designing the structure for tax expenditure performance
    reviews, OMB should consider

    o 	the roles of OMB, Treasury, and departments or agencies with outlay
    program responsibilities in assessing the performance of tax expenditures
    and their relationship and interaction with related spending programs; and

    o 	which tax expenditures and outlay programs are related or interact and
    should be jointly considered.

    GAO recommended that OMB and Treasury conduct case studies of the proposed
    review structure to identify (1) successful methods agencies devise for
    reviewing tax expenditures' performance, (2) how best to report the
    results of these reviews, and (3) how to ensure that adequate resources
    are available for such reviews.

    Although OMB, working with Treasury, took a number of steps consistent
    with our recommendation, it has not resolved the roles of OMB, Treasury,
    and departments or agencies with outlay program responsibilities;
    established a schedule for reviewing tax expenditures; or addressed
    lessons learned from tax expenditure case study reviews that Treasury
    performed. If the Executive Branch cannot define roles and set firm plans,
    it will continue to face additional challenges in developing objective,
    measurable, and quantifiable performance measures for tax expenditures
    that support federal missions and goals.

    Defining roles of agencies. One of the key impediments to moving forward
    in conducting reviews of tax expenditures' performance is the continuing
    lack of clarity about the roles of OMB, Treasury, IRS, and departments or
    agencies with outlay program responsibilities. According to officials at
    OMB, it is difficult to determine which agencies in addition to Treasury
    and IRS have jurisdiction over particular tax expenditures. For

    example, one OMB official noted that tax expenditures meant to encourage
    savings were not the purview of any single agency. OMB officials also
    stated that OMB does not have the expertise or resources to conduct its
    own comprehensive analyses of tax expenditures, so individual agencies
    should take responsibility for identifying tax expenditures that affect
    their missions, with Treasury's Office of Tax Analysis leading efforts to
    evaluate tax expenditures.

    Without clarification on the roles of federal agencies, inaction, overlap
    or inconsistency in evaluating tax expenditures can occur. For example, in
    2002 we reported that gaps existed in monitoring the relative
    effectiveness of Title IV grants and loans and the HOPE and Lifetime
    Learning tax credits in promoting postsecondary education.83 The lack of
    collaboration between the Department of Education and the Treasury left
    little information available to help Congress weigh the relative
    effectiveness of grants, loans, and tax credits. Although data and
    methodological challenges make it difficult to isolate the impact of these
    tools, some academic researchers have used statistical techniques and
    research designs to mitigate these challenges. We recommended in 2002 that
    the departments develop a plan to share data and collaborate to provide
    Congress with evidence about the impact of higher education tax credits
    and student aid, but little action has been taken to implement the
    recommendation.

    To define the roles of federal agencies in reviewing tax expenditures,
    OMB, working with Treasury and other federal agencies, will need to
    exercise judgment in resolving how to address tax expenditures spanning
    mission areas. In some cases, Treasury could take the lead, such as in
    evaluating tax expenditures that broadly support investment and saving, or
    other agencies could work with Treasury to evaluate tax expenditures that
    directly affect their mission areas. For example, an evaluation of the
    various energy supply tax expenditures might involve both Treasury and the
    Department of Energy in assessing their effects on increasing production
    as well as on energy security and the environment.

    Establishing a schedule for evaluations. Periodic reviews of tax
    expenditures are also impeded because OMB has not developed a schedule for
    such reviews. In its 1997 GPRA report and again in the fiscal year 1999
    budget, OMB set the expectation that the Executive Branch would lay out a

    83GAO-02-751.

    schedule for tax expenditure evaluations. Beyond three initial pilot
    studies in 1997, however, no schedule has been set for further evaluations
    or case studies to explore methods and resource needs for measuring and
    reporting tax expenditure performance.

    As the roles of federal agencies are clearly defined, OMB and Treasury,
    working with other agencies, would be positioned to establish a schedule
    for tax expenditure evaluations. Opportunities exist to develop a
    strategic approach to the selection and prioritization of areas in
    allocating scarce evaluation resources. In our January 2004 report on
    OMB's PART, we recommended that OMB target PART assessments based on such
    factors as the relative priorities, costs, and risks associated with
    related clusters of programs and activities and that OMB select similar
    programs for review in the same year to facilitate comparisons and
    tradeoffs.84 Similar considerations would be useful in setting a schedule
    for tax expenditure evaluations.

    Testing the evaluation framework. Although OMB outlined an initial
    framework for tax expenditure analysis in its May 1997 GPRA report to the
    President and Congress, OMB has not taken steps to address lessons learned
    from tax expenditure case study reviews that Treasury performed. OMB's
    framework focused on the methodology that could be used to assess the
    performance of tax expenditures. OMB emphasized that developing a
    framework that is comprehensive, accurate, and flexible to reflect the
    objectives and effects of the wide range of tax expenditures would be a
    significant challenge. The initial framework for evaluating tax
    expenditures was expected to follow the basic structure for performance
    measurement-inputs, outputs, and outcomes. For tax expenditures, the
    primary input is the revenue loss. The outputs are the quantitative or
    qualitative measures of goods and services, or changes in investment and
    income, produced by the tax expenditures. Outcomes, in turn, were defined
    as the changes in the economy, society, or environment that the tax
    expenditures aim to accomplish.

    In 1997, Treasury did three pilot evaluations of selected tax expenditures
    to test the evaluation methods that OMB had described in its framework for
    tax expenditure analysis. In addition to seeking to learn lessons about
    applying the framework, the pilots were also intended to help identify

    84GAO, Performance Budgeting: Observations on the Use of OMB's Program
    Assessment Rating Tool for the Fiscal Year 2004 Budget, GAO-04-174
    (Washington, D.C.: Jan. 30, 2004).

    resource needs for evaluating tax expenditures. Treasury selected one
    pilot each to be done by the individual, corporate, and international
    units within its Office of Tax Analysis. Results from the three tax
    expenditure pilots-the exclusion for worker's compensation benefits, the
    tax credit for non-conventional fuels, and the tax exclusion for certain
    amounts of income earned by Americans living abroad85-were summarized
    alongside each tax expenditure's description in the tax expenditure
    chapter of the Analytical Perspective volume of the fiscal year 1999
    budget. Although OMB originally expected to complete additional
    evaluations to refine the tax expenditure framework and improve
    performance measures, no further pilot evaluations have been completed. In
    reporting the results of these pilots, Treasury said that much of the data
    needed for thorough analysis was not available and that in at least one
    case, it was difficult to identify a clear purpose for the tax
    expenditure. Treasury did not discuss the resources that would be needed
    to continue doing such evaluations.

    However, OMB officials we interviewed reiterated that the data
    availability issues raised in the 1997 pilots remain a major challenge,
    and data constraints limit the assessment of the effectiveness of many tax
    expenditures. To improve the data available to assess the effects of some
    major tax expenditures, principally those aimed at personal savings,
    Treasury and IRS are developing a data set that is to follow a sample of
    individual income taxpayers over at least 10 years, beginning with tax
    year 1999. The new data set aims to capture the changing demographic and
    economic circumstances of individual taxpayers for use in analyzing the
    effects of changes in tax law over time. In addition to the panel sample,
    OMB reported in the fiscal year 2006 budget that it is working with
    Treasury's Office of Tax Analysis and other agencies to improve data
    available for assessment of saving-related tax expenditures. No time frame
    was given in the 2006 budget for when any results will be reported.

    The challenges in producing credible performance information and the
    ability of federal agencies to produce evaluations of their programs'
    effectiveness are not unique to tax expenditures. As our work on GPRA and
    PART implementation shows, the credibility of performance data has

    85Revenue loss estimates for the three tax expenditures included in
    Treasury's first pilot study amounted to approximately $7.8 billion (in
    2004 dollars) or 1.4 percent of total revenue loss in fiscal year 1997;
    the three amounted to $9.2 billion or 1.3 percent of total revenue loss
    for fiscal year 2004.

    been a long-standing weakness.86 Developing and reporting credible
    information on outcomes achieved through federal programs remains a work
    in progress. In past reports, we have identified several promising ways
    agencies can maximize their evaluation capacity. For example, careful
    targeting of federal evaluation resources on key policy or performance
    questions and leveraging federal and nonfederal resources show promise for
    addressing key questions about program results. Other ways agencies might
    leverage their current evaluation resources include adapting existing
    information systems to yield data on program results, drawing on the
    findings of a wide array of evaluations and audits, making multiple use of
    an evaluation's findings, mining existing databases, and collaborating
    with state and local program partners to develop mutually useful
    performance data.

    Statutory Impetus for Tax Congressional expectations for reviews of tax
    expenditures in connection Expenditure Reviews Is with agencies' reviews
    of related outlay and other programs generally have

                                     Underutilized

    not been met. Enacted in 1993, GPRA is designed to inform congressional
    and executive decisionmaking by providing objective information on the
    effectiveness and efficiency of federal programs and spending.87 GPRA
    requires agencies to measure performance toward the achievement of annual
    goals and report on their progress in annual program performance reports.
    Through the strategic planning requirement, GPRA requires federal agencies
    to consult with the Congress and key stakeholders to regularly reassess
    their missions and strategic goals as well as the strategies and resources
    they will need to achieve their goals. Although GPRA offers a promising
    opportunity for the Executive Branch to develop useful information about
    the results of tax expenditures, agencies are not using their GPRA
    strategic plans and annual performance plans and reports to assess tax
    expenditures and their performance relative to spending programs
    contributing to the same strategic goals and objectives. Without

    86GAO has suggested various approaches to addressing this and other
    challenges. See GAO, The Government Performance and Results Act: 1997
    Governmentwide Implementation Will Be Uneven, GAO/GGD-97-109 (Washington,
    D.C.: June 2, 1997); and GAO, Results-Oriented Government: GPRA Has
    Established a Solid Foundation for Achieving Greater Results, GAO-04-38
    (Washington, D.C.: Mar. 10, 2004).

    87GPRA is the centerpiece of a statutory framework for helping resolve
    long-standing management problems that have undermined the federal
    government's efficiency and effectiveness. The framework also includes the
    Chief Financial Officers Act of 1990 as amended by the Government
    Management Reform Act of 1994 and other reform legislation such as the
    Paperwork Reduction Act of 1995 and the Clinger-Cohen Act of 1996. For
    more information on the Government Performance and Results Act, see
    GAO-04-38.

    integrating tax expenditures that have a direct bearing on federal
    missions and goals, policymakers may not have complete information to
    fully evaluate whether the government is achieving results or how the
    performance of tax expenditures interact with or compare to related
    spending programs.

    The Senate Governmental Affairs Committee Report on GPRA stated that tax
    expenditures should be taken into consideration in a comprehensive
    examination of government performance. The report stated that a schedule
    for periodically assessing the effects of specific tax expenditures in
    achieving performance goals should be included in the annual performance
    plans and that annual performance reports would subsequently be used to
    report on these tax expenditure assessments. In addition, the report noted
    that these assessments should consider the relationship and interactions
    between spending programs and tax expenditures and the effects of tax
    expenditures in achieving federal performance goals.

    Although GPRA expanded the supply of performance information generated by
    federal agencies, evaluating crosscutting federal efforts continues to be
    a challenge. GPRA requires the President to include in his annual budget
    submission a federal government performance plan. Congress intended that
    this plan provide a single cohesive picture of the annual performance
    goals for the fiscal year.88 The governmentwide performance plan could
    help Congress and the Executive Branch address critical federal
    performance and management issues, including redundancy and other
    inefficiencies in how we do business. However, this provision has not been
    fully implemented, and the current agency-by-agency focus of the budget
    does not have a broad, integrated perspective of planned performance on
    governmentwide outcomes. As envisioned by Congress, the governmentwide
    plan could relate and address the contributions of alternative federal
    strategies, including tax expenditures, to governmentwide goals. Agencies'
    annual performance plans and reports could highlight crosscutting program
    efforts and provide evidence of the coordination of those efforts. We have
    previously recommended that OMB fully implement GPRA's requirement to
    develop a governmentwide plan to

    88S. Rep. No. 103-58, p. 29 (1993).

    provide a more cohesive picture of the federal government's goals and
    strategies.89

    Prior to a 2003 revision, OMB's Circular A-11 guidance on GPRA reporting
    stated that descriptions should be provided for use of tax expenditures in
    annual performance plans when achievement of program or policy goals is
    dependent upon these governmental actions and annual performance reports
    must include the results of any assessment of how specific tax
    expenditures affect achieving its performance goals.90 However, the
    circular also stated that few agencies were responsible for such analyses.
    In addition, as part of a broader A-11 revision update, OMB streamlined
    its GPRA guidance in 2003 and no longer describes tax expenditures as part
    of guidance on performance plans and performance reports in the circular.
    According to OMB, it is up to individual agencies to decide whether to
    address tax expenditures in their GPRA reports and that many agencies
    focus on outlay programs over which they have more direct control. OMB
    officials told us that some agencies see tax expenditures as closely
    related to what they do and some do not, or agencies might not have enough
    knowledge about tax expenditures to consider them carefully. Our review of
    selected GPRA Performance and Accountability reports indicated the
    acknowledgement of tax expenditures in achieving federal performance goals
    varied by agency. For example:

    o 	The Department of Energy (DOE) and HUD both acknowledged tax
    expenditures or tax policy as factors that affect agency goals. However,
    the DOE's fiscal year 2004 report provided no further discussion on how
    the tax expenditures contributed to achieving the agencies' performance
    goals. HUD's fiscal year 2004 report acknowledged the tax incentives for
    renewal communities, empowerment zones, and enterprise communities as
    helping to achieve its objective of providing capital resources to improve
    economic conditions in distressed communities. As discussed previously,
    the outlay-equivalent value for tax expenditures amounts to more than
    other spending in the energy as well as the commerce and housing credit
    mission areas.

    89GAO-04-38.

    90OMB, "Preparation and Submission of Strategic Plans, Annual Performance
    Plans, and Annual Program Performance Report", Part 6 of Circular A-11,
    Preparation, Submission, and Execution of the Budget (Washington, D.C.:
    2002).

    o 	The fiscal year 2004 reports released by the Department of Commerce
    (Commerce), the Department of Veterans Affairs, and the Department of
    Health and Human Services (HHS) do not mention tax expenditures at all,
    even though tax expenditures exist under the different mission areas
    related to these departments. For instance, several large tax
    expenditures, such as capital gains and accelerated depreciation, are
    listed by Treasury as related to the Commerce mission area, but it is
    unclear how, if at all, these tax expenditures relate to Commerce's
    performance goals. Also, the income tax exclusion for employerprovided
    health care, the largest single tax expenditure, clearly intersects with
    HHS's mission to assure access to health care.

    o 	Treasury's fiscal year 2004 report explicitly identified a few tax
    expenditures-the New Markets Tax Credit and a new health coverage tax
    credit-as related to achieving its strategic objective to stimulate U.S.
    economic growth. In the context of its strategic objective to improve and
    simplify the tax code, Treasury reported on its efforts to, among other
    things, simplify the EITC and consolidate the higher education tax
    benefits. Treasury also reported on its efforts to improve determination
    of EITC eligibility and educate taxpayers about this provision. Treasury
    did not include information about tax expenditures as other accompanying
    information in the financial statement in its 2004 report.

