[Background Material and Data on Programs within the Jurisdiction of the Committee on Ways and Means (Green Book)]
[Program Descriptions]
[Section 13. Tax Provisions Related to Retirement, Health, Poverty, Employment, Disability, and Other Social Issues]
[From the U.S. Government Printing Office, www.gpo.gov]


[1998 Green Book] SECTION 13. TAX PROVISIONS RELATED TO RETIREMENT, HEALTH, POVERTY, 
             EMPLOYMENT, DISABILITY AND OTHER SOCIAL ISSUES

                                CONTENTS

Introduction
  Tax Provisions
  Use of Distributional Analysis
  Tax Provision Estimates
Net Exclusion of Pension Contributions and Earnings
Individual Retirement Plans
Exclusion of Social Security and Railroad Retirement Benefits
Exclusion of Employer Contribution for Medical Insurance 
        Premiums and Medical Care
Medical Savings Accounts
Cafeteria Plans
Health Care Continuation Rules
Group Health Plan Requirements
Tax Benefits for Accelerated Death Benefits and Long-Term Care 
        Insurance
Deduction for Health Insurance Expenses of Self-Employed 
        Individuals
Exclusion of Medicare Benefits
Deductibility of Medical Expenses
Earned Income Credit
Exclusion of Public Assistance and SSI Benefits
Dependent Care Tax Credit
HOPE Credit and Lifetime Learning Credit
Qualified State Tuition Programs and Education IRAs
Student Loan Interest Deduction
Exclusion for Employer-Provided Dependent Care
Work Opportunity Tax Credit
Welfare-to-Work Tax Credit
Exclusion of Workers' Compensation and Special Benefits for 
        Disabled Coal Miners
Additional Standard Deduction for the Elderly and Blind
Tax Credit for the Elderly and Certain Disabled Individuals
Tax Provisions Related to Housing
  Owner-Occupied Housing
  Low-Income Housing Credit
Tax Credit and Exclusion for Adoption Expenses
Child Tax Credit
The Effect of Tax Provisions on the Income and Taxes of the 
        Elderly and the Poor
  Hypothetical Tax Calculations for Selected Families
  Tax Treatment of the Elderly
  Distribution of Family Income and Taxes
  Federal Tax Treatment of Families in Poverty
References

                              INTRODUCTION

    The preceding sections of this publication discuss direct 
payments to individuals for retirement, health, public 
assistance, employment, and disability benefits provided 
through entitlement programs within the jurisdiction of the 
Committee on Ways and Means. The Federal Government also 
provides benefits to individuals through elements of the income 
tax set forth in the Internal Revenue Code of 1986 (the Code). 
The Code is entirely within the jurisdiction of the Committee 
on Ways and Means.

                             Tax Provisions

    Several different types of income tax provisions are 
available to provide economic incentives. Examples include: 
exclusions, exemptions, deductions, preferential rates, 
deferrals and credits (see Joint Committee, 1996). Measuring 
the amount of benefit afforded by a tax provision is difficult. 
However, one way to measure the benefit is to review the total 
estimated amounts excluded, exempted, or otherwise afforded 
special treatment under various provisions of the income tax.

                     Use of Distributional Analysis

    Analyzing the effectiveness of tax provisions at achieving 
their policy goals often involves examining the distribution of 
benefits from the provisions allocated by the income class of 
those who take advantage of the provisions. The income concept 
used to show the distribution of tax expenditures by income 
class is adjusted gross income plus: (1) tax-exempt interest; 
(2) employer contributions for health plans and life insurance; 
(3) employer share of FICA taxes; (4) workers' compensation; 
(5) nontaxable Social Security benefits; (6) insurance value of 
Medicare benefits; (7) minimum tax preferences; and (8) 
excluded income of U.S. citizens living abroad.
    This definition of income includes items that clearly 
increase the ability to pay taxes, but that are not included in 
the definition of adjusted gross income. However, it omits 
certain items that clearly affect ability to consume goods and 
services either now or in the future, including accrual of 
pension benefits, other fringe benefits (such as military 
benefits, veterans benefits, and parsonage allowances), and 
means-tested transfer payments (such as AFDC, Supplemental 
Security Income, food stamps, housing subsidies, and general 
assistance).
    The tax return is the unit of analysis. Table 13-1 shows 
the distribution of all tax returns for 1997 by income class.
    Unless specifically indicated, all distributional tables 
exclude returns filed by dependents. All projections of income 
and deduction items and tax parameters are based on economic 
assumptions consistent with the December 1996 forecast of the 
Congressional Budget Office.

                         TABLE 13-1.--DISTRIBUTION OF TAX RETURNS BY INCOME CLASS, 1997                         
----------------------------------------------------------------------------------------------------------------
                                                              All returns    Taxable      Itemized       Tax    
                Income class (thousands) \1\                      \2\        returns      returns     liability 
----------------------------------------------------------------------------------------------------------------
Below $10...................................................       21,496        1,642          130      -$5,364
$10-$20.....................................................       24,714        9,122          921       -4,029
$20-$30.....................................................       19,926       12,990        2,156       16,455
$30-$40.....................................................       16,441       13,966        3,399       33,817
$40-$50.....................................................       12,449       11,502        3,947       40,823
$50-$75.....................................................       19,605       19,397       10,041      108,548
$75-$100....................................................        9,241        9,206        6,975       92,691
$100-$200...................................................        7,310        7,293        6,441      145,699
$200 and over...............................................        1,648        1,644        1,527      208,042
                                                             ---------------------------------------------------
    Total...................................................      132,830       86,763       35,537     636,683 
----------------------------------------------------------------------------------------------------------------
\1\ The income concept is defined at the beginning of this chapter.                                             
\2\ Includes filing and nonfiling units. Filing units include all taxable and nontaxable returns. Nonfiling     
  units include individuals with income that is exempt from Federal income taxation (e.g., transfer payments,   
  interest from tax-exempt bonds, etc.). Excludes individuals who are dependents of other taxpayers and         
  taxpayers with negative income.                                                                               
                                                                                                                
 Note.--Money amounts in millions of dollars, returns in thousands. Detail may not add to total due to rounding.
                                                                                                                
 Source: Joint Committee on Taxation.                                                                           

                        Tax Provision Estimates

     Table 13-2 provides various estimates for 33 tax 
provisions related to retirement, health, poverty, employment, 
disability, and housing. These provisions are examined in 
detail in this chapter including their legislative history, an 
explanation of current law, and a brief assessment of their 
effects.

          NET EXCLUSION OF PENSION CONTRIBUTIONS AND EARNINGS

                          Legislative History

    Prior to 1921, no special tax treatment applied to employee 
retirement trusts. Retirement payments to employees and 
contributions to pension trusts were deductible by the employer 
as an ordinary and necessary business expense. Employees were 
taxed on amounts actually received as well as on employer 
contributions to a trust if there was a reasonable expectation 
of benefits accruing from the trust. The 1921 Code provided an 
exemption for a trust forming part of a qualified profit 
sharing or stock bonus plan.
    The rules relating to qualified plans were substantially 
revised by the Employee Retirement Income Security Act of 1974 
(ERISA), which added overall limitations on contributions and 
benefits and other requirements on minimum participation, 
coverage, vesting, benefit accrual, and funding. Further 
revisions of these rules have been made in every major tax bill 
enacted after 1974.

    TABLE 13-2.--ESTIMATED TAX BASE EXCEPTIONS AND CREDITS UNDER THE PRESENT INCOME TAX FOR VARIOUS ITEMS,\1\   
                                            CALENDAR YEARS 1998-2002                                            
                                            [In billions of dollars]                                            
----------------------------------------------------------------------------------------------------------------
                                                                     Year                                       
                  Item                   ------------------------------------------------------------    Total  
                                             1998        1999        2000        2001        2002      1998-2002
----------------------------------------------------------------------------------------------------------------
   I. Tax base exceptions related to:                                                                           
                                                                                                                
Retirement:                                                                                                     
    Net exclusion of pension                                                                                    
     contributions and earnings.........      $320.0      $333.7      $348.0      $347.7      $342.1    $1,691.5
    Keogh plans.........................        19.6        20.9        22.2        23.6        25.1       111.4
    Individual retirement plans.........        49.8        52.3        55.2        58.4        62.8       278.5
    Exclusion of Social Security and                                                                            
     railroad retirement benefits in                                                                            
     excess of employee share of payroll                                                                        
     tax \2\............................       262.4       272.0       281.9       292.0       302.5      1410.8
Health:                                                                                                         
    Exclusions of employer contributions                                                                        
     for medical care, health insurance                                                                         
     premiums and long-term care                                                                                
     insurance premiums \3\.............       248.2       260.0       272.7       286.4       301.6     1,369.0
    Exclusion of Medicare benefits:                                                                             
        Medicare part A.................       135.6       146.8       158.8       171.1       184.4       796.7
        Medicare part B.................        63.2        70.5        78.5        86.2        94.6       393.0
    Deductibility of medical expenses                                                                           
     \4\................................        34.7        37.8        40.9        44.8        48.7       206.9
    Deductibility of health insurance                                                                           
     expenses of the self-employed \5\..         5.3         5.8         6.9         7.4         9.4        34.8
    Exclusion of accelerated death                                                                              
     benefits...........................         1.1         1.4         1.7         2.1         2.5         8.8
Poverty:                                                                                                        
    Exclusion of public assistance and                                                                          
     SSI cash benefits..................        51.1        52.5        55.7        54.6        59.1       273.0
Employment:                                                                                                     
    Exclusion of employer-provided                                                                              
     dependent care \6\.................         5.2         6.0         6.6         6.9         7.1        31.8
    Employee stock ownership plans                                                                              
     (ESOPs)............................        11.6        12.5        13.3        14.0        14.7        66.1
    Exclusion for benefits provided                                                                             
     under cafeteria plans \7\..........        29.6        33.3        36.6        40.2        44.2       184.0
Elderly and disabled:                                                                                           
    Exclusion of workers' compensation                                                                          
     and special benefits for disabled                                                                          
     coal miners:                                                                                               
        Workers' compensation...........        30.7        31.5        32.5        33.2        34.0       161.9
        Special benefits for disabled                                                                           
         coal miners....................         1.1         1.0         1.0         1.0         0.9         5.0
    Additional standard deduction for                                                                           
     elderly and blind..................        12.3        12.9        13.8        14.6        15.8        69.4
Housing:                                                                                                        
    Deductibility of mortgage interest..       168.9       174.9       181.0       187.9       194.6       907.3
    Deductibility of property tax on                                                                            
     owner-occupied housing.............        69.2        72.7        75.9        80.1        84.5       382.4
    Exclusion of interest on State and                                                                          
     local government bonds for owner-                                                                          
     occupied housing...................         7.9         8.4         8.4         8.5         8.5        41.7
    Depreciation of rental housing in                                                                           
     excess of alternative depreciation                                                                         
     system.............................         9.2         8.4         8.3         8.6         9.6        44.1
    Exclusion of interest on State and                                                                          
     local government bonds for rental                                                                          
     housing............................         3.6         3.7         3.6         3.5         3.4        17.9
Families:                                                                                                       
    Qualified State tuition programs and                                                                        
     education IRAs.....................         0.4         0.5         0.7         0.8         1.1         3.5
    Student loan interest deduction.....         0.1         0.1         0.1         0.2         0.3         0.8
     Employer-provided adoption expenses       (\8\)       (\8\)       (\8\)       (\8\)       (\8\)       (\8\)
                                                                                                                