    Tax Expenditures Are Not Tax expenditures have not been incorporated into
    Executive Branch Subject to Annual Budget budget reviews, as we
    recommended in 1994. We recommended that OMB

    Reviews

    use information on outlay programs and tax expenditures to make
    recommendations to the President and Congress about the most effective
    methods for accomplishing federal objectives. We concluded that better
    targeting by Congress and the Executive Branch of all federal spending and
    subsidy programs could save resources and increase economic efficiency
    through (1) better coordination of spending programs with tax
    expenditures; (2) reduction of overlap and inconsistencies among all
    federal subsidy programs; and (3) encouragement of trade-offs among tax
    expenditures, outlays, and loans.

    The congressional budget process is the annual vehicle through which
    Congress articulates both an overall fiscal stance-overall targets for
    spending and revenue-and its priorities across various broad categories.
    The process provides the overall constraints for spending and revenue
    actions by Congress for each year and the rules of procedure that can be
    used to constrain new entitlement and tax legislation not assumed in the

    annual budget resolution. The conflicts and uncertainties entailed in
    budgeting and policymaking are often mitigated by focusing decisions on
    incremental changes in resources each year. As a result, this incremental
    process focuses disproportionate attention on proposed changes to existing
    programs and proposals for new programs, with the base of programs often
    being taken as "given." Moreover, the process routinely examines only the
    one-third of federal spending subject to the annual appropriations
    process. Unlike discretionary spending programs, which are subject to
    periodic reauthorization and annual appropriation, tax expenditures-like
    entitlement programs-are permanent law and are generally not subject to a
    legislative process that would ensure systematic annual or periodic
    review. In addition, the budget rules that were grounded in
    statute-including discretionary spending caps, pay-as-you-go (PAYGO)
    limits on mandatory spending and tax cuts-and enforced by executive
    actions if violated, expired at the end of fiscal year 2002. Before their
    expiration, PAYGO procedures restricted Congress' ability to add new tax
    expenditures or expand existing ones unless offsetting funds could be
    raised. Because tax provisions are not as visible in the budget as
    spending programs, there is an incentive for policymakers to use tax
    provisions rather than spending programs to accomplish programmatic ends.
    However, both have a negative effect on the government's "bottom-line."
    Reinstituting budget enforcement mechanisms, such as discretionary
    spending caps, PAYGO discipline on both the spending and tax side, and
    fiscal benchmarks, could help the President and Congress sort out the many
    claims on the federal budget, including tax expenditures.

    Within the Executive Branch, OMB has not used its PART process, which is
    central to the Executive Branch's budget and performance integration
    initiative,91 to systematically review tax expenditures and promote joint
    and integrated reviews of tax and spending programs sharing common,
    crosscutting goals. OMB describes PART as a diagnostic tool meant to
    provide a consistent approach to assessing federal programs as part of the
    executive budget formulation process. It applies 25 questions to all

    91GAO, 21st Century Challenges: Performance Budgeting Could Help Promote
    Necessary Reexamination, GAO-05-709T (Washington, D.C.: June 14, 2005).
    For a detailed examination of PART, see GAO-04-174. Another significant
    element of the performance and budget integration initiative is efforts to
    restructure budgets. See GAO, Performance Budgeting: Efforts to
    Restructure Budgets to Better Align Resources with Performance,
    GAO-05-117SP (Washington, D.C.: February 2005).

    "programs"92 under four broad topics: (1) program purpose and design, (2)
    strategic planning, (3) program management, and (4) program results (i.e.,
    whether a program is meeting its long-term and annual goals) as well as
    additional questions that are specific to one of seven mechanisms or
    approaches used to deliver the program.93 PART is designed to be
    evidence-based, drawing on a wide array of information, including
    authorizing legislation, GPRA strategic plans and performance plans and
    reports, financial statements, inspectors general and GAO reports, and
    independent program evaluations. Drawing on available performance and
    evaluation information, the PART questionnaire attempts to determine the
    strengths and weaknesses of federal programs with a particular focus on
    individual program results and improving outcome measures.

    Since the fiscal year 2004 budget cycle, OMB has applied PART to 607
    programs (about 60 percent of the federal budget), and given each program
    one of four overall ratings: (1) "effective," (2) "moderately effective,"
    (3) "adequate," or (4) "ineffective" based on program design, strategic
    planning, management, and results. A fifth rating, "results not
    demonstrated," was given-independent of a program's numerical score- if
    OMB decided that a program's performance information, performance
    measures, or both were insufficient or inadequate. Over the next 2 years,
    OMB plans to assess nearly all remaining Executive Branch spending

    94

    programs.

    Whereas OMB, through its development and use of PART, has provided
    agencies with a powerful incentive for improving data quality and
    availability on the spending side, relatively little progress has been
    made in evaluating the effectiveness of tax expenditures. So far, OMB has
    used

    92 There is no standard definition for the term "program." For purposes of
    PART, OMB described the unit of analysis (program) as (1) an activity or
    set of activities clearly recognized as a program by the public, OMB,
    and/or Congress; (2) having a discrete level of funding clearly associated
    with it; and (3) corresponding to the level at which budget decisions are
    made.

    93The seven major categories are competitive grants, block/formula grants,
    capital assets and service acquisition programs, credit programs,
    regulatory-based programs, direct federal programs, and research and
    development programs.

    94For the limited exceptions, the Administration is considering
    alternative methods and timelines for assessment of programs with limited
    impact and large activities where it is difficult to determine an
    appropriate unit of analysis.

    PART to address tax expenditures in only two cases-the EITC compliance
    initiative and the New Markets Tax Credit (NMTC).95

    o 	For the EITC, which has outlays for the refundable portion, the direct
    federal spending PART instrument was used to evaluate IRS' initiative to
    improve the payment accuracy rate for the EITC-and not the refundable EITC
    itself. OMB rated the compliance initiative as "ineffective" in the fiscal
    year 2004 budget because data showed no progress in reducing the high
    rates of erroneous payments. The review did not evaluate the effects of
    the EITC on workforce participation or examine its contribution relative
    to other federal programs aimed at reducing poverty.

    o 	The NMTC, which is administered like a grant by CDFI, was evaluated as
    part of OMB's crosscutting review of community and economic development
    programs. OMB rated the NMTC as "adequate" and reported in 2005 that CDFI
    had established meaningful long-term and annual performance measures but
    that data were not yet available to evaluate the effectiveness of the NMTC
    or establish baselines for the performance measures.

    We have urged a more comprehensive, consistent, and integrated approach to
    evaluating all programs relevant to common goals-encompassing spending,
    tax expenditures, and regulatory programs-using a common framework. Such
    an analysis is necessary to capture whether a program complements and
    supports other related programs, whether it is duplicative and redundant,
    or whether it actually works at cross-purposes to other initiatives. OMB
    officials we interviewed said that OMB would need Treasury's assistance to
    determine what information or criteria to include in a PART instrument
    tailored to examine tax expenditures. As of July 2005, OMB said that it
    was planning to review the health insurance tax credit program next year
    but that it has not decided whether the PART review will be limited to
    administration or will also cover the program's tax policy purpose.

    95The NMTC program issues federal tax credits to private sector entities
    in return for investments in low-income communities, such as development
    or rehabilitation of real estate projects.

    Conclusions	As we move forward in shaping government for this century, the
    federal government cannot accept all of its existing programs, policies,
    functions, and activities as "givens." Outmoded commitments and operations
    constitute an encumbrance on the future that can erode the capacity of the
    nation to better align its government with the needs and demands of a
    changing world and society. Reexamining the base of all major existing
    federal spending and tax programs, policies, functions, and activities by
    reviewing their results and testing their continued relevance and relative
    priority for our changing society is an important step in recapturing our
    fiscal flexibility and bringing the panoply of federal activities into
    line with 21st century trends and challenges. The decisions we face
    involve difficult choices about the appropriate size and role of the
    federal government and how to finance the federal government. The revenues
    forgone through tax expenditures reduce resources available to fund other
    federal activities or they require higher tax rates to raise a given
    amount of revenue. Reviewing their results and testing their continued
    relevance and relative priority is an important step in the process
    towards fiscal responsibility and national renewal. Such a fundamental
    review of major programs, policies, and activities, including tax
    expenditures, can serve the vital function of updating the federal
    government's approach to meet current and future challenges.

    Regular and systematic evaluation will be necessary to inform policy
    decisions about the efficiency, effectiveness, and equity of tax
    expenditures or whether they are the best tool for accomplishing federal
    objectives within a functional area. Beginning the governmentwide
    reexamination process now would enable decisionmakers to be more strategic
    and selective in choosing areas for review over a period of years.
    Reexamining selected parts of the budget base over time may make the
    reviews more feasible and less burdensome, and it would allow
    decisionmakers to focus on all federal efforts-discretionary spending,
    mandatory spending, and tax expenditures-sharing common goals.

    Unfortunately, over a decade has passed since Congress encouraged
    systematic reviews of tax expenditures and since we made recommendations
    to facilitate such reviews and to display information on tax expenditures
    in the federal budget in a manner that enables policymakers to look at
    resource commitments across related outlays and tax expenditures. Although
    specific tax expenditures, such as the EITC and Liberty Zone tax benefits,
    have received varying degrees of scrutiny, efforts to date have not
    provided the Congress and others with an

    integrated perspective on the extent to which programs and tools-
    including tax expenditures-contribute to national goals and position the
    government to successfully meet 21st century demands. In addition, the
    lack of a requirement to disclose tax expenditures in agencies' annual
    performance and accountability reports may result in important performance
    and cost related data not being fully considered with other federal
    resources allocated to achieve similar objectives. Although challenges
    must be overcome to provide systematic reviews of tax expenditures, these
    challenges cannot be addressed absent effective leadership within the
    Executive Branch. Accordingly, we are making several recommendations to
    OMB.

      Recommendations for Executive Action

    To ensure that policymakers and the public have the necessary information
    to make informed decisions and to improve the progress toward exercising
    greater scrutiny of tax expenditures, we recommend that the Director of
    OMB, in consultation with the Secretary of the Treasury, take the
    following four actions:

    o 	resume presenting tax expenditures in the budget together with related
    outlay programs to show a truer picture of the federal support within a
    mission area;

    o 	develop and implement a framework for conducting performance reviews of
    tax expenditures. In developing the framework, (1) determine which
    agencies will have leadership responsibilities to review tax expenditures,
    how reviews will be coordinated among agencies with related
    responsibilities, and how to address the lack of credible performance
    information on tax expenditures; (2) set a schedule for conducting tax
    expenditure evaluations; (3) re-establish appropriate methods to test the
    overall evaluation framework and make improvements as experience is
    gained; and (4) to identify any additional resources that may be needed
    for tax expenditure reviews.

    o 	develop clear and consistent guidance to Executive Branch agencies on
    how to incorporate tax expenditures in strategic plans, annual performance
    plans, and performance and accountability reports, to provide a broader
    perspective and more cohesive picture of the federal government's goals
    and strategies to address issues that cut across Executive Branch
    agencies; and

    o 	require that tax expenditures be included in the PART process and any
    future such budget and performance review processes so that tax
    expenditures are considered along with related outlay programs in
    determining the adequacy of federal efforts to achieve national
    objectives.

      Agency Comments and Our Evaluation

    We provided a draft of this report to OMB, Treasury, and IRS for their
    review and comments. We received written comments from OMB's Associate
    Director for Economic Policy in a letter dated September 2, 2005. These
    comments are reprinted in app. II along with our analysis of certain
    issues raised by OMB. OMB disagreed with our recommendations and several
    of our findings, and also raised concerns about our use of Treasury's tax
    expenditure estimates. Where appropriate, we made changes in our report in
    response to these comments. The Secretary of the Treasury did not submit
    comments, instead deferring to OMB. IRS staff provided a technical
    correction that we incorporated.

    In commenting on our report, OMB raised concerns about our use of tax
    expenditure estimates developed by Treasury and reported in the annual
    federal budget. For example, OMB commented that we accepted uncritically
    the concept of tax expenditures first advanced in the 1960s and said that
    we ignored limitations about the "volume" of total tax expenditures. To
    the contrary, the background section of our draft report, as well as
    several pages in app. III, clearly identified issues related to the tax
    expenditure concept, including that characterizing individual provisions
    as tax expenditures is a matter of judgment, and that disagreements exist
    about classifying what should be included in the income tax base. Pursuant
    to the Congressional Budget Act of 1974, the term tax expenditure, as our
    draft stated, has been used in the federal budget for three decades, and
    the tax expenditure concept-while not precisely defined-is nevertheless a
    valid representation of one tool that the federal government uses to
    allocate resources. Regarding the "volume" of tax expenditures, we
    acknowledged throughout our draft report limitations in the methodology of
    summing the individual tax expenditures. To provide an example of the
    extent that interaction effects among tax expenditure estimates can affect
    summing them, at our request, Treasury calculated total tax expenditures
    for five itemized deductions that took these effects into account; we
    included this information in our draft report. As our report stated, tax
    expenditure estimates-both those published in the budget as well as those
    produced by JCT-are the best and only data available to measure the value
    of tax expenditures and make comparisons

    to other spending programs. In our opinion, summing the estimates provides
    perspective on the use of tax expenditures as a policy tool and represents
    a useful gauge of the general magnitude of government subsidies carried
    out through the tax code.

    OMB also stated that we reported that more attention should be given to
    tax expenditures due to the severity of the nation's long-term fiscal
    imbalance and stated that the Administration rejects any attempt to
    address the long-term fiscal imbalance with tax increases. To the
    contrary, we believe that tax expenditures, like other federal programs
    and activities, should be reevaluated as to their effectiveness and
    continued relevance as part of a periodic reexamination of what the
    federal government does and how it does business. Although the long-term
    fiscal gap heightens the need to ensure resources are not wasted, this
    reexamination would be appropriate regardless of the fiscal position.
    Further, OMB's implication that focusing more attention on tax
    expenditures would automatically increase taxes is unfounded. As our
    report clearly stated, for any given level of revenue, the revenues
    forgone through tax expenditures require higher tax rates to obtain a
    given amount of revenue. Thus, if the evaluations of tax expenditures we
    call for lead to reducing or eliminating some tax expenditures, the net
    change after rate adjustments could, depending on overall congressional
    priorities and preferences, result in tax reductions for many taxpayers.
    We adjusted sections of our report to reinforce the point that reviewing
    tax expenditures is consistent with good stewardship of taxpayers'
    resources and does not automatically result in tax increases depending on
    other related changes. At the same time, our current and projected fiscal
    imbalance serves to reinforce the need for reassessing all activities. We
    also added a recent estimate calculated by the Department of the Treasury
    for the President's Advisory Panel on Federal Tax Reform which showed that
    a tax system where basically all tax expenditures were eliminated could
    raise the same amount of revenue as the current tax system while lowering
    tax rates by about a third.