       II. Tax credits related to:                                                                              
                                                                                                                
Poverty:                                                                                                        
    Earned income credit:                                                                                       
        Nonrefundable portion...........        22.5        23.4        24.4        25.3        26.4       122.0
        Refundable portion..............         5.2         5.3         5.5         5.9         6.1        28.0
Employment:                                                                                                     
    Dependent care credit...............         2.7         2.8         2.9         2.9         3.0        14.3
    Work opportunity tax credit.........         0.2         0.1       (\8\)       (\8\)       (\8\)         0.4
     Welfare-to-work tax credit.........       (\8\)       (\8\)       (\8\)       (\8\)       (\8\)         0.1
Elderly and disabled:                                                                                           
    Tax credit for elderly and disabled.       (\8\)       (\8\)       (\8\)       (\8\)       (\8\)         0.1
Housing:                                                                                                        
    Low-income housing tax credit.......         3.2         3.5         3.9         4.3         4.6        19.6
 Families:                                                                                                      
     Child tax credit:                                                                                          
         Nonrefundable portion..........        16.6        20.5        20.4        20.2        19.8        97.5
         Refundable portion.............         0.9         1.1         1.1         1.1         1.1         5.3
     HOPE credit and lifetime learning                                                                          
     credit.............................         6.2         6.3         7.2         7.7         7.6        35.1
     Adoption credit....................         0.4         0.4         0.4         0.2         0.2        1.5 
----------------------------------------------------------------------------------------------------------------
\1\ Estimates of exclusions and deductions represent changes in the tax base; they do not measure changes in tax
  liability. Tax effects of provisions are not comparable.                                                      
\2\ In addition to OASDI benefits for retired workers, these figures also include disability insurance benefits 
  and benefits for dependents and survivors.                                                                    
\3\ Estimate includes employer-provided health insurance purchased through cafeteria plans and health care      
  spending through flexible spending accounts.                                                                  
\4\ Amounts reported on tax returns in excess of the medical deductions floor (7.5 percent of adjusted gross    
  income).                                                                                                      
\5\ Amounts deductible from gross income: 45 percent of health insurance expenses in 1998 and 1999, 50 percent  
  in 2000 and 2001, and 60 percent in 2002. Remaining amounts are deductible on schedule A with other itemized  
  medical expenses.                                                                                             
\6\ Estimate includes employer-provided child care purchased through dependent care flexible spending accounts. 
\7\ Estimate includes amounts of employer-provided health insurance purchased through cafeteria plans and       
  employer-provided child care purchased through dependent care flexible spending accounts. These amounts are   
  also included in other line items in this table.                                                              
\8\ Less than $50 million.                                                                                      
                                                                                                                
 Note.--Details may not add to totals due to rounding.                                                          
                                                                                                                
 Source: Joint Committee on Taxation.                                                                           

    Since ERISA, Congress has also acted to broaden the range 
of qualified plans. In the Revenue Act of 1978, Congress 
provided special rules for qualified cash or deferred 
arrangements under section 401(k). Under these arrangements, 
known popularly as 401(k) plans, employees can elect to receive 
cash or have their employers contribute a portion of their 
earnings to a qualified profit sharing, stock bonus, or pre-
ERISA money purchase pension plan.
    An employee stock ownership plan (ESOP) is a special type 
of qualified plan that is designed to invest primarily in 
securities of the employer maintaining the plan. Certain 
qualification rules and tax benefits apply to ESOPs that do not 
apply to other types of qualified plans.