    OMB also stated that information on tax expenditures is not useful for
    budgeting and that tax expenditures have never been included in the
    congressional budget process. To the contrary, the tax expenditure list is
    legally required under the 1974 Congressional Budget Act and, before the
    expiration of the Budget Enforcement Act in 2002, PAYGO procedures
    restricted Congress' ability to add new tax expenditures or expand
    existing ones unless offsetting funds could be raised. Whereas OMB favors
    reporting tax expenditures separately from the rest of the budget, we
    believe an integrated presentation is also useful to show the relative

    magnitude of tax expenditures compared to spending and credit programs
    across mission areas. This is not a recommendation to equate tax
    expenditures with outlays. We are recommending that OMB focus on
    integrating tax expenditures in the President's budget presentation to
    show a truer picture of federal support in a mission area and on including
    tax expenditures under budget and performance review processes that apply
    to related spending programs. As our report stated, OMB began presenting
    tax expenditure sums alongside outlays and credit activity for each budget
    function in the federal budget from fiscal year 1998 through fiscal year
    2002, but has discontinued the practice.

    Finally, OMB commented that it would be unwise to follow our
    recommendations for the conceptual and methodological reasons mentioned
    above, as well as for other practical reasons. We address OMB's comments
    on our recommendation to resume including tax expenditures in the budget
    together with related outlay programs in the paragraph above.

    o 	Regarding our recommendation to develop a framework for conducting
    performance reviews of tax expenditures, OMB stated that it has some
    potential promise but it is clearly a job for Treasury because no other
    agency has access to the data that would be needed to conduct such an
    analysis. However, we are not recommending that OMB be responsible for
    conducting the actual reviews, just for developing and overseeing the
    implementation of a framework for conducting the performance reviews. OMB
    would not need to have access to taxpayer data to manage the process. In
    addition, we recognize the challenges in using taxpayer data, which is the
    reason we recommend that OMB work in consultation with Treasury to develop
    and implement the framework. Also, our report recognizes the scarcity of
    evaluation resources, and we suggest factors that would be useful in
    taking a strategic approach to selecting and prioritizing tax expenditure
    evaluations. To make this point more apparent in our report, we added a
    fourth requirement to our recommendation to identify any additional
    resources that may be needed for tax expenditure reviews.

    o 	OMB said that our recommendation to develop clear and consistent
    guidance to Executive Branch agencies on how to incorporate tax
    expenditures in GPRA reports would be counterproductive because agencies
    do not administer the tax code, and they should not be saddled with
    responsibility for something they do not control. OMB misstated our
    recommendation; this report does not recommend that agencies be
    responsible for administering parts of the tax code. As the tax

    expenditure chapter in OMB's Analytical Perspectives volume of the fiscal
    year 2006 budget states, tax expenditures may also contribute to achieving
    goals identified in Federal agencies annual and strategic plans for their
    programs and activities. The aim of our recommendation was to provide a
    more cohesive perspective of the government's programs and
    strategies-including tax expenditures-to address common federal goals. As
    our report states, in passing the Government Performance and Results Act,
    the Senate Governmental Affairs Committee called for inclusion of tax
    expenditures in the GPRA process so that more and better information would
    be available on the performance of tax expenditures themselves and the
    effects of tax expenditures would be considered in achieving federal
    performance goals. Our recommendation is consistent with this intent.

    o 	Regarding our recommendation to require tax expenditures to be included
    in the PART process and any future such budget and performance review
    processes, OMB stated that it has no current plans to implement any of the
    recommendations in this report, but stated that other tax expenditures may
    be evaluated with the PART in the future. OMB also stated that the
    Department of the Treasury manages the tax code, so any new PARTs for tax
    expenditures would generally mean more PARTs for Treasury. Within the
    Executive Branch, major responsibility for management of the tax code was
    given to the Department of the Treasury. Given that the Administration is
    aiming to assess nearly 100 percent of federal outlay programs under PART,
    Treasury would be facing less scrutiny than other agencies to the extent
    that tax expenditures are not similarly evaluated under PART. Our
    recommendation merely calls for bringing tax expenditures in line with the
    performance management attention PART gives to outlay programs. Further,
    if our second recommendation to develop an evaluation framework for tax
    expenditures is implemented, OMB would be better positioned to target
    crosscutting reviews of related clusters of programs and activities.

    We are sending copies of this report to the relevant congressional
    committees and other interested parties. Copies of this report will also
    be made available to others upon request. In addition, the report will
    also be available at no charge on GAO's Web site at http://www.gao.gov.

    If you or your staff have any questions about this report, please contact
    Mike Brostek at (202) 512-9110 or brostekm@gao.gov. Contact points for our
    Offices of Congressional Relations and Public Affairs may be found on the
    last page of this report. GAO staff who made major contributions to this
    report are listed in appendix VI.

    David M. Walker Comptroller General of the United States

    Appendix I

    Scope and Methodology

    A decade ago, we examined the growth in tax expenditures and examined
    opportunities to focus policymakers' attention on tax expenditures.1 To
    assist the Congress in reexamining the base of federal programs and
    policies critical to achieving fiscal discipline in the budget as a whole,
    this report updates our 1994 work. Specifically, this report describes (1)
    how tax expenditures have changed over the past three decades in reported
    number and aggregate size and in comparison to federal spending, revenue,
    and the economy; and (2) the progress that has been made since 1994 in how
    the Executive Branch scrutinizes tax expenditures. To meet each of our
    objectives, we relied on past GAO work, agency and congressional reports,
    and relevant tax expenditure literature. In addition, we interviewed
    agency officials from the Department of the Treasury's Office of Tax
    Analysis; the Internal Revenue Service's Office of Research, Analysis, and
    Statistics; the Office of Management and Budget (OMB); congressional staff
    from the Joint Committee on Taxation (JCT); and experts on tax policy to
    obtain a greater understanding of information gained through our
    literature review and to corroborate findings.

    To identify how tax expenditures have changed over the past three decades
    in number and size in terms of aggregate revenue loss and
    outlayequivalents, we analyzed tax expenditure estimates developed by
    Treasury and reported by OMB in the Federal Budget's Special Analyses,
    Appendixes, and Analytical Perspectives for fiscal years 1974 to 2004. Tax
    expenditure estimates are reported for individual and corporate taxpayer
    groups and categorized by budget function. We chose the tax expenditure
    estimates reported in the budget for our analysis because Treasury
    develops (1) revised estimates based on changes in tax policy and economic
    activity for the year prior to the reported fiscal budget year (i.e.,
    retrospective estimates), and (2) outlay-equivalent estimates that
    facilitate comparison to federal spending. Even though Treasury's
    estimates are retrospective, the final reported numbers are still
    estimates and may not reflect additional policy changes. Although the tax
    expenditure concept can also be applied to other kinds of taxes, such as
    excise taxes, this report only covers tax expenditures for the federal
    income tax system.

    We determined the number of tax expenditures for each fiscal year by
    adding the number of items in the list of tax expenditures reported by
    Treasury for each fiscal year. In certain fiscal years, Treasury reported

    1GAO, Tax Policy: Tax Expenditures Deserve More Scrutiny,
    GAO/GGD/AIMD-94-122 (Washington, D.C.: June 3, 1994).

    Appendix I Scope and Methodology

    estimates for select tax expenditures as two line items on their list,
    such as the expensing of exploration and development costs, which was
    split out as two tax expenditures, one pertaining to oil and gas and one
    for other fuels between fiscal years 1980 and 1995. To be consistent with
    Treasury's reporting of these tax expenditures in years when they were
    listed as only one item, we summed the revenue loss estimates in the years
    they were listed as two tax expenditures and counted them as one. To
    determine the number of distinct tax expenditures across fiscal years, we
    reviewed the names and descriptions for each tax expenditure reported by
    OMB in the Budget's Special Analyses, Appendixes, and Analytical
    Perspectives for fiscal years 1974 to 2004. We conducted two independent
    reviews to verify that our list contained only distinct tax expenditures
    across fiscal years. To assist in our review, we also relied on the
    descriptions reported in the Congressional Research Service's compendiums
    on tax expenditures and legislative histories of certain tax expenditures,
    as needed. App. IV contains our compilation of all tax expenditures
    reported by Treasury between 1974 and 2004.

    We aggregated tax expenditure revenue loss estimates to measure growth
    over time. We also summed the revenue loss estimates by their reported
    corporate and individual basis to see how the amounts differed between the
    two taxpayer groups. We converted all sums for each fiscal year into
    constant dollars to adjust for inflation using the chain price indexes
    reported in the fiscal year 2006 federal budget. While summing tax
    expenditure estimates provides a useful perspective, aggregate numbers
    should be interpreted carefully due to interactive effects between tax
    expenditures and potential behavioral changes.

    To identify how tax expenditures have changed over the past three decades
    in comparison to federal spending, revenue, and the economy, we summed the
    outlay-equivalent estimates for each fiscal year and compared them to the
    federal budget position in aggregate. We used historical data on spending
    drawn from OMB historical tables and compared them to the sums for tax
    expenditure outlay-equivalent estimates in dollar value and as a
    percentage of GDP. We also used outlay-equivalent estimates to compare tax
    expenditure trends over time by budget function. Finally, we used
    historical data on spending by budget function from OMB historical tables
    and compared them to the sum of tax expenditures by budget functions for
    fiscal year 2004. We worked with Treasury officials to verify any
    discrepancies we found in using the tax expenditure estimates and modified
    our data accordingly.

    Appendix I Scope and Methodology

    To determine the amount of progress since 1994 in how the federal
    government scrutinizes tax expenditures, we examined actions taken to
    implement our earlier recommendations to OMB intended to encourage more
    informed policy debate about tax expenditures and to stimulate joint
    review of related tax and spending programs. We recommended (1) developing
    a structure for conducting reviews of tax expenditures' performance (2)
    conducting case studies to assess performance review structure (3)
    presenting tax expenditures in the annual budget, and (4) incorporating
    tax expenditures into the annual budgetary review process. We reviewed
    relevant literature, interviewed relevant agency officials and tax policy
    experts, and relied on previous GAO work to determine the progress that
    has been made in implementing our recommendations. We reviewed efforts to
    include tax expenditures under the Government Performance and Results
    Act's statutory framework for strategic planning, performance measurement,
    and program evaluation.2 We also considered activities to include tax
    expenditures under OMB's Program Assessment Rating Tool process.

    To describe how tax expenditures are measured and reported, we reviewed,
    but did not verify, the procedures used by the Joint Committee on Taxation
    and Treasury to estimate the magnitude of revenues forgone through tax
    expenditures or, in Treasury's case, their outlay-equivalent values as
    well. As described in app. III, JCT and Treasury use different conceptual
    approaches to identify the provisions of the tax code they label as tax
    expenditures. In addition, their estimating models, macroeconomic
    assumptions, and choice of data cause their revenue loss estimates to
    differ somewhat.

    We conducted our work between August 2003 and July 2005 in accordance with
    generally accepted government auditing standards.

    2 Pub. L. No. 103-62.

    Appendix II

    Comments from the Office of Management and Budget

    Note: GAO comments supplementing those in the report text appear at the
    end of this appendix.

    See comment 1.

    See comment 2.

    See comment 3.

    See comment 1.

    Appendix II
    Comments from the Office of Management
    and Budget

                                     See comment 1.

                                     See comment 4.

    Appendix II
    Comments from the Office of Management
    and Budget

    See comment 5.

                                 See comments 1 and 6.

    Appendix II
    Comments from the Office of Management
    and Budget

                                     See comment 1.

                                     See comment 7.

    Appendix II
    Comments from the Office of Management
    and Budget

                                     See comment 8.

                                     See comment 9.

    Appendix II
    Comments from the Office of Management
    and Budget

                                    See comment 10.

                                    See comment 11.

                                      Appendix II
                         Comments from the Office of Management
                                       and Budget

    The agency comments and evaluation section of this report discusses our
    overall comments on the Office of Management and Budget's letter dated
    September 2, 2005. The following are our additional comments on issues
    raised by OMB.

      GAO Comments 1.

    2.

    3.

    4.

    5.

    6.

    See the agency comments and evaluation section of this report.

    While we believe that the nation's current and projected fiscal imbalance
    provides an additional impetus for engaging in such a review and
    reassessment, we believe tax expenditures should be reviewed and evaluated
    for efficiency and effectiveness even if there were no fiscal imbalance.
    We did not suggest that extra attention to tax expenditures would
    eliminate the long-term fiscal imbalance. As our report stated,
    substantive reform of Social Security and the major health programs
    remains critical to recapturing our fiscal flexibility.

    Our report cites several examples of changes in the presentation of tax
    expenditures over time. For example, starting with the fiscal year 1999
    budget, OMB began including a section outlining possible performance
    measures and issues in evaluating tax expenditures. This section was a
    first step in responding to congressional expectations for the Executive
    Branch to provide information about how tax expenditures meet their
    objectives and affect the performance of other federal programs.

    We do not take for granted that tax expenditures are similar to spending
    programs. We devote a section of our background to describing how tax
    expenditures differ from, may substitute for, and work in conjunction with
    other spending programs to achieve policy objectives. Also, see the agency
    comments and evaluation section of this report.

    In our report, we recommend adding useful comparisons to spending programs
    to the budget document, while not detracting from or changing in any way
    how the tax expenditure lists can be used to think about tax policies.

    To the contrary, throughout our draft report we note and even emphasize
    the limitations in the methodology of summing the individual tax
    expenditures. In fact, to ensure that summing limitations of tax
    expenditures were clearly acknowledged, we discussed the limitations in
    (1) the introduction of our methodology, (2) a footnote in

    Appendix II
    Comments from the Office of Management
    and Budget

    the Results In Brief section, (3) the section devoted to explaining the
    limitations which precedes our presentation of the trends in tax
    expenditures over time, and (4) a footnote for all 10 figures where we
    summed the tax expenditure estimates. In addition, we report a
    quantitatively significant example of interaction effects of tax
    expenditure estimates, which was developed by Treasury at our request. The
    example shows that the revenue loss calculation assuming the simultaneous
    elimination of several itemized deductions would be less than the sum of
    the revenue loss estimates for each itemized deduction, each calculated
    assuming the rest of the tax code was unchanged. As our report stated, tax
    expenditure estimates produced by Treasury and JCT are the best and only
    available data to measure the value of tax expenditures and make
    comparisons to other spending programs. In our view, summing the estimates
    provides perspective on the use of tax expenditures as a policy tool and
    represents a useful gauge of the general magnitude of government subsidies
    carried out through the tax code. Our report also cites several other
    researchers who have summed tax expenditure estimates to help gain
    perspective on the use of this policy tool and examine trends in the
    aggregate growth of tax expenditure estimates over time.

    7.	In this report, we provide a number of examples of studies we and
    others have done of tax expenditures; our reviews often are at the request
    of Congress, and OMB examined two tax expenditures under the
    Administration's PART initiative. We also provide illustrations of the
    major legislation that has affected tax expenditures since the late 1970s.
    However, we stand by our statement that tax expenditures are not subject,
    or effectively subject, to several major processes that apply to outlay
    programs that increase the likelihood of reviews and, perhaps more
    importantly, increase the quantity and quality of information available to
    policymakers in determining whether and how to modify tax expenditures.
    Developing such enhanced information for policymakers and displaying it in
    a manner that facilitates their understanding of the total federal effort
    to address functionally related issues, e.g., ensuring adequate housing or
    stimulating economic development, is the thrust and intent of our report
    and recommendations.