                        Explanation of Provision

In general
    Under a plan of deferred compensation that meets the 
qualification standards of the Internal Revenue Code (sec. 
401(a)), an employer is allowed a deduction for contributions 
to a tax-exempt trust to provide employee benefits. Similar 
rules apply to plans funded with annuity contracts. An employer 
that makes contributions to a qualified plan in excess of the 
deduction limits is subject to a 10-percent excise tax on such 
excess (sec. 4972).
    The qualification rules limit the amount of benefits that 
can be provided through a qualified plan and require that 
benefits be provided on a basis that does not discriminate in 
favor of highly compensated employees. In addition, qualified 
plans are required to meet minimum standards relating to 
participation (the restrictions that may be imposed on 
participation in the plan), coverage (the number of employees 
participating in the plan), vesting (the time at which an 
employee's benefit becomes nonforfeitable), and benefit accrual 
(the rate at which an employee earns a benefit). Also, minimum 
funding standards apply to the rate at which employer 
contributions are required to be made to certain plans to 
ensure the solvency of pension plans.
    If a defined benefit pension plan is terminated, any assets 
remaining after satisfaction of the plan's liabilities may 
revert to the employer. Such reversions are included in the 
gross income of the employer and are subject to income tax plus 
an additional excise tax (sec. 4980). The excise tax is 20 
percent if the employer establishes a qualified replacement 
plan or provides certain benefit increases. Otherwise, the 
excise tax is 50 percent. Transfers of excess assets can be 
made from an ongoing defined benefit plan to pay certain 
retiree health benefits if certain requirements are satisfied 
(sec. 420). The assets transferred are not includable in the 
income of the employer or subject to the tax on reversions.
Minimum participation rules
    A qualified plan generally may not require as a condition 
of participation that an employee complete more than 1 year of 
service or be older than age 21 (sec. 410(a)).
Vesting rules
    A plan is not a qualified plan unless a participant's 
employer-provided benefit vests at least as rapidly as under 
one of two alternative minimum vesting schedules (sec. 411).
Benefit accrual rules
    The protection afforded employees under the minimum vesting 
rules depends not only on the minimum vesting schedules, but 
also on the accrued benefits to which these schedules are 
applied. In the case of a defined contribution plan, the 
accrued benefit is the participant's account balance. In the 
case of a defined benefit plan, a participant's accrued benefit 
is determined under the plan benefit formula, subject to 
certain restrictions. In general, the accrued benefit is 
defined in terms of the benefit payable at normal retirement 
age and does not include certain ancillary nonretirement 
benefits.
    Each defined benefit plan is required to satisfy one of 
three accrued benefit tests. The primary purpose of these tests 
is to prevent undue backloading of benefit accruals (i.e., by 
providing low rates of benefit accrual in the employee's early 
years of service when the employee is most likely to leave and 
by concentrating the accrual of benefits in the employee's 
later years of service when he is most likely to remain with 
the employer until retirement) (sec. 412).
Coverage rules
    A plan is not qualified unless the plan satisfies at least 
one of the following coverage requirements: (1) the plan 
benefits at least 70 percent of all nonhighly compensated 
employees, (2) the plan benefits a percentage of nonhighly 
compensated employees that is at least 70 percent of the 
percentage of highly compensated employees benefiting under the 
plan, or (3) the plan meets an average benefits test (sec. 
410(b)). In addition, a plan is not a qualified plan unless it 
benefits the lesser of: (1) 50 employees, or (2) 40 percent of 
the employees of the employer (sec. 401(a)(26)). For years 
beginning after 1996, pursuant to the Small Business Job 
Protection Act of 1996, the latter rule is modified to apply 
only to defined benefit plans. For years beginning after 1996, 
a defined benefit plan is not a qualified plan unless it 
benefits at least the lesser of: (1) 50 employees, or (2) the 
greater of 40 percent of the employees of the employer or 2 
employees (or if there is only 1 employee, such employee).
General nondiscrimination rule
    In general, a plan is not a qualified plan if the 
contributions or benefits under the plan discriminate in favor 
of highly compensated employees (sec. 401(a)(4)).
Limitations on contributions and benefits
    The maximum annual benefit that may be provided by a 
defined benefit pension plan (payable at the Social Security 
retirement age) is the lesser of 100 percent of average 
compensation, or $125,000 for 1997 (sec. 415(b)). The dollar 
limit is adjusted annually for inflation. The dollar limit is 
reduced if payments of benefits begin before the Social 
Security retirement age and increased if benefits begin after 
the Social Security retirement age.
Funding rules
    Pension plans are required to meet a minimum funding 
standard for each plan year (sec. 412). In the case of a 
defined benefit pension plan, an employer must contribute an 
annual amount sufficient to fund a portion of participants' 
projected benefits determined in accordance with one of several 
prescribed funding methods, using reasonable actuarial 
assumptions. Plans with asset values of less than 100 percent 
of current liabilities are subject to additional, faster 
funding rules.
Taxation of distributions
    An employee who participates in a qualified plan is taxed 
when the employee receives a distribution from the plan to the 
extent the distribution is not attributable to employee 
contributions (sec. 402). With certain exceptions, a 10-percent 
additional income tax is imposed on early distributions from a 
qualified plan (sec. 72(t)). A 15-percent excise tax is imposed 
on distributions that exceed a certain amount in any year (sec. 
4980A). Section 4980A was repealed by the Taxpayer Relief Act 
of 1997 for excess distributions received after December 31, 
1996.
Failure to satisfy qualification requirements
    If a plan fails to satisfy the qualification requirements, 
the trust that holds the plan's assets is not tax exempt. An 
employer's deduction for plan contributions is only allowed 
when the employee includes the contributions or benefits in 
income, and benefits generally are includable in an employee's 
income when they are no longer subject to a substantial risk of 
forfeiture.
SIMPLE retirement plans
    The Small Business Job Protection Act of 1996 created a 
simplified retirement plan for small business called the 
Savings Incentive Match Plan for Employees (SIMPLE) (secs. 
408(p) and 401(k)(11)). SIMPLE plans may be adopted by 
employers with 100 or fewer employees and who do not maintain 
another employer-sponsored retirement plan. A SIMPLE plan can 
be either an individual retirement arrangement (IRA) for each 
employee or part of a qualified cash or deferred arrangement 
(401(k) plan). If established in IRA form, a SIMPLE plan is not 
subject to the nondiscrimination rules generally applicable to 
qualified plans and simplified reporting requirements apply. If 
adopted as part of a 401(k) plan, the plan does not have to 
satisfy the special nondiscrimination tests applicable to 
401(k) plans and is not subject to the top-heavy rules. The 
other qualified plan rules continue to apply. SIMPLE plans are 
subject to special rules regarding eligibility of employees to 
participate and special contribution limits.