    8.	We disagree with OMB's characterization that the current tax
    expenditure presentation is "more than adequate" for the public and
    policymakers. We realize that the current budget volume is not organized
    by separate budget functions; however, OMB had previously

    Appendix II
    Comments from the Office of Management
    and Budget

    presented revenue loss sums for tax expenditures alongside outlays and
    credit activity for each budget function in the federal budget from fiscal
    year 1998 through fiscal year 2002. As we state in our report, these
    summary tables were a useful starting point in highlighting the relative
    magnitude of tax expenditures and related outlay programs across mission
    areas. In addition, our current recommendation gives OMB latitude on how
    to present them with other outlay programs with similar purposes. Further,
    Congress has shown significant interest in reviewing all tools within a
    mission area. For example, recent congressionally-requested studies we
    conducted have reviewed all tools-including tax expenditures-used in the
    post-secondary education and energy areas.1 Also, see comment 2 as well as
    the agency comments and evaluation section of this report.

    9.	We disagree with the opinion that OMB has implicitly expressed that it
    would not have a leadership role regarding our second recommendation.
    First, we are not recommending that OMB be responsible for conducting the
    actual reviews, just to develop and oversee the implementation of a
    framework for conducting the performance reviews. OMB would not need to
    have access to taxpayer data to manage the process. Secondly, we recognize
    the challenges in using taxpayer data, which is the reason we recommend
    that OMB work in consultation with Treasury to develop and implement the
    framework. Third, taxpayer data may not be the only source of performance
    information on tax expenditures, which is why we recommend that the
    framework address the lack of credible performance information on tax
    expenditures. Finally, our report recognizes the scarcity of evaluation
    resources and we suggest taking a strategic approach to select and
    prioritize tax expenditure evaluations based on such factors as the
    relative priorities, costs, and risks associated with related clusters of
    programs and activities and that OMB select similar programs for review in
    the same year to facilitate comparisons and tradeoffs. To make this point
    more apparent in our report, we added a fourth element to our
    recommendation that OMB and Treasury in developing a framework for
    evaluating tax

    1GAO, Student Aid and Postsecondary Tax Preferences: Limited Research
    Exists on Effectiveness of Tools to Assist Students and Families Through
    Title IV Student Aid and Tax Preferences, GAO-05-684 (Washington, D.C.:
    Jul. 29, 2005), and National Energy Policy: Inventory of Major Federal
    Energy Programs and Status of Policy Recommendations, GAO-05-379
    (Washington, D.C.: Jun. 10, 2005).

    Appendix II
    Comments from the Office of Management
    and Budget

    expenditures are to identify any additional resources that may be needed
    for tax expenditure reviews.

    10. OMB misstated our recommendation. This report does not recommend that
    agencies be responsible for administering parts of the tax code. As we
    state in our report, in passing the Government Performance and Results
    Act, the Senate Governmental Affairs Committee called for inclusion of tax
    expenditures in the GPRA process so that more and better information would
    be available on the performance of tax expenditures themselves and the
    effects of tax expenditures would be considered in achieving federal
    performance goals. Our recommendation is consistent with this intent.
    Also, see the agency comments and evaluation section of this report.

    11. Our recommendation aims to bring tax expenditures in line with the
    performance management attention PART gives to outlay programs. Our report
    discussed the two cases where OMB has applied PART to tax expenditures-the
    EITC compliance initiative and the New Markets Tax Credit. Within the
    executive branch, the Department of the Treasury has major responsibility
    for managing programs implemented through the tax system. Given that over
    the next 2 years the Administration plans to assess nearly all remaining
    executive branch outlay programs, Treasury would be facing relative less
    scrutiny than other agencies to the extent that the tax expenditure tool
    is not similarly evaluated under PART. Although OMB disagreed with our
    recommendations as a whole, we are encouraged that OMB is still
    considering how other tax expenditures could be evaluated with PART in the
    future. In moving forward, PART reviews of tax expenditures in isolation
    might be revealing, but we would urge a more comprehensive and
    crosscutting approach to assessing all tools-including tax
    expenditures-related to common goals.

    Appendix III

    How Tax Expenditures Are Measured and Reported

    To understand the trends in the size of tax expenditures, it is helpful to
    understand how tax expenditures are measured and reported annually. This
    appendix explains the baselines used to distinguish tax expenditures from
    other provisions in the tax code and provides an explanation of the
    different methods that are used to measure tax expenditures.

      Tax Expenditures Are Reported Annually by Law and Measurements Depend on
      Baselines Used

    The Congressional 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
    which provide a special credit, a preferential rate of tax, or a deferral
    of tax liability. Both the congressional Joint Committee on Taxation (JCT)
    and the Department of the Treasury's Office of Tax Analysis annually
    compile a list of tax expenditures and estimates of their cost each year.
    The Department of the Treasury's (Treasury) tax expenditure estimates are
    included in the annual federal budget by the Office of Management and
    Budget (OMB).

    While, in general, the tax expenditure lists published annually by JCT and
    Treasury are similar, they differ somewhat in the number of tax
    expenditures reported and the estimated revenue loss for particular
    expenditures. Part of this difference arises because the organizations use
    different income tax baselines to determine tax expenditures. To determine
    the tax code provisions that satisfy the definition of a tax expenditure,
    the existing tax law must be compared or measured against an alternative
    set of tax rules that represent a baseline. The Congressional Budget Act
    did not define a specific baseline tax structure. As a result, the
    Treasury and the staff of the JCT have used judgment to define the
    different baselines that they use to develop lists of tax expenditures.
    Before the fiscal year 1983 budget, there were few differences between the
    Treasury and JCT tax expenditure lists because both organizations used a
    baseline patterned on a comprehensive income tax, which was deemed the
    "normal" baseline. JCT has used this baseline consistently over time in
    producing its tax expenditure list, while Treasury has modified its normal
    baseline over time and provided alternative baselines. In general, the
    normal income tax law baseline developed by both Treasury and JCT
    represents a broad-based income tax on individuals and a separate income
    tax on corporations. The normal baseline includes income from all sources,
    including wages and salaries, fringe benefits and other forms of employee
    compensation, interest income, dividends, realized capital gains, and net
    income from noncorporate businesses such as sole proprietorships and
    partnerships. The

    Appendix III How Tax Expenditures Are Measured and Reported

    normal baseline generally allows for personal exemptions, deductions for
    costs incurred to earn income, and a standard deduction.

    Currently, the normal baselines used by both Treasury and JCT differ
    somewhat. Treasury's normal baseline excludes several tax expenditures
    that are included in the normal baseline used by JCT and leads to several
    tax expenditures being reported by JCT only. For instance, the exclusion
    of Medicare hospital insurance benefits is included in the JCT list but
    this provision is not included in the federal budget tax expenditure list
    because Treasury views the exclusion of government benefits received in
    kind as part of its normal baseline. Additional examples of specific tax
    expenditures reported by only JCT or Treasury can be found at the end of
    this appendix in table 2.

    In the fiscal year 1983 budget, Treasury introduced the concept of a
    reference baseline. The reference baseline used by Treasury is also
    patterned on a broad-based income tax, but it is closer to existing law
    because tax expenditures by definition are limited to special exceptions
    that serve programmatic functions, such as national defense, income
    security, and education. Under Treasury's reference baseline, two
    conditions are necessary for a provision to qualify as a tax expenditure:
    (1) The provision must be "special" in that it applies to a narrow class
    of transactions or taxpayers and (2) There must be a general provision to
    which the special provision is a clear exception. The set of general tax
    rules in the existing tax code is used as the standard by which various
    provisions are determined to be special. Whereas accelerated depreciation
    was considered a special rule exception under the normal baseline, these
    provisions were not considered tax expenditures under the reference
    baseline, because accelerated depreciation was considered to be the
    general treatment for the depreciation of business assets. The
    preferential tax rate for capital gains was included in Treasury's tax
    expenditure list based on the general tax code rule that income from any
    source is considered taxable. For fiscal year 1983, Treasury began to
    report estimates using the reference baseline for some tax expenditures
    and then reinstituted reporting estimates for the normal baseline in
    fiscal year 1985. This reporting practice has continued to the present.

    In recent years, Treasury modified treatment of certain provisions under
    its normal and reference baselines and introduced two supplemental
    baselines. In the 2005 and 2006 budgets, Treasury excluded the reduced tax
    rate on dividends and capital gains that have already been taxed under the
    corporate income tax from the reference law baseline because it believes

    Appendix III How Tax Expenditures Are Measured and Reported

    that since current law taxes these forms of corporate income twice, it is
    an inappropriate baseline to use. Also, in the 2004, 2005, and 2006
    budgets, Treasury changed how it computed the accelerated depreciation tax
    expenditure under the normal baseline by using a measure of economic
    depreciation rather than straight-line depreciation as the baseline
    depreciation method, which was used in prior years. The measure of
    economic depreciation is generally faster than the straight-line method,
    so the tax expenditure estimates for accelerated depreciation for fiscal
    years 2002, 2003, and 2004 (from the 2004, 2005, and 2006 budgets) are
    smaller than what they would have been if the straight-line depreciation
    method were used. In addition, in the 2004 budget, Treasury began
    reporting two supplemental baselines, as discussed in figure 14.

    Figure 14: Treasury's Supplemental Reporting for Comprehensive Income and
    Consumption Tax Baselines

    In the 2004 budget, Treasury began reporting estimates for the 30 largest
    tax expenditures using comprehensive income and consumption tax baselines.

    o  Treasury defines its comprehensive income baseline as the
    real-inflation adjusted- accrual of wealth arising between the beginning
    and end of the year. The comprehensive income baseline includes all
    accrual of wealth, whether or not realized, whether or not related to a
    market transaction, and whether it is a return to capital or labor.
    Inflation adjusted capital gains would be included in comprehensive income
    as they accrue. According to Treasury's reporting, 13 large tax
    expenditures under its normal and reference baselines, such as capital
    gains on home sales, would continue to be considered tax expenditures
    under a comprehensive baseline. Treasury was uncertain about whether 6
    would still be considered tax expenditures and concluded 4 would probably
    not be tax expenditures under the comprehensive income tax baseline. The
    tax exemption of in-kind benefits from government programs such as food
    stamps, public housing, and Medicaid would be added to Treasury's tax
    expenditure list under the comprehensive income tax baseline.

    o  Treasury defines its consumption baseline as a combination of an income
    tax plus a deduction for net saving. The major difference between
    Treasury's comprehensive income and consumption baselines is the treatment
    of tax expenditures related to saving. According to Treasury, 4 tax
    expenditures under its normal or reference baseline would still be
    considered tax expenditures under its consumption baseline, and another 12
    would probably still be considered tax expenditures as well, such as the
    child tax credit. The capital gains exclusion on home sales would not be
    considered a tax expenditure under the consumption tax baseline. However,
    tax expenditures unrelated to broad based saving incentives would remain
    tax expenditures under a consumption baseline.

    Source: Office of Management and Budget. Analytical Perspectives, Budget
    of the United States Government, Fiscal Year 2006, (Washington, D.C.:
    2005).

    Appendix III How Tax Expenditures Are Measured and Reported

    Both Treasury and JCT provide estimates of revenue loss, which is the
    amount of revenue that the government forgoes as the result of each
    special provision in the tax code. Revenue loss is estimated for each tax
    expenditure separately by comparing the revenue raised under current law
    with the revenue that would have been raised if the single provision did
    not exist, assuming that taxpayer behavior and all other tax and spending
    provisions remain constant. A revenue loss estimate does not represent the
    amount of revenue that would be gained if a particular tax expenditure
    were repealed, since repeal of the expenditure would probably change
    taxpayer behavior in some way that would affect revenue.

    Treasury and JCT tax expenditure lists will also differ because each
    organization uses a different de minimis amount, which is the minimum
    amount of revenue loss threshold for Treasury and JCT to report a tax
    expenditure. JCT excludes tax expenditure estimates that result in revenue
    losses that are less than $50 million over its 5-year projected period.
    For instance, the tax exemption for certain small insurance companies was
    not included in JCT's January 2005 list of tax expenditures because the
    estimated revenue loss was below its de minimis amount. Treasury rounds
    all yearly estimates to the nearest $10 million and excludes tax
    expenditures with estimates that round to zero in each of the 7 years that
    it reports tax expenditure estimates.

    JCT and Treasury estimates of revenue loss also differ somewhat due to
    different economic and technical assumptions. For instance, JCT and
    Treasury use different sources for macroeconomic assumptions incorporated
    in their revenue loss estimates. JCT uses CBO macroeconomic assumptions in
    its tax expenditure projections and Treasury uses assumptions based on
    consultations with OMB, and the Council of Economic Advisers,1 the same
    assumptions used for the President's budget. In addition to projecting
    future revenue losses, Treasury also reports re-estimates for the past
    fiscal year, which incorporate changes in tax policy and reflect more
    up-to-date economic and taxpayer data. Table 3 compares tax expenditure
    reporting by JCT and Treasury.

    1 At OMB, the economic forecast is produced by the Troika: economists
    drawn from the Council of Economic Advisers, the Department of the
    Treasury, and OMB.

              Appendix III How Tax Expenditures Are Measured and Reported

          Table 3: Comparison of Tax Expenditure Reporting by JCT and Treasury

                                      Joint Committee on  U.S. Department of the
                    Report Elements       Taxation (JCT)                 Treasury
                     Period covered Current fiscal year         Last fiscal year,
                                    and 4                          current fiscal
                                     future fiscal years       year, and 5 future
                                                                     fiscal years
                      Baseline used               Normal Reference (since 1983),
                                                                           normal
              Measurement estimates         Revenue loss    Revenue loss, outlay-
                           produced                                    equivalent

    Macroeconomic assumptions

    Congressional Budget Office (CBO) (mid-year update)

    OMB, Treasury, and Council of Economic Advisersa

    De minimis rule	Excludes provisions with estimates of less than $50
    million over the 5-year period Rounds all yearlyestimates to the nearest
    $10 million and excludes provisions with estimates that round to zero in
    each of the 7 years

    Categorized by	Budget function, taxpayer Budget function, taxpayer group
    (i.e., individual or group (i.e., individual or corporate) corporate)

    Supplemental information	Distributional estimates by Present value
    estimates (for income class (for 9 deferral expenditures); expenditures);
    summary of comprehensive and recent legislation regarding consumption
    baselines used tax expenditures; list of (for select expenditures)
    expiring tax expenditure provisions; and summary of differences between
    Treasury and JCT lists of tax expenditures

    Sources: Office of Management and Budget, Analytical Perspectives, Budget
    of the United States Government, Fiscal Year 2006 (Washington, D.C.:
    2005); Joint Committee on Taxation, Estimates of Federal Tax Expenditures
    for Fiscal Years 2005-2009, JCS-1-05 (Washington, D.C.: Jan. 12, 2005);
    and Polackova Brixi, Hana, and Christian M.A. Valenduc, and Zhicheng Li
    Swift, Tax Expenditures- Shedding Light on Government Spending through the
    Tax System: Lessons from Developed and Transition Economies (Washington,
    D.C.: The World Bank, 2004).

    a Estimates are based on mid-session economic assumptions; exceptions are
    the earned income tax credit and the child tax credit, which involve
    outlay components and hence are updated to reflect the economic
    assumptions used elsewhere in the budget. At OMB, the economic forecast is
    produced by the Troika: economists drawn from the Council of Economic
    Advisers, the Department of the Treasury, and OMB. See Analytical
    Perspectives, "Economic Assumptions and Analyses" for a discussion of the
    Troika assumptions.

    Outlay-Equivalent Estimates In addition to revenue loss estimates,
    Treasury also measures tax Facilitate Comparison to expenditures in terms
    of their outlay-equivalent value, which allows the Direct Spending
    Programs cost of a tax expenditure to be compared with a direct federal
    outlay, were

    each to provide the same benefit to the taxpayer. JCT does not produce
    outlay-equivalent estimates. The underlying economic assumptions used

    Appendix III How Tax Expenditures Are Measured and Reported

    for the outlay-equivalent and revenue loss estimates are the same.
    However, to estimate outlay-equivalents, Treasury will increase-"gross
    up"-the revenue loss estimate by the average marginal tax rate that
    applies to the relevant taxpayers (the taxpayers that take the particular
    credit or deduction or earn the income that is excluded from tax).2 The
    result is an estimate of the amount of direct spending that would be
    needed to leave the relevant taxpayer with the same amount of benefit,
    after he or she paid tax on the amount received through the spending, as
    the taxpayer would get from the tax provision itself. For example, the
    outlay-equivalent estimate for the housing and meal allowances for
    military personnel tax expenditure reflects the additional pre-tax income
    that military personnel would have to be paid to raise their income after
    federal taxes by the amount of the benefits, so that it can be compared
    with other defense outlays on a consistent basis. An exception to this
    general rule of increasing the revenue loss estimate is made for tax
    expenditures that are believed to reduce the price of particular goods and
    services. In this case no gross up is made because a spending program that
    led to the same price reduction would not increase the tax liability of
    the taxpayer. For instance, revenue loss estimates for accelerated
    depreciation on rental housing and state prepaid tuition do not differ
    from the outlay-equivalent estimates for these tax expenditures.

    Outlay-equivalents can also differ from revenue loss estimates because
    they are calculated based on an even flow of virtual payments over the
    year to make the estimates comparable to actual outlay programs. Even for
    those tax expenditures that do not require a calculated adjustment,
    differences between the revenue losses and outlay-equivalents can occur
    solely because of differences in timing factors. Although revenue loss
    estimates can be affected by the collection patterns of the corporate and
    personal income taxes, the cash flow of direct spending programs can
    differ widely from the annual tax collection cycle. Of the 146 tax
    expenditures reported in the fiscal year 2006 budget, 91 were "grossed up"
    for the outlay-equivalent estimate with the implied rate varying across
    different provisions. Just as there is debate over which tax provisions
    should be listed as tax expenditures, tax experts do not always agree on
    whether specific tax expenditures should be grossed up or not. It may not

    2The net revenue loss for the federal government would be unchanged.
    Assuming the comparable outlay program would be taxable, the recipients
    would pay taxes on the higher outlay amount, and federal revenue also
    would be higher-resulting in no net change in the federal budget position.

              Appendix III How Tax Expenditures Are Measured and Reported

    be apparent to observers why the outlay-equivalent and revenue loss
    estimates are the same for some tax expenditures and why they differ for
    other tax expenditures. 3

    Other estimates of tax expenditures produced by JCT and Treasury also may
    differ from revenue loss estimates. These supplemental estimates are
    discussed in figure 15.

    Figure 15: Supplemental Estimates Developed by Treasury and JCT

    o  Since the 1995 fiscal year budget, Treasury has produced present value
    estimates for the approximately 20 tax expenditures that involve tax
    deferrals or other long-term revenue effects. Revenue loss estimates,
    which are cash based, can overstate the real effect on receipts to the
    government for tax deferrals because deferred taxes will ultimately be
    paid. To produce present value estimates Treasury must make certain
    assumptions. Assumptions also may be specific to individual tax
    expenditures, such as the time frame when people will retire and begin to
    collect funds from retirement accounts (and pay income taxes on them).
    Treasury uses the simplifying assumption that interest rates and tax rates
    remain constant over time.

    o  JCT also presents a distributional analysis of several tax
    expenditures. This analysis estimates the amount of benefits by income
    class for the deductions for medical expenses, real estate taxes,
    charitable contributions, and the child care and earned income credits.
    JCT does not report all individual tax expenditures because of the
    difficulty in making reliable estimates of the income distribution of
    items that do not appear on tax returns under present law.

    Sources: Office of Management and Budget, Analytical Perspectives, Budget
    of the United States Government, Fiscal Year 2006 (Washington, D.C.:
    2005); and Joint Committee on Taxation, Estimates of Federal Tax
    Expenditures for Fiscal Years 2004-2008, JCS-803 (Washington, D.C.: Dec.
    22, 2003).

      Comparison of JCT With Treasury Tax Expenditure Lists

    Although there are differences between how Treasury and JCT develop and
    measure tax expenditures, the sum of revenue loss estimates from each list
    has followed relatively the same trend in the past. Figure 16 compares the
    sum of revenue loss estimates for JCT and Treasury since the last
    comprehensive tax reform, when the Tax Reform Act of 1986 was adopted.
    Since fiscal year 2002, the trends in the sums of the two sets of revenue
    loss estimates have diverged. Since the fiscal year 2004 Budget,
    Treasury's

    3For more information on how outlay-equivalent estimates are measured, see
    the Office of Management and Budget, Special Analysis G-Fiscal Year 1983
    (Washington, D.C.: 1982); and the U.S. Congressional Budget Office, Tax
    Expenditures: Current Issues and 5-Year Budget Projections for Fiscal
    Years 1984-1988 (Washington, D.C.: October 1983).

              Appendix III How Tax Expenditures Are Measured and Reported

    estimates of dividends and capital gains tax expenditures are lower than
    JCT's, at least in part, because Treasury changed its definition of the
    tax expenditures to reflect the reduced tax rates only on dividends and
    capital gains from sources other than corporate equity. Treasury also
    redefined the accelerated depreciation tax expenditures under the normal
    baseline to reflect depreciation relative to a replacement cost basis,
    rather than the historic cost basis previously used.

    Figure 16: Sum of Revenue Loss Estimates Reported by the Joint Committee
    on Taxation and the U.S. Department of the Treasury (1987-2004)

    Dollars in billions (in constant 2004 dollars) 900 850 800 750 700 650 600
    550 500 450 400 350 300 250 200 150 100

    50 0

    1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
    2002 2003 2004

    Fiscal year

                            U.S. Department of the Treasury

                              Joint Committee on Taxation

    Source: GAO analysis of OMB Fiscal Year Budget and Joint Committee on
    Taxation Reports on Tax Expenditures, fiscal years 1989-2005.

    Notes: Summing the revenue loss estimates does not take into account
    possible interaction effects among the tax expenditures. Changes in
    economic conditions and estimation techniques, can affect revenue loss
    estimates for tax expenditures, making them differ from year to year.
    Changes to the number of tax expenditures reported by Treasury would also
    affect the amount of revenue loss reported if some tax expenditures were
    eliminated or added. Finally, revenue loss estimates include the effect of
    certain tax credits on receipts only and not the effect of the credits on
    outlays.

    Table 4 lists the tax expenditures and their associated revenue loss
    estimates that were reported by both Treasury and JCT for fiscal year
    2004. The table details the number and size of tax expenditure estimates
    between the two lists. For example, in the National Defense budget
    function, the revenue loss estimate for the exclusion of benefits and
    allowances to

              Appendix III How Tax Expenditures Are Measured and Reported

    armed forces personnel was estimated at $2.5 billion by Treasury and $2.7
    billion by JCT. In the same function, JCT also reported revenue losses for
    two tax expenditures not listed by Treasury.

    Table 4: List of Tax Expenditures Reported by the U.S. Department of the
    Treasury and the Joint Committee on Taxation for Fiscal Year 2004

    Dollars in millions

                                                          Treasury  JCT estimates
                                                         estimates
    Budget function       Tax expenditure name         Corporate     Corporate
                                                         Individual    Individual
          National         Exclusion of benefits and
           Defense            allowances to Armed             2,460         2,700
                               Forces personnel

    Exclusion of military disability benefitsb

    Deduction for overnight-travel expenses of National Guard and Reserve
    Membersb

         International     Exclusion of income earned           2,680       3,400
            Affairs          abroad by U.S. citizens
                         Exclusion of certain allowances         850
                              for federal employees
                                     abroad
                             Extraterritorial income     5,500        5,200
                                    exclusion
                         Inventory property sales source 1,500        5,400
                                 rule exception
                              Deferral of income of      7,240        4,600
                         controlled foreign corporations
                          Deferred taxes for financial
                             firms on certain income     2,130        1,900
                                 earned overseas
                            Expensing of research and            -50
    General Science,           experimental           -2,280       3,500
          Space, and              expenditures
          Technology
                         Credit for increasing research  4,630   50   3,900     a
                                   activities
                          Expensing of exploration and    230    30    500      a
            Energy             development costs d

    aa

    Expensing of exploration and development costs: other fuels b

    a

    Excess of percentage over cost depletione 1,210 110 400

    aa

    Excess of percentage over cost depletion: other fuels

    b

                Alternative fuel production credit           1,000  40  500   100
        Exception from passive loss limitation for working          20
              interests in oil and gas properties c
          Capital gains treatment of royalties on coal c            70

    a

    Exclusion of interest on energy facility bonds 20 80 100 Enhanced oil
    recovery credit 300 30 200 100

    aa

    New technology credit 330

              Appendix III How Tax Expenditures Are Measured and Reported

                             (Continued From Previous Page)

    Dollars in millions

                                                          Treasury  JCT estimates
                                                         estimates
        Budget function       Tax expenditure name       Corporate      Corporate
                                                         Individual    Individual
                              Alcohol fuel credit f           20 10       a
                          Tax credit and deduction for        20 50
                               clean fuel-burning
                                   vehicles c
                            Exclusion from income of                            a
                             conservation subsidies             100
                          provided by public utilities
                           Tax credit for electricity                        a200
                              production from wind,
                          biomass, and poultry waste b
    Natural Resources  Expensing of exploration and       210 20           a a
                               development costs,
        and Environment         nonfuel minerals
                         Excess of percentage over cost                  100
                               depletion, nonfuel
                                    minerals
                         Exclusion of interest on bonds     110 390      200
                         for water, sewage, and
                           hazardous waste facilities
                           Capital gains treatment of            70
                             certain timber income c
                            Expensing of multiperiod        230 110          a200
                              timber-growing costs
                         Tax incentives for preservation     230 70      400
                             of historic structures
                         (under Commerce and housing
                         credit budget function
                                    for JCT)
                            Special rules for mining                          a a
                             reclamation reserves b
                         Special tax rate for nuclear                    300
                         decommissioning reserve
                                     fund b

    a

    Exclusion of contributions in aid of construction for water and sewer
    utilities b

    Expensing of capital costs with respect to complying with EPA sulfur
    regulations b

    Exclusion of gain or loss on sale or exchange of certain brownfield sites
    b

    a

    Agriculture Expensing of certain capital outlays 20 80 300

    Expensing of fertilizer and soil conditioner costsb	a 100 aa

    Expensing of soil and water conservation expenditures b

    Expensing of certain multiperiod production costs c 10 40

    Treatment of loans forgiven for solvent farmers 10 100

    Capital gains treatment of certain income c 670

    a

    Income averaging for farmers 40
    Deferral of gain on sales of farm refiners c 10
    Bio-Diesel tax credit b
    Exclusion of cost-sharing payments b a a

              Appendix III How Tax Expenditures Are Measured and Reported

                             (Continued From Previous Page)

    Dollars in millions

    Treasury estimates JCT estimates Budget function Tax expenditure name
    Corporate Individual Corporate Individual

    a

    Expensing of the costs of raising dairy and breeding cattle b

    aa

    Five-year carryback period for net operating losses attributable to
    farming b

        Commerce and  Exemption of credit union income  1,270        1,200
    Housing Credit
                         Excess bad debt reserves of      -20
                          financial institutions c
                        Exclusion of interest on life   2,010 18,820 1,400 24,700
                              insurance savings
                      Special alternative tax on small     10
                      property and casualty
                            insurance companies c
                      Deduction of unpaid property loss
                                reserves for                         1,500
                       property and casualty insurance
                                 companies b
                      Tax exemption of certain           180
                      insurance companies owned
                        by tax-exempt organizations c
                        Small life insurance company       80         100
                                  deduction
                          Special treatment of life
                              insurance company                      1,700
                                  reservesb
                          Exclusion of interest on       220   800    300
                           owner-occupied mortgage
                                subsidy bonds
                       Exclusion of interest on rental     80  280    100
                                housing bonds
                      Deductibility of mortgage
                      interest on owner-occupied              61,450       61,400
                                    homes
                      Deductibility of state and local
                      property tax on owner-                  19,930       18,700
                               occupied homes
                       Capital gains exclusion on home        29,730       17,900
                                    sales
                       Exclusion of net imputed rental
                              income on owner-                24,590
                              occupied homes c
                      Exception from passive loss rules
                               for $25,000 of                 5,030
                                rental loss c
                        Credit for low-income housing   2,930  730   3,000  1,300
                                 investments
                         Accelerated depreciation on      -10  760    300   3,000
                               rental housing
                      Deferral of income from post-1987  290   810    600     400
                              installment sales
                       Cancellation of indebtedness c           30
                      Exceptions from imputed interest          50       a    300
                                    rules
                      Capital gains (except
                      agriculture, timber, iron ore,
                      and                                     25,150       66,100
                                    coal)
                      Capital gains exclusion of small         160
                             corporation stock c
                      Step-up basis of capital gains at
                                    death                     24,200       35,900

              Appendix III How Tax Expenditures Are Measured and Reported

                             (Continued From Previous Page)

    Dollars in millions

                                                       Treasury    JCT estimates
                                                       estimates
    Budget function     Tax expenditure name          Corporate      Corporate
                                                        Individual     Individual
                        Carryover basis of capital             210          4,300
                              gains on gifts
                       Ordinary income treatment of             50
                              loss from small
                        business corporation stock
                                  sale c
                        Accelerated depreciation of
                           buildings other than        -2,980 -280    1,800 1,900
                              rental housing
                        Accelerated depreciation of
                               machinery and          37,080 7,610  52,900 16,100
                                 equipment
                        Expensing of certain small         680 840
                                investments
                       (JCT did not report a revenue
                              loss estimate)
                         Amortization of start-up            70 10       a
                                   costs

    Deduction for U.S. production activities b

                   Special rules for certain film and TV productionb

    Graduated corporation income tax rate 2,450 3,300

    Exclusion of interest on small issue bonds 100 350 100

    Deferral of gain on like-kind exchanges b 1,200

    a

    Deferral of gain on involuntary conversions resulting from
    Presidentially-declared disastersb

    Expensing of magazine circulation expenditures b a a

    aa

    Special rules for magazine, paperback book, and record returns b

    Completed contract rules b 200 a

              Cash accounting, other than agriculture b                a      700
          Exception from net operating loss limitations for          700
              corporations in bankruptcy proceedings b
          Tax credit for employer-paid FICA taxes on tipsb           200      300

    Transportation Deferral of tax on shipping companies 20 100

    Deduction for clean fuel vehicles and refueling 200
    property b
    Exclusion of reimbursed employee parking expenses 2,470
    c

    a

    Exclusion of employer-provided transit passes 410 3,800

    Tax credit for certain expenditures for maintaining railroad tracks b a

    Community and Investment credit for rehabilitation of structures, other 20
    20 100
    Regional than historic
    Development