                          Effect of Provision

    The tax treatment of pension contributions and earnings has 
encouraged employers to establish qualified retirement plans 
and to compensate employees in the form of pension 
contributions to such plans. There are two potential tax 
advantages of being compensated through pension contributions. 
One advantage is the ability to earn tax-free returns to 
savings. When saving is done through a pension plan, the 
employee earns a higher rate of return than on fully taxed 
savings.\1\ The second advantage is that an employee's tax rate 
may be lower during retirement than during the working years.
---------------------------------------------------------------------------
    \1\ This applies to pension contributions made by employers. 
Employees may also be able to contribute to qualified plans. Employee 
contributions may be made with aftertax dollars. If so, the tax 
advantage given to these contributions is smaller than the tax 
advantage given to employer contributions, and consists of the deferral 
of tax on accumulated earnings.
---------------------------------------------------------------------------
    These tax provisions directly benefit only persons who work 
for employers with qualified plans and who work for a 
sufficient period of time before their benefits vest in such 
plans. The current extent of this coverage and recent trends in 
coverage are described below.

                                Coverage

    The term covered, as used here, means that an employee is 
accruing benefits in an employer pension or other retirement 
plan. The best current comprehensive evidence on pension 
coverage comes from a supplement to the April 1993 Current 
Population Survey (U.S. Department of Labor, 1994). The data 
referred to below come from that survey unless otherwise noted.
    As of April 1993, 63 percent of full-time wage and salary 
workers employed in the private sector reported that they 
worked in firms with an employer-sponsored pension plan. Half 
of the full-time wage and salary workers employed in the 
private sector were covered by an employer-sponsored pension 
plan. Most of these workers were covered by basic defined 
benefit or defined contribution plans (23 percent), and another 
10 percent had both a basic plan and a 401(k) type contributory 
plan (see table 13-3).\2\ For another 17 percent, the 401(k) 
type plan was their only retirement plan.
---------------------------------------------------------------------------
    \2\ Some private-sector employees contribute to 403(b) tax-
sheltered annuities instead of 401(k) plans.
---------------------------------------------------------------------------
    Pension coverage varies substantially among full-time, 
privately employed workers. Differences depend on the age of 
the worker, job earnings, the industry of employment, and the 
size of the firm.
    Younger workers are much less likely to be covered by a 
pension than middle aged and older workers. Coverage rates rise 
steadily from 21 percent for those under age 25 to about 60 
percent for those between ages 40 and 60 before falling off 
somewhat. This pattern holds for both men and women. However, 
the jump in coverage for middle aged men is slightly larger 
than the increase for middle aged women (see table 13-4).
    Higher paying jobs are more likely to offer pensions. Just 
8 percent of full-time private wage and salary workers earning 
less than $10,000 per year in 1993 were covered compared to 81 
percent of those earning $50,000 or more (see table 13-5). 
Coverage may be higher for higher paying jobs because of the 
greater value of the pension tax benefits to workers in higher 
tax brackets and because of the declining replacement rate of 
Social Security at higher earnings levels.

TABLE 13-3.--EMPLOYER SPONSORSHIP AND EMPLOYEE COVERAGE UNDER PENSION OR
            RETIREMENT PLAN, PRIVATE WAGE AND SALARY WORKERS            
                                [Percent]                               
------------------------------------------------------------------------
                                      Total      Full time    Part time 
------------------------------------------------------------------------
Employer sponsorship:                                                   
    Employer sponsors plan.......           58           63           37
        Basic pension only.......           24           24           23
        Basic and 401(k) type....           14           16            4
        401(k) type only.........           21           23           10
    Employer does not sponsor....           35           32           49
    Does not know................            7            5           14
                                                                        
Employee coverage:                                                      
    Employee covered under plan..           43           50           12
        Basic pension only.......           20           23            7
        Basic and 401(k) type....            8           10            2
        401(k) type only.........           15           17            4
    Employee is not covered......           50           44           73
    Does not know................            7            6           14
                                  --------------------------------------
          Number of private wage                                        
           and salary workers (in                                       
           thousands)............       88,679       72,752      15,927 
------------------------------------------------------------------------
Source: U.S. Department of Labor, 1994, tables A2, B1, B2.              


  TABLE 13-4.--COVERAGE UNDER EMPLOYER-SPONSORED PENSION OR RETIREMENT  
           PLANS FOR FULL-TIME PRIVATE WAGE AND SALARY WORKERS          
------------------------------------------------------------------------
                                              Percent covered           
          Age (in years)          --------------------------------------
                                      Total         Men         Women   
------------------------------------------------------------------------
Under 25.........................           21           19           22
25-29............................           41           41           42
30-34............................           50           50           51
35-39............................           54           57           51
40-44............................           58           61           54
45-49............................           63           66           59
50-54............................           61           60           62
55-59............................           59           60           57
60-64............................           56           59           52
65 or older......................           46           54           34
                                  --------------------------------------
      Total......................           50           51          48 
------------------------------------------------------------------------
Source: U.S. Department of Labor, 1994, table B5.                       


  TABLE 13-5.--COVERAGE UNDER EMPLOYER-SPONSORED PENSION OR RETIREMENT  
  PLANS FOR FULL-TIME PRIVATE WAGE AND SALARY WORKERS BY WORKERS' WAGES 
------------------------------------------------------------------------
                                              Percent covered           
              Wages               --------------------------------------
                                      Total         Men         Women   
------------------------------------------------------------------------
Under $10,000....................            8            7            9
$10,000-$14,999..................           27           21           31
$15,000-$19,999..................           42           35           49
$20,000-$24,999..................           57           51           65
$25,000-$29,999..................           62           61           64
$30,000-$34,999..................           67           66           71
$35,000-$39,999..................           73           74           72
$40,000-$49,999..................           78           79           77
$50,000-$74,999..................           81           81           80
$75,000 or over..................           81           82           78
                                  --------------------------------------
      Total \1\..................           50           51          48 
------------------------------------------------------------------------
\1\ Total includes workers not responding on wages, not shown           
  separately.                                                           
                                                                        
 Source: U.S. Department of Labor, 1994, table B11.                     

    Industries with high pension coverage include 
manufacturing, mining, financial services, and communications 
and public utilities. Coverage rates exceed 60 percent for 
full-time private wage and salary workers in each of these 
industries (U.S. Department of Labor, 1994, pp. B-8 & B-9). In 
contrast, coverage rates are under 35 percent in agriculture, 
retail trade, and construction. Part of the difference among 
industries appears to be due to differences in firm size. 
Coverage is much lower for smaller firms. Smaller firms are 
less likely to offer comprehensive fringe benefit packages as 
part of total compensation. Only 13 percent of full-time 
private wage and salary workers in firms with fewer than 10 
employees are covered. The rate rises with employer size but 
does not reach 50 percent (the average across all firm sizes) 
until firms have 100 or more employees (table 13-6).
    Significant differences in coverage also are apparent 
between full-time private wage and salary workers and other 
wage and salary workers. Coverage is much lower among part-time 
workers and much higher among public employees. Among part-
time, private wage and salary workers, 12 percent are covered. 
Seventy-seven percent of public sector wage and salary workers 
are covered including 85 percent of those who are full-time 
workers (see table 13-7).

                           Trends in Coverage

    At the outset of World War II, private employer pensions 
were offered by about 12,000 firms. Pensions spread rapidly 
during and after the war, encouraged by high marginal tax rates 
and wartime wage controls that exempted pension benefits. By 
1972, when the first comprehensive survey was undertaken, 48 
percent of full-time private employees were covered. Subsequent 
surveys found that coverage reached 50 percent in 1979, but by 
1983 had fallen back to 48 percent. The decline continued in 
the 1980s, reaching 46 percent in 1988 (Woods, 1989, p. 17). By 
1993, coverage had returned to 50 percent.