    Exclusion of interest for airport, dock, and similar 180 670 200 600 bonds

    Appendix III How Tax Expenditures Are Measured and Reported

                             (Continued From Previous Page)

    Dollars in millions

                                                          Treasury  JCT estimates
                                                         estimates
    Budget function       Tax expenditure name         Corporate     Corporate
                                                         Individual    Individual
                       Exemption of certain mutuals and      60
                                 cooperatives
                                   income c
                       Empowerment zones, enterprise        280 800
                       communities, and
                             renewal communities c
                       Empowerment zone tax incentives b                 300
                       Renewal community tax incentives                  100
                                       b
                            New markets tax credit           70 220      100

    aa

    Expensing of environmental remediation costs 70 10 Deferral of capital
    gains with respect of dispositions of transmission property b

    New York City Liberty Zone tax incentives b 100

    aa

    District of Columbia tax incentives b

                             Wage credit for Indian reservation          a      a
                                         employmentb
                             Accelerated depreciation for Indian        100
                                         reservation
                                        investments b
                                Exclusion of scholarship and
    Education, Training,           fellowship income           1,320     1,500
         Employment, and
         Social Services
                                       HOPE tax credit            3,320     4,300
                               Lifetime Learning tax credit c     2,190
                               Education Individual Retirement
                                          Accounts                  110

              Deductibility of student loan interest               760        700
              Deduction for higher education expenses             1,280     2,700
                   State pre-paid tuition plans                    210        500
            Exclusion of interest on student loan bonds        60  230  100   300
    Exclusion of interest on bonds for private nonprofit  210   760  300   800
                      educational facilities
             Credit for holders of zone academy bonds          90       100

    Exclusion of interest on savings bonds redeemed to 10
    finance educational expenses
    Parental personal exemption for students age 19 or 3,200 1,500
    over
    Deductibility for charitable contributions (education) 510 3,180 1,100
    5,200
    Exclusion of employer-provided education assistance 530 800
    Special deduction for teacher expenses 150 100

    a

    a

    Work opportunity tax credit 240 40 200

    Appendix III How Tax Expenditures Are Measured and Reported

                             (Continued From Previous Page)

    Dollars in millions

                                                        Treasury    JCT estimates
                                                        estimates
        Budget          Tax expenditure name          Corporate         Corporate
    function                                       Individual       Individual
                     Welfare-to-work tax credit               50 10          a100
                    Employer-provided child care                600
                             exclusion g
                 Employer-provided child care credit                         a100
                    Assistance for adopted foster               290
                             children c
                    Adoption credit and exclusion               450
                Exclusion of employee meals and                 810
                lodging (other than
                              military)
                           Child credit h                    22,400        44,100
                 Credit for child and dependent care          2,990         3,100
                              expenses
                     Credit for disabled access               10 20       a
                            expenditures
                    Deductibility for charitable
                      contributions, other than        1,170 26,200  1,800 27,900
                        education and health
                  Exclusion of certain foster care              440
                              payments
                  Exclusion of parsonage allowances             430
                Exclusion of benefits provided under                       16,900
                cafeteria plans b i
                  Exclusion of miscellaneous fringe
                             benefits b                                     5,800

    Exclusion of employee awards b

           Exclusion of income earned by voluntary employees'               3,200
                       beneficiary associations b

              Deferral of taxation on spread on                               400
              acquisition of stock
                 under incentive stock option plans and
                                employee
                        stock purchase plans b j
    Health   Exclusion of employer contributions for
                                 medial                        102,250     96,000
                  insurance premiums and medical carek
                 Deductibility of self-employed medical
                               insurance                        3,300       3,300
                                premiums
                Medical savings accounts/health savings          620          300
                                accounts
                   Deductibility of medical expenses            7,380       5,900
              Exclusion of interest on hospital            400  1,470  500  1,200
              construction bonds
              Exclusion of workers' compensation benefits
              (medical                                                      3,700
                               benefits)b
               Deductibility of charitable contributions   150  2,940  900  3,500
                                (health)
                  Tax credit for orphan drug research      180         200
              Special Blue Cross/Blue Shield deduction (in 400         500

    Commerce and housing credit budget function for JCT)

    Appendix III How Tax Expenditures Are Measured and Reported

                             (Continued From Previous Page)

    Dollars in millions Exclusion of untaxed Medicare benefits: prescription
    drug insurance (Part D)b

                                                          Treasury  JCT estimates
                                                         estimates
        Budget            Tax expenditure name            Corporate     Corporate
    function                                          Individual    Individual
                 Tax credit for health insurance                 50           a a
                 purchased by certain
                   displaced and retired individuals l
                 Exclusion of medical care and
                 CHAMPUS/TRICARE                                            1,700
                 medical insurance for military
                 dependents, retirees,
                        and retiree dependents b
    Medicare  Exclusion of untaxed Medicare benefits:
                                hospital                                   16,800
                           insurance (Part A)b
                 Exclusion of untaxed Medicare benefits:                   11,000
                  supplementary medical insurance (Part
                                   B)b

    Exclusion of certain subsidies to employers who maintain prescription drug
    plans for Medicare b

    Income Security	Exclusion of railroad retirement system benefitsc (For 400
    JCT this is combined with the exclusion of Social Security benefits:
    retired workers)

                   Exclusion of worker's compensation benefits    5,490     4,800
                       Exclusion of public assistance benefits     410      3,200
        Exclusion of special benefits for disabled coal miners      60
                   Exclusion of military disability pensions c     100
                   Exclusion of damages on account of personal              1,400
                      physical injuries or physical sickness b
          Net exclusion of pension contributions and earnings:    46,970   94,600
                                                employer plans
          Net exclusion of pension contributions and earnings:    47,730
                                                401(k) plans c
          Net exclusion of pension contributions and earnings:    7,450    13,000
                                   individual retirement plans
          Net exclusion of pension contributions and earnings:     970
                       low and moderate income savers credit c
          Net exclusion of pension contributions and earnings:    8,830     6,200
                                                   Keogh plans
             Exclusion of other employee benefits: premiums on    2,070     2,400
                                     group term life insurance
             Exclusion of other employee benefits: premiums on     260      2,400
                             accident and disability insurance
                         Small business retirement plan credit 40   40   a      a
                     Income of trusts to finance supplementary      20

                                unemployment benefits c

              Appendix III How Tax Expenditures Are Measured and Reported

                             (Continued From Previous Page)

    Dollars in millions

                                                          Treasury  JCT estimates
                                                         estimates
    Budget function       Tax expenditure name         Corporate     Corporate
                                                         Individual    Individual
                       Special employee stock ownership                  800
                                 plans (ESOPs)            1,600 320
                           rules (Located under the
                           Education budget function
                                   for JCT)
                         Additional deduction for the            30
                                    blind c
                         Additional deduction for the         1,700
                                   elderly c
                       Additional standard deduction for
                               the blind and the                            2,000
                                   elderly b
                        Tax credit for the elderly and           20             a
                                   disabled
                         Deduction of casualty losses           550
                       Earned income tax credit (EITC)m       4,893        34,100
                       Tax credit for certain
                       individuals for elective
                       deferrals                                            2,500
                            and IRA contributions b
                       Exclusion of Social Security
    Social Security benefits: retired workers             19,200        20,000
                       (JCT included railroad retirement
                                   benefits)
                         Exclusion of Social Security         3,580
                             benefits: disabled c
                         Exclusion of Social Security
                             benefits: dependents             4,140
                                and survivors c
          Veterans'       Exclusion of veterans death
          Benefits          benefits and disability           3,300         3,100
        and Services             compensation
                        Exclusion of veterans' pensions         110
                         Exclusion of GI bill benefits          130

    aa

    Exclusion of interest on veterans' housing bonds 10 40

        General Purpose     Exclusion of interest on    6,210 19,940 7,100 18,200
                            public purpose state and
    Fiscal Assistance          local bonds
                          Deductibility of nonbusiness
                             state and local taxes            45,290       44,300
                           other than owner-occupied
                                     homes
                          Tax credit for corporations
                             receiving income from      1,000        1,400
                             doing business in U.S.
                                  possessions
           Interest       Deferral of interest on U.S.          50
                                 savings bonds                              1,700

    Source: OMB. Analytical Perspectives, Budget of the United States
    Government, Fiscal Year 2006. (Washington, D.C.: 2005; and JCT, Estimates
    of Federal Tax Expenditures for Fiscal Years 2004-2008, JCS-8-03
    (Washington, D.C.: December 22, 2003).

    Notes: Treasury estimates were rounded to the nearest $10 million.
    Provisions with estimates that rounded to zero in each year were not
    reported by Treasury.

    a An estimate was not reported by JCT because the positive tax expenditure
    was less than $50 million.

    bTax expenditure reported by JCT only. The exclusion of untaxed Medicare
    benefits: prescription drug insurance (Part D) and the exclusion of
    certain subsidies to employers who maintain prescription drug plans for
    Medcare were listed by JCT as tax expenditures, but revenue loss estimates
    were reported only for future years.

    cTax expenditure reported by Treasury only. Seven additional tax
    expenditures were reported on Treasury's list in the fiscal year 2006
    budget, but estimates for these tax expenditures were reported

    Appendix III How Tax Expenditures Are Measured and Reported

    only for future years. The seven tax expenditures are: (1) expensing of
    capital costs with respect to complying with EPA sulfur regulations, (2)
    exclusion of gain or loss on sale or exchange of certain Brownfield sites,
    (3) Bio-diesel tax credit, (4) deduction for U.S. production activities,
    (5) special rules for certain film and TV production, (6) tax credit for
    certain expenditures for maintaining railroad tracks, and (7) deferral of
    capital gains with respect of dispositions of transmission property.

    dJCT reported this tax expenditure as "expensing of exploration and
    development costs, oil and gas."

    eJCT reported this tax expenditure as "excess of percentage over cost
    depletion, oil and gas."

    fFor the Treasury estimates, the partial exemption from the excise tax for
    alcohol fuels results in a reduction in excise tax receipts of $1.4
    billion in 2004. For the JCT estimates, the exemption from the excise tax
    for alcohol fuels results in a reduction in excise tax receipts, net of
    income tax effect, of $1.1 billion in each of the fiscal years 2004
    through 2006, and $1.2 billion per year in fiscal years 2007 and 2008.

    gThe JCT estimate includes employer-provided child care purchased through
    dependent care flexible spending accounts.

    hThe Treasury estimate in the table indicates the effect of the child tax
    credit on receipts. The effect of the credit on outlays is $8.9 billion in
    2004. The JCT estimate includes refundable amounts, amounts used to offset
    income taxes, and amounts used to offset other taxes. The amount of
    refundable child tax credit and earned income tax credit used to offset
    taxes other than income tax or paid out as refunds is $44.3 billion in
    2004.

    IThe estimate includes amounts of employer-provided health insurance
    purchased through cafeteria plans and employer-provided child care
    purchased through dependent care flexible spending accounts.

    jThe estimate does not include offsetting denial of corporate deduction
    for qualified stock option compensation.

    kThe JCT estimate includes employer-provided health insurance purchased
    through cafeteria plans.

    lIn addition to the receipts shown, there are outlays of $70 million in
    2004.

    mThe Treasury estimate indicates the effect of the earned income tax
    credit on receipts. The effect of the credit on outlays is $33.1 billion
    in 2004. The JCT estimate includes refundable amounts, amounts used to
    offset income taxes, and amounts used to offset other taxes. The amount of
    refundable child tax credit and earned income tax credit used to offset
    taxes other than income tax or paid out as refunds is $44.3 billion in
    2004.

    For fiscal year 2004, table 5 lists the aggregate revenue loss estimates
    reported by both Treasury and JCT for each budget function. The table
    permits a comparison of the number and size of Treasury's versus JCT's tax
    expenditure estimates when summed by budget function.

              Appendix III How Tax Expenditures Are Measured and Reported

    Table 5: Sum of Revenue Loss Estimates for Tax Expenditures by Budget
    Function Reported by the U.S. Department of the Treasury and Joint
    Committee on Taxation, Fiscal Year 2004

    Dollars in millions General purpose fiscal assistance 72,440 3 71,000 3
    Interest 50 1 1,700 1

                                         Treasury               JCT
                                      Sum of Revenue Sum of Revenue Number of Tax
                                      Number of Tax
              Budget Function         Loss Estimates Loss Estimates  Expenditures
                                        Expenditures
              National defense              $2,460 1         $2,900
           International affairs            19,900 6         20,900
        General science, space, and         2,350 12          7,500
                 technology
                   Energy                   3,670 11          2,100
           Natural resources and             1,440 5          1,900
                environment
                Agriculture                    880 6            600
        Commerce and housing credit       265,750 29        325,900
               Transportation                2,900 3          4,100
           Community and regional            2,400 6          2,700
                development
            Education, training,
           employment, and social          74,270 27        128,000
                  services
                   Health                  119,140 9        117,700
                  Medicare                   N/A N/A         27,800
              Income security             129,953 20        168,000
              Social security               26,920 3         20,000
           Veterans' benefits and
                  services                   3,590 4          3,400

    Source: GAO Analysis.

    Note: Summing the revenue loss estimates by budget fuction does not take
    into account possible interaction effects among the tax expenditures.

    Appendix IV

    Compilation of Tax Expenditures Reported by Treasury (1974 to 2004)

    To identify how tax expenditures have changed over the past three decades
    in number and size, in terms of aggregate revenue loss, we analyzed the
    list of tax expenditures reported by the Department of the Treasury
    (Treasury) in the Budget's Special Analyses, Appendixes, and Analytical
    Perspectives for fiscal years 1974 to 2004. The tax expenditures reported
    by Treasury during this period are listed in table 6.