  TABLE 13-6.--COVERAGE UNDER EMPLOYER-SPONSORED PENSION OR RETIREMENT  
   PLANS FOR FULL-TIME PRIVATE WAGE AND SALARY WORKERS BY SIZE OF FIRM  
------------------------------------------------------------------------
                                              Percent covered           
  Firm size (number of workers)   --------------------------------------
                                      Total         Men         Women   
------------------------------------------------------------------------
Fewer than 10....................           13           12           14
10-24............................           25           23           28
25-49............................           30           32           27
50-99............................           42           46           37
100-249..........................           53           57           49
250-499..........................           62           66           57
500-999..........................           62           66           58
1,000 or more....................           73           76           70
                                  --------------------------------------
    Total \1\....................           50           51          48 
------------------------------------------------------------------------
\1\ Total includes workers not responding or for whom firm size is      
  unknown, not shown separately.                                        
                                                                        
 Source: U.S. Department of Labor, 1994, table B9.                      


    TABLE 13-7.--COVERAGE OF WAGE AND SALARY WORKERS UNDER EMPLOYER-    
    SPONSORED PENSION OR RETIREMENT PLAN, BY PRIVATE OR PUBLIC SECTOR   
------------------------------------------------------------------------
                                              Percent covered           
              Sector              --------------------------------------
                                      Total      Full time    Part time 
------------------------------------------------------------------------
All wage and salary workers......           49           56           15
    Men..........................           51           56            9
    Women........................           46           56           17
Private sector...................           43           50           12
    Men..........................           46           51            8
    Women........................           39           48           15
Public sector....................           77           85           30
    Men..........................           80           86           22
    Women........................           74           84          33 
------------------------------------------------------------------------
Source: U.S. Department of Labor, 1994, table B1.                       

    The decline in coverage in the 1980s was concentrated among 
younger men. The coverage rate among older men has fallen less 
dramatically, and among women it has risen at some ages and 
fallen at others.
    The decline in pension coverage has occurred at the same 
time that employers have been shifting from defined benefit 
plans. Defined benefit plans provided basic plan coverage for 
87 percent of private wage and salary workers in 1975 (Turner & 
Beller, 1989, pp. 65 & 357). This proportion dropped to 83 
percent by 1980 and to 71 percent by 1985. This shifting 
composition has largely been the result of rapid growth in 
primary defined contribution plans. Employee stock ownership 
plans and 401(k) plans have been among the most rapidly growing 
defined contribution plans.

                      INDIVIDUAL RETIREMENT PLANS

                          Legislative History

    ERISA added section 219 to the Internal Revenue Code, 
providing a tax deduction for certain contributions to 
individual retirement arrangements (IRAs) and permitting the 
deferral of tax on amounts held in such arrangements until 
withdrawal. Active participants in employer plans were not 
permitted to make deductible IRA contributions.
    The Economic Recovery Tax Act of 1981 expanded eligibility 
to individuals who were active participants and increased the 
amount of the permitted deduction. The Tax Reform Act of 1986 
limited the full IRA deduction to individuals with income below 
certain levels and to individuals who are not active 
participants in employer plans. Individuals who are not 
entitled to the full IRA deduction may make nondeductible 
contributions to an IRA. The Small Business Job Protection Act 
of 1996 increased contributions that can be made to the IRA of 
a nonworking spouse. The Health Insurance Portability and 
Accountability Act provided that the early withdrawal tax does 
not apply to withdrawals from IRAs: (1) for medical expenses 
that would be deductible (i.e., to the extent that total 
medical expenses exceed 7.5 percent of adjusted gross income); 
and (2) for health insurance expenses of unemployed 
individuals.
    The Taxpayer Relief Act of 1997, effective for years 
beginning after December 31, 1997, made the following changes 
to the IRA provisions: (1) the income limits on deductible IRA 
contributions that apply to active participants in an employer-
sponsored retirement plan were increased; (2) the nonworking 
spouse of an active participant in an employer-sponsored 
retirement plan may make a deductible contribution of up to 
$2,000 to an IRA; (3) a new tax-free nondeductible IRA, the 
Roth IRA, was added; and (4) the 10-percent early withdrawal 
tax was waived for distributions from IRAs for education and 
first-time home buyer expenses.