    Table 6: Tax Expenditures Reported by the U.S. Department of the Treasury
    (1974 to 2004)

    First Year Last Year Name of Tax Expenditure Reported by Reported by
    (Organized by Budget Function) Treasury Treasury Type Taxpayer Group
    National defense

    Exclusion of benefits and allowances to armed forces 1974 2004 Exclusion
    Individual personnel

                                 International affairs

           Exclusion of gross-up on     1974 1976    Exclusion       Corporate
        dividends of LDC corporations
           Special rate for Western     1974 1979 Preferential tax   Corporate
        Hemisphere trade corporations
                                                        rate
        Deferral of income of domestic  1974 1985     Deferral
    international sales corporations                              Corporate
                    (DISC)
          Exclusion of income earned    1974 2004    Exclusion       Individual
           abroad by U.S. citizens
           Deferral of income from
    controlled foreign corporations  1977 2004     Deferral
                   (normal                                           Corporate
                 tax method)
        Exclusion of income of foreign  1984 2000    Exclusion       Corporate
           sales corporations (FSC)
          Interest allocation rules     1986 1995    Deduction
    exception for certain financial                               Corporate
                  operations
    Inventory property sales source  1986 2004      Credit        Corporate
               rules exception
         Deferred taxes for financial   1998 2004     Deferral       Corporate
        firms on certain income earned
                   overseas
    Exclusion of certain allowances  1999 2004    Exclusion       Individual
         for federal employees abroad
           Extraterritorial income      2000 2004    Exclusion       Corporate
                  exclusion
         General science, space, and
                  technology
          Expensing of research and     1974 2004     Deferral     Individual and
         experimentation expenditures
             (normal tax method)                                     Corporate
        Credit for increasing research  1981 2004      Credit      Individual and
                  activities
                                                                     Corporate
    Suspension of the allocation of  1983 1995    Deduction
         research and experimentation                                Corporate
                 expenditures

    Appendix IV Compilation of Tax Expenditures Reported by Treasury (1974 to 2004)

                             (Continued From Previous Page)

                                                  First Year Reported by Treasury

    Last Year Reported by

    Treasury Type Taxpayer Group Name of Tax Expenditure (Organized by Budget
    Function) Energy

          Capital gains treatment of    1974 2004 Preferential tax   Individual
              royalties on coal
                                                        rate
        Excess of percentage over cost  1974 2004    Deduction     Individual and
               depletion, fuels
                                                                     Corporate
         Expensing of exploration and   1974 2004     Deferral     Individual and
           development costs, fuels
                                                                     Corporate
          Residential energy credits    1978 1987      Credit        Individual
            New technology credit       1978 2004      Credit        Corporate
         Energy credit for intercity    1980 1989      Credit        Corporate
                    buses
             Alcohol fuel credits       1980 2004      Credit      Individual and
                                                                     Corporate
         Alternative fuel production    1980 2004      Credit      Individual and
                    credit
                                                                     Corporate
    Exclusion of interest on energy  1980 2004    Exclusion     Individual and
                facility bonds
                                                                     Corporate
         Exception from passive loss
    limitation for working interests 1988 2004    Deduction       Individual
                      in
            oil and gas properties
         Tax credit and deduction for   1992 2004                  Individual and
         clean-fuel burning vehicles                  Credit/
                                                     Deduction       Corporate
          Exclusion of conservation
         subsidies provided by public   1993 2004    Exclusion       Individual
                  utilities
         Enhanced oil recovery credit   1994 2004      Credit      Individual and
                                                                     Corporate

                           Natural resources and environment

          Pollution control: 5-year     1974 1980     Deferral       Corporate
                 amortization
          Capital gains treatment of    1974 2004 Preferential tax   Individual
            certain timber income
                                                        rate
        Exclusion of interest on bonds  1975 2004    Exclusion     Individual and
            for water, sewage, and
          hazardous waste facilities                                 Corporate
    Exclusion of payments in aid of  1976 1981    Exclusion
        construction of water, sewage,                               Corporate
          gas and electric utilities
    Capital gains treatment of iron  1977 1997 Preferential tax   Individual
                     ore
                                                        rate
    Tax incentives for preservation  1977 2004      Credit      Individual and
            of historic structures
                                                                     Corporate
         Investment credit and 7-year   1980 2000                    Individual
        amortization for reforestation            Credit/ Deferral
                 expenditures
        Excess of percentage over cost  1980 2004     Deferral     Individual and
         depletion, nonfuel minerals
                                                                     Corporate
         Expensing of exploration and   1980 2004     Deferral
          development costs, nonfuel                                 Corporate

    minerals

    Appendix IV Compilation of Tax Expenditures Reported by Treasury (1974 to 2004)

                             (Continued From Previous Page)

                                                  First Year Reported by Treasury

    Last Year Reported by

    Treasury Type Taxpayer Group Name of Tax Expenditure (Organized by Budget
    Function) Agriculture

        Special rules for mining reclamation   1984 1997 Deduction Individual and
                      reserves
                                                                     Corporate
    Expensing of multiperiod timber growing 1986 2004 Deferral  Individual and
                        costs
                                                                     Corporate
    Expensing of capital costs with respect 2004 2004 Deferral
                to complying with EPA                                Corporate
                 sulfur regulations
        Exclusion of gain or loss on sale or   2004 2004 Exclusion Individual and
                 exchange of certain
                  brownfield sites                                   Corporate

          Capital gain treatment of     1974 2004 Preferential tax   Individual
                certain income
                                                        rate
         Expensing of certain capital   1974 2004     Deferral     Individual and
                   outlays
                                                                     Corporate
           Deductibility of noncash
    patronage dividends and certain  1977 1981    Deduction     Individual and
                    other
            items of cooperatives                                    Corporate
             Exclusion of certain       1978 1981    Exclusion       Individual
            cost-sharing payments
        Special investment tax credit   1986 1987      Credit        Individual
         carryback rules for farming
    Expensing of certain multiperiod 1986 2004     Deferral     Individual and
               production costs
                                                                     Corporate
    Treatment of loans forgiven for  1986 2004    Exclusion       Individual
               solvent farmers
    Deferral of 1988 drought-related 1988 1990     Deferral       Individual
                   payments
         Income averaging for farmers   1997 2004 Preferential tax   Individual
                                                        rate
    Deferral of gain on sale of farm 1998 2004     Deferral       Corporate
                   refiners
            Bio-diesel tax credit       2004 2004      Credit        Individual

                              Commerce and housing credit

    Surtax exemption (through 1978)  1974 1980 Preferential tax   Corporate
                                                        rate
              Dividend exclusion        1974 1987    Exclusion       Individual
         Deductibility of interest on   1974 1990    Deduction       Individual
               consumer credit
    Deferral of capital gain on home 1974 1997     Deferral       Individual
                    sales
            Capital gains (except
        agriculture, timber, iron ore,  1974 2004 Preferential tax   Individual
                  and coal)
                                                        rate
          Deductibility of mortgage     1974 2004    Deduction       Individual
    interest on owner-occupied homes
    Deductibility of state and local 1974 2004    Deduction       Individual
        property tax on owner-occupied
                    homes
         Accelerated depreciation of
         buildings other than rental    1974 2004     Deferral     Individual and
                   housing
             (normal tax method)                                     Corporate
         Accelerated depreciation on    1974 2004     Deferral     Individual and
          rental housing (normal tax
                   method)                                           Corporate

    Appendix IV Compilation of Tax Expenditures Reported by Treasury (1974 to 2004)

                             (Continued From Previous Page)

                                                  First Year Reported by Treasury

    Last Year Reported by

    Treasury Type Taxpayer Group Name of Tax Expenditure (Organized by Budget
    Function)

         Excess bad debt reserves of    1974 2004    Deduction       Corporate
            financial institutions
        Exclusion of interest on life   1974 2004    Exclusion     Individual and
              insurance savings
                                                                     Corporate
    Exemption of credit union income 1974 2004    Exemption       Corporate
    Credit for purchase of new home  1975 1977      Credit        Individual
        Excess first year depreciation  1975 1980     Deferral     Individual and
                                                                     Corporate
    Expensing of construction period 1975 1981     Deferral     Individual and
              interest and taxes
                                                                     Corporate
        Exclusion of interest on small  1975 2004    Exclusion     Individual and
                 issue bonds
                                                                     Corporate
        Exclusion of certain income of  1976 1976    Exclusion     Individual and
                 cooperatives
                                                                     Corporate
         Accelerated depreciation of    1977 2004     Deferral     Individual and
           machinery and equipment
                                                                     Corporate
        Step-up basis of capital gains  1977 2004    Exclusion       Individual
                   at death
        Investment credit, other than   1978 1990      Credit
        employee stock ownership plans                               Corporate
        (ESOPs) and rehabilitation of
    structures, energy property, and
          reforestation expenditures
        Exclusion of capital gains on   1978 1997    Exclusion       Individual
        home sales for persons age 55
                   and over
           Exclusion of interest on     1978 2004    Exclusion     Individual and
    owner-occupied mortgage subsidy
                    bonds                                            Corporate
    Graduated corporation income tax 1978 2004 Preferential tax   Corporate
           rate (normal tax method)
                                                        rate
        Amortization of start-up costs  1980 2004     Deferral     Individual and
                                                                     Corporate
    Exclusion of interest on rental  1980 2004    Exclusion     Individual and
                housing bonds
                                                                     Corporate
    Exclusion of interest on certain 1981 1984    Exclusion       Individual
             savings certificates
         Reinvestment of dividends in   1981 1986    Exclusion       Individual
             public utility stock
          Safe harbor leasing rules     1981 1990    Deduction/      Corporate
                                                       Credit
            Net interest exclusion      1983 1983    Exclusion       Individual
         Small life insurance company   1984 2004    Deduction       Corporate
                  deduction
        Special investment tax credit   1986 1987      Credit
          carryback rules for steel                                  Corporate
                  companies
        Credit for low-income housing   1986 2004      Credit      Individual and
                 investments
                                                                     Corporate
        Exemption of RIC expenses from  1987 1993    Deduction       Individual
          the 2% floor miscellaneous

    itemized deduction

    Appendix IV Compilation of Tax Expenditures Reported by Treasury (1974 to 2004)

                             (Continued From Previous Page)

                                                  First Year Reported by Treasury

    Last Year Reported by

    Treasury Type Taxpayer Group Name of Tax Expenditure (Organized by Budget
    Function)

         Deferral of income from post   1987 2004     Deferral     Individual and
            1987 installment sales
                                                                     Corporate
         Exception from passive loss
         rules for $25,000 of rental    1987 2004    Deduction       Individual
                    losses
         Small property and casualty    1988 1988 Preferential tax
         insurance company deduction                                 Corporate
                                                        rate
           Special merger rules for     1988 1990    Deduction       Corporate
            financial institutions
          Treatment of Alaska Native    1988 1996    Exemption       Corporate
                 Corporation
    Carryover basis of capital gains 1988 2004     Deferral       Individual
                   on gifts
    Exceptions from imputed interest 1988 2004    Exclusion       Individual
                    rules
    Special alternative tax on small 1988 2004
            property and casualty                    Exemption       Corporate
             insurance companies
           Tax exemption of certain
         insurance companies owned by   1988 2004
                     tax-                            Exemption       Corporate
             exempt organizations
         Ordinary income treatment of   1989 2004    Deduction       Individual
           loss from small business
            corporation stock sale
        Deferral of gains from sale of
          broadcasting facilities to    1990 1995     Deferral
                   minority                                          Corporate
                owned business
          Cancellation of indebtness    1993 2004    Exclusion       Individual
          Expensing of certain small    1993 2004     Deferral     Individual and
                 investments
                                                                     Corporate
    Capital gains exclusion of small 1994 2004    Exclusion       Individual
              corporation stock
    Capital gains exclusion on home  1997 2004    Exclusion       Individual
                    sales
    Exclusion of net imputed rental  2004 2004    Exclusion       Individual
           income on owner-occupied
                    homes
        Deduction for U.S. production   2004 2004    Deduction     Individual and
                  activities
                                                                     Corporate
        Special rules for certain film  2004 2004    Deduction     Individual and
              and TV production
                                                                     Corporate
                Transportation
         Deductibility of nonbusiness   1974 1979    Deduction       Individual
             state gasoline taxes
          Five-year amortization on     1974 1980     Deferral       Corporate
            railroad rolling stock
         Deferral of tax on shipping    1974 2004     Deferral       Corporate
                  companies
         Deduction for motor carrier    1981 1986    Deduction       Corporate
               operating rights
        Exclusion of interest on state  1981 1990    Exclusion
        and local government bonds for                               Corporate
           mass commuting vehicles
    Exclusion for employer-provided  1993 2004    Exclusion       Individual
                transit passes
    Exclusion of reimbursed employee 1993 2004    Exclusion       Individual
               parking expenses
            Tax credit for certain
         expenditures for maintaining   2004 2004      Credit
                   railroad                                          Corporate

    tracks

    Appendix IV Compilation of Tax Expenditures Reported by Treasury (1974 to 2004)

                             (Continued From Previous Page)

                                                  First Year Reported by Treasury

    Last Year Reported by

    Treasury Type Taxpayer Group Name of Tax Expenditure (Organized by Budget
    Function)

     Community and regional development Education, training, employment, and social
                                        services

         Five-year amortization for housing    1974 1990 Deferral  Individual and
                   rehabilitation
                                                                     Corporate
    Investment credit for rehabilitation of 1974 2004  Credit   Individual and
               structures (other than
                      historic)                                      Corporate
         Exclusion of interest for airport,    1983 2004 Exclusion Individual and
               dock, and similar bonds
                                                                     Corporate
          Exemption of certain mutuals and     1989 2004 Exemption   Corporate
                 cooperatives income
            Empowerment zones, enterprise      1993 2004  Credit   Individual and
              communities, and renewal
                     communities                                     Corporate
    Expensing of environmental remediation  1997 2004 Deferral  Individual and
                        costs
                                                                     Corporate
                New market tax credit          2000 2004  Credit   Individual and
                                                                     Corporate
    Deferral of capital gains with respect  2004 2004 Deferral
                 of dispositions of                                  Corporate
                transmission property

            Child care facilities: 5-year      1974 1975 Deferral    Corporate
                    amortization
        Credit for employing AFDC recipients   1974 1982  Credit   Individual and
                and public assistance
    recipients under work incentive program                       Corporate
         Credit for child and dependent care   1974 2004  Credit     Individual
                      expenses
             Deductibility of charitable       1974 2004 Deduction Individual and
              contributions (education)
                                                                     Corporate
             Deductibility of charitable       1974 2004 Deduction Individual and
         contributions, other than education
                     and health                                      Corporate
    Exclusion of employee meals and lodging 1974 2004 Exclusion   Individual
                (other than military)
    Exclusion of scholarship and fellowship 1974 2004 Exclusion   Individual
                       income
           Parental personal exemption for     1974 2004 Exemption   Individual
               students age 19 or over
    Maximum tax on personal service income  1975 1980 Exclusion   Individual
             Investment credit for ESOPs       1976 1990  Credit     Corporate
        Exclusion of other employee benefits:  1976 1992 Exclusion   Individual
               employer contributions
            to prepaid legal expense plan
    Expensing of costs of removing certain  1976 1999 Deferral
              architectural barriers to                              Corporate
                   the handicapped
                 General jobs credit           1977 1984  Credit     Corporate
           Exclusion of employer-provided      1978 2004 Exclusion   Individual
               educational assistance
             Work opportunity tax credit       1978 2004  Credit   Individual and
                                                                     Corporate
        Exclusion of interest on student loan  1980 2004 Exclusion Individual and
                        bonds
                                                                     Corporate

    Appendix IV Compilation of Tax Expenditures Reported by Treasury (1974 to 2004)

                             (Continued From Previous Page)

                                                  First Year Reported by Treasury

    Last Year Reported by

    Treasury Type Taxpayer Group Name of Tax Expenditure (Organized by Budget
    Function)

          Deduction for certain adoption    1981 1987    Deduction Individual
                     expenses
         Deduction for two earner married   1983 1987    Deduction Individual
                     couples
           Employer-provided child care     1983 2004    Exclusion Individual
                    exclusion
        Exclusion of interest on bonds for  1983 2004    Exclusion Individual and
          private nonprofit educational
                    facilities                                          Corporate
        Exclusion of parsonage allowances   1984 2004    Exclusion Individual
         Exclusion of certain foster care   1988 2004    Exclusion Individual
                     payments
         Exclusion of interest on savings   1988 2004    Exclusion Individual
            bonds redeemed to finance
               educational expenses
            Credit for disabled access      1990 2004       Credit Individual and
                   expenditures
                                                                        Corporate
          Adoption credit and exclusion     1996 2004 Credit/Exclusion Individual
                   Child credit             1997 2004      Credit Individual
        Credit for holders of zone academy  1997 2004      Credit Corporate
                      bonds
          Deductibility of student loan     1997 2004    Deduction Individual
                     interest
           State prepaid tuition plans      1997 2004    Exclusion Individual
         Education individual retirement    1997 2004    Exclusion Individual
                     accounts
            Welfare-to-work tax credit      1997 2004       Credit Individual and
                                                                        Corporate
                 HOPE tax credit            1997 2004      Credit Individual
           Lifetime Learning tax credit     1997 2004      Credit Individual
          Assistance for adopted foster     2000 2004    Exclusion Individual
                     children
          Deduction for higher education    2001 2004    Deduction Individual
                     expenses
    Employer-provided child care credit  2001 2004      Credit Corporate
          Special deduction for teacher     2003 2004    Deduction Individual
                     expenses
            Discharge of student loan       2004 2004    Exclusion Individual
                   indebtedness
                      Health
        Deductibility of medical expenses   1974 2004    Deduction Individual
    Exclusion of employer contributions  1974 2004    Exclusion Individual
              for medical insurance
            premiums and medical care
           Deductibility of charitable      1977 2004    Deduction Individual and
              contributions (health)
                                                                        Corporate
        Exclusion of interest on hospital   1980 2004    Exclusion Individual and
                construction bonds
                                                                        Corporate
    Tax credit for orphan drug research  1982 2004      Credit Corporate
          Exclusion of employer share of    1988 1992    Exclusion Individual
              hospital insurance tax
          Special Blue Cross/Blue Shield    1988 2004     Deduction Corporate
                    deduction
        Credit for child medical insurance  1990 1993      Credit Individual
                     premiums

    Appendix IV Compilation of Tax Expenditures Reported by Treasury (1974 to 2004)

                             (Continued From Previous Page)

                                                  First Year Reported by Treasury

    Last Year Reported by

    Treasury Type Taxpayer Group Name of Tax Expenditure (Organized by Budget
    Function) Income security

         Medical Savings Accounts/Health Savings   1996 2004 Deduction Individual
                        Accounts
        Workers' compensation insurance premiums   1998 2002 Deduction Individual
        Self-employed medical insurance premiums   1998 2004 Deduction Individual
        Tax credit for health insurance purchased  2002 2004  Credit   Individual
                  by certain displaced
                 and retired individuals

         Excess of percentage standard deduction   1974 1977 Deduction Individual
                      over minimum
                   standard deduction
        Exclusion on capital gains on home sales   1974 1979 Exclusion Individual
                   for persons age 65
                        and over
               Exclusion of disability pay         1974 1984 Exclusion Individual
            Additional exemption for elderly       1974 1987 Exemption Individual
           Additional exemption for the blind      1974 1987 Exemption Individual
    Exclusion of untaxed unemployment insurance 1974 1987 Exclusion Individual
                        benefits
            Deductibility of casualty losses       1974 2004 Deduction Individual
        Exclusion of military disability pensions  1974 2004 Exclusion Individual
          Exclusion of other employee benefits:    1974 2004 Exclusion Individual
                  premiums on accident
                and disability insurance
          Exclusion of other employee benefits:    1974 2004 Exclusion Individual
                 premiums on group term
                     life insurance
        Income of trusts to finance supplementary  1974 2004 Exclusion Individual
                      unemployment
                        benefits
         Exclusion of public assistance benefits   1974 2004 Exclusion Individual
         Exclusion of railroad retirement system   1974 2004 Exclusion Individual
                        benefits
    Exclusion of worker's compensation benefits 1974 2004 Exclusion Individual
    Net exclusion of pension contributions and  1974 2004 Exclusion Individual
                   earnings: employer
                          plans
    Net exclusion of pension contributions and  1974 2004 Exclusion Individual
                  earnings: individual
                   retirement accounts
         Tax credit for the elderly and disabled   1974 2004  Credit   Individual
                Earned income tax credit           1975 2004  Credit   Individual
    Exclusion of special benefits for disabled  1975 2004 Exclusion Individual
                       coal miners
    Net exclusion of pension contributions and  1983 2004 Exclusion Individual
                     earnings: Keogh
                          plans
           Additional deduction for the blind      1986 2004 Deduction Individual
          Additional deduction for the elderly     1986 2004 Deduction Individual
        Extending tax-exempt organizations status  1988 1990           Individual
                      to voluntary                           Exemption
    employee beneficiary and other associations
          Exclusion of employer provided death     1988 1997 Exclusion Individual
                        benefits

    Appendix IV Compilation of Tax Expenditures Reported by Treasury (1974 to 2004)

                             (Continued From Previous Page)

                                                  First Year Reported by Treasury

    Last Year Reported by

    Treasury Type Taxpayer Group Name of Tax Expenditure (Organized by Budget
    Function) Social Security

                 Special ESOP rules            1988 2004 Exemption Individual and
                                                                     Corporate
        Small business retirement plan credit  2001 2004  Credit   Individual and
                                                                     Corporate
    Net exclusion of pension contributions  2001 2004 Exclusion   Individual
                and earnings: 401(k)
                        plans
    Net exclusion of pension contributions  2001 2004 Exclusion   Individual
                and earnings: low and
            moderate income savers credit

         Exclusion of Social Security benefits:    1974 2004 Exclusion Individual
                     dependents and
                        survivors
         Exclusion of Social Security benefits:    1974 2004 Exclusion Individual
                        disabled
         Exclusion of Social Security benefits:    1974 2004 Exclusion Individual
                     retired workers

           Veterans' benefits and services General Purpose Fiscal Assistance

            Exclusion of GI bill benefits      1974 2004 Exclusion   Individual
        Exclusion of veterans' death benefits  1974 2004 Exclusion   Individual
                   and disability
                    compensation
           Exclusion of veterans' pensions     1974 2004 Exclusion   Individual
         Exclusion of interest on veterans'    1983 2004 Exclusion Individual and
                    housing bonds
                                                                     Corporate

           Credit for corporations in U.S.     1974 1976  Credit     Corporate
                     possessions
    Deductibility of nonbusiness state and  1974 2004 Deduction   Individual
               local taxes (other than
        on owner-occupied homes and gasoline)
    Exclusion of interest on public purpose 1974 2004 Exclusion Individual and
                state and local bonds
                                                                     Corporate

          Tax credit for corporations receiving    1977 2004  Credit    Corporate
                    income from doing
              business in U.S. possessions
                        Interest
    Deferral of interest on U.S. savings bonds  1975 2004 Deferral  Individual
                   General government
          Credits and deductions for political     1974 1987           Individual
                      contributions                           Credit/
                                                             Deduction

    Source: GAO analysis of OMB budget reports on tax expenditures, fiscal
    years 1976-2006.

    Note: Names of tax expenditures may have changed over time. Our list
    includes the most recent name reported by Treasury for each tax
    expenditure. The list of tax expenditures reflects all provisions reported
    by Treasury, including those enacted but effective for future fiscal
    years.

    Appendix V

    Glossary

    Adjusted gross income (AGI): All income subject to taxation under the
    individual income tax after subtracting above-the-line deductions, such as
    certain contributions for individual retirement accounts and alimony
    payments. Personal exemptions and the standard or itemized deductions are
    subtracted from AGI to determine taxable income.

    Alternative Minimum Tax (AMT): A separate tax system that applies to both
    individual and corporate taxpayers. It parallels the regular individual
    income tax system but with different rules for determining taxable income,
    different tax rates for computing tax liability, and different rules for
    allowing the use of tax credits.

    Baseline: A benchmark for measuring the budgetary effects of proposed
    changes in federal revenues or spending. Or, a benchmark for identifying
    and measuring exceptions to the basic provisions of the tax structure.

    o 	CBO baseline: CBO's estimate of spending, revenue, the deficit or
    surplus, and debt held by the public during a fiscal year under current
    laws and current policy. For revenues and mandatory spending, CBO projects
    the baseline under the assumption that present laws continue without
    change. For discretionary spending subject to annual appropriations, CBO
    is required to adjust the current year's discretionary budget authority to
    reflect inflation, among other factors.

    o 	Comprehensive income tax baseline: This baseline, also called
    Haig-Simons income, is the real, inflation adjusted, accretion to wealth
    arising between the beginning and ending of the year. It includes all
    accretions to wealth, whether or not realized, whether or not related to a
    market transaction, and whether a return to capital or labor. Inflation
    adjusted capital gains would be included in comprehensive income as they
    accrue.

    o 	Consumption tax baseline: A broad-based consumption tax is a
    combination of an income tax plus a deduction for net saving. Many current
    tax expenditures related to preferential taxation of capital income and
    savings would not be considered tax preferences under a consumption tax
    (e.g., capital gains), but preferences unrelated to broad-based saving or
    investment incentives would remain tax preferences under a consumption
    baseline.

    o 	Normal income tax baseline: The Budget Act did not specify the baseline
    income tax against which tax preference provisions should be

    Appendix V Glossary

    measured, and deciding whether provisions are exceptions from the normal
    baseline is a matter of judgment. The normal income tax baseline is meant
    to represent a practical and broad-based income tax that reflects the
    general and widely applicable provisions of the current federal income
    tax. For the individual income tax, the Joint Committee on Taxation's
    (JCT) normal tax baseline includes one personal exemption for each
    taxpayer, one for each dependent, the standard deduction, the existing tax
    rate schedule, and deductions for investment and employee business
    expenses. Itemized deductions that are not necessary for the generation of
    income but exceed the standard deduction level are classified as tax
    expenditures. Very similar in scope to JCT's normal income tax baseline,
    Treasury's baseline is patterned on, but allows several major departures
    from, a comprehensive income tax, where income is defined as the sum of
    consumption and the change in net wealth during a given period.

    o 	Reference tax law baseline: The reference baseline is closer to
    existing tax law and is also patterned on, but still allows several major
    departures from, a comprehensive income tax. Thus fewer tax provisions are
    considered tax preferences under the reference tax baseline than under the
    normal tax baseline. These include the lower tax rate for certain
    corporations, preferential rates on capital gains, accelerated
    depreciation, deferral of tax on income from controlled foreign
    corporations, etc.

    Budget function: One of 20 broad categories into which budgetary resources
    are grouped so that all budget authority and outlays can be presented
    according to the national interests being addressed. There are 17 broad
    budget functions, including national defense, international affairs,
    energy, agriculture, health, income security, and general government.
    Three other functions-net interest, allowances, and undistributed
    offsetting receipts-are included to complete the budget.

    De minimis rule: The level of revenue loss below which a revenue loss
    estimate is not reported for a tax preference.

    Direct loans: A disbursement of funds by the government to a nonfederal
    borrower under a contract that requires the repayment of such funds with
    or without interest.

    Discretionary spending: Outlays controlled by appropriation acts, other
    than those that fund mandatory programs.

    Appendix V Glossary

    Entitlement authority: Authority to make payments (including loans and
    grants) for which budget authority is provided in advance by
    appropriations acts to any person or government if, under the provisions
    of the law containing such authority, the U.S. government is obligated to
    make the payments to persons or governments who meet the requirements
    established by law.

    Government Performance and Results Act (GPRA): Enacted in 1993, GPRA, also
    known as the Results Act, intends to improve the efficiency and
    effectiveness of federal programs by requiring federal agencies to develop
    strategic plans, annual performance plans, and annual program performance
    reports.

    Grants: A federal financial assistance award making payment in cash or in
    kind for a specified purpose. The federal government is not expected to
    have substantial involvement with the state or local government or other
    recipient while the contemplated activity is being performed.

    Gross domestic product (GDP): The value of all final goods and services
    produced within the borders of a country such as the United States during
    a given period. The components of GDP are consumption expenditures (both
    personal and government), gross investment (both private and government),
    and net exports.

    Mandatory spending: Also known as direct spending. Mandatory spending
    includes outlays for entitlement authority (for example, the food stamp,
    Medicare, and veterans' pension programs), payment of interest on the
    public debt, and nonentitlements such as payments to the states from
    Forest Service receipts. By defining eligibility and setting the benefit
    or payment rules, the Congress controls spending for these programs
    indirectly rather than directly through appropriations acts.

    Tax expenditure: A revenue loss attributable to a provision of the federal
    tax laws that grants special tax relief designed to encourage certain
    kinds of behavior by taxpayers or to aid taxpayers in special
    circumstances. The Congressional Budget and Impoundment Control Act of
    19741 lists six types of tax expenditures: exclusions, exemptions,
    deductions, credits, preferential tax rates, and deferral of tax
    liability.

    1Pub. L. No. 93-344, July 12, 1974.

    Appendix V Glossary

    o 	Preferential tax rates: A reduction of the tax rate on some forms of
    income, such as capital gains.

    o 	Tax credit: An amount that offsets or reduces tax liability. When the
    allowable tax credit amount exceeds the tax liability, and the difference
    is paid to the taxpayer, the credit is considered refundable. Otherwise,
    the difference can be (1) allowed as a carryforward against future tax
    liability, (2) allowed as a carryback against past taxes paid, or (3) lost
    as a tax benefit.

    o 	Tax deduction: An amount that is subtracted from the tax base before
    tax liability is calculated. Deductions claimed before and after the
    adjusted gross income line on the Form 1040 are sometimes called
    "above-the-line" and "below-the-line" deductions, respectively.

    o 	Tax deferral: A provision allowing taxpayers to reduce current tax
    liability by delaying recognition of some income or accelerating some
    deductions otherwise attributable to future years. This can increase the
    taxpayer's future tax liability, as the deferred income is eventually
    recognized, or reduce the deductions available on future income.

    o 	Tax exclusion: An item of income that would otherwise constitute a part
    of the taxpayer's gross income, but is excluded under a specific provision
    of the tax code. Exclusions generally do not appear on the U.S. Individual
    Income Tax Return (Form 1040), and excluded income is not reflected in
    total reported income.

    o 	Tax exemption: A reduction in taxable income offered to taxpayers
    because of their status or circumstances.

    Tax expenditure revenue loss estimate: The measure of the revenue cost of
    each tax expenditure. The revenue cost is the difference between tax
    liability under current law and the tax liability that would result if
    taxes were recomputed without that tax expenditure. Revenue cost estimates
    assume (1) economic behavior does not change, and (2) all other tax
    expenditures remain in the code unchanged.

    Tax expenditure outlay-equivalent estimate: The amount of budget outlays
    that would be required to provide the taxpayer the same after-tax income
    as would be received through the tax provision. The outlayequivalent
    measure allows the cost of a tax preference to be compared with

    Appendix V Glossary

    a direct federal outlay, were each to provide the same benefit to the
    taxpayer.

    Unified budget: A comprehensive budget in which receipts and outlays from
    federal funds and trust funds are consolidated; generally a cash or cash
    equivalent measure in which receipts are recorded when received and
    expenditures are recorded when paid, regardless of the accounting period
    in which the receipts are earned or the costs incurred.

    Appendix VI

                            GAO Contact and Acknowledgments

    GAO Contact Michael Brostek, (202) 512-9110

    Acknowledgments	In addition to the individual named above, MaryLynn
    Sergent, Assistant Director, as well as Eric Gorman, Edward Nannenhorn,
    Anne Stevens, and Lynn Wasielewski made key contributions to this report.
    Other individuals also contributing to this report included Ellen Grady,
    Susan Irving, Shirley Jones, Donna Miller, Amy Rosewarne, and William
    Trancucci.

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