                        Explanation of Provision

Deductible IRAs
     An individual who is an active participant in an employer-
sponsored retirement plan may deduct annual IRA contributions 
up to the lesser of $2,000 or 100 percent of compensation if 
the individual's adjusted gross income (AGI) does not exceed 
certain limits.
     The full $2,000 IRA deduction limit is phased out for 
married individuals over the following levels of AGI: for 1998, 
$50,000-$60,000; for 1999, $51,000-$61,000; for 2000, $52,000-
$62,000; for 2001, $53,000-$63,000; for 2002, $54,000-$64,000; 
for 2003, $60,000-$70,000; for 2004, $65,000-$75,000; for 2005, 
$70,000-$80,000; for 2006, $75,000-$85,000; and for 2007 and 
thereafter, $80,000-$100,000. The phase-out range for married 
individuals filing separate returns is $0-$10,000. A couple is 
not treated as married if the spouses file separate returns and 
do not live together at any time during the year. The phase-out 
range for single individuals is: for 1998, $30,000-$40,000; for 
1999, $31,000-$41,000; for 2000, $32,000-$42,000; for 2001, 
$33,000-$43,000; for 2002, $34,000-$44,000; for 2003, $40,000-
$50,000; for 2004, $45,000-$55,000; for 2005 and thereafter, 
$50,000-$60,000.
     For years beginning after 1997, an individual who is not 
an active participant, but whose spouse is, may make a full 
$2,000 deductible IRA contribution if the AGI for the couple 
does not exceed $150,000. The deduction limit is phased out for 
AGI between $150,000 and $160,000. An individual who is not an 
active participant in an employer-sponsored retirement plan may 
deduct IRA contributions up to the limits described above 
without limitation based on income.
     The investment income of IRA accounts is not taxed until 
withdrawn. Withdrawn amounts attributable to deductible 
contributions and all earnings are includable in income. A 10-
percent additional income tax is levied unless the withdrawal: 
(1) is made after the IRA owner attains age 59\1/2\ or dies; 
(2) is made on account of the disability of the IRA owner; (3) 
is one of a series of substantially equal periodic payments 
made not less frequently than annually over the life or life 
expectancy of the IRA owner (or the IRA owner and his or her 
beneficiary); or (4) is made to pay medical expenses in excess 
of 7.5 percent of AGI or for insurance premiums for unemployed 
individuals; or (5) is made after 1997 for first-time home 
buyer expenses (subject to a $10,000 lifetime cap) or for 
qualified higher education expenses.
Roth IRAs
     For years beginning after December 31, 1997, an individual 
may make nondeductible contributions up to the lesser of $2,000 
or 100 percent of compensation to a Roth IRA if the 
individual's AGI does not exceed $95,000 for an unmarried 
individual, or $150,000 for a married couple filing a joint 
return. The maximum contribution is phased out between AGI 
ranges of $95,000-$110,000 for unmarried individuals and of 
$150,000-$160,000 for married individuals filing a joint 
return. No more than $2,000 of contributions can be made to all 
an individual's IRAs for a taxable year.
     Qualified distributions from a Roth IRA are not includable 
in income. Qualified distributions are distributions: (1) made 
after the 5-year taxable period beginning with the first 
taxable year for which a contribution is made, and (2) which 
are made on or after the date the individual attains age 59\1/
2\, are made to a beneficiary on or after the death of the 
individual, are attributable to the individual's being 
disabled, or are for a qualified special purpose distribution. 
A qualified special purpose distribution is a distribution for 
first-time home buyer expenses, as described above. 
Distributions that are not qualified distributions are 
includable in income, to the extent earnings are included in 
the distribution, and are subject to the 10-percent tax on 
early withdrawal, unless an exception applies, as described 
above for deductible IRAs.
     Taxpayers with AGI of less than $100,000 may convert an 
IRA to a Roth IRA at any time. If the conversion is made before 
January 1, 1999, the amounts that would have been includable in 
income had the amounts converted been withdrawn are includable 
in income ratably over 4 years. The 10-percent tax on early 
withdrawals does not apply to conversions of IRAs to Roth IRAs.
Nondeductible IRAs
     An individual may make nondeductible contributions to an 
IRA to the extent the individual does not or cannot make 
deductible contributions to an IRA or contributions to a Roth 
IRA. Earnings on contributions to a nondeductible IRA 
accumulate tax free, and are includable in income when 
withdrawn. The 10-percent early withdrawal tax applies to such 
earnings, subject to the exceptions for deductible and Roth 
IRAs as described above.

                          Effect of Provision

    Use of IRAs expanded significantly when eligibility was 
expanded in 1982 to all persons with earnings and contracted 
correspondingly in 1987 when deductibility was restricted for 
higher income taxpayers who were covered by an employer-
provided pension. The number of taxpayers claiming a deductible 
IRA contribution jumped from 3.4 million in 1981 to 12.0 
million in 1982 and to 15.5 million in 1986. In 1987, only 7.3 
million taxpayers reported deductible contributions. Since 
then, the number has continued to fall (see table 13-8).

              TABLE 13-8.--USE OF DEDUCTIBLE IRAs, 1980-95              
------------------------------------------------------------------------
                                         Number of tax                  
                                            returns         Total IRA   
                 Year                    deducting IRA      deductions  
                                         contributions      (billions)  
                                           (millions)                   
------------------------------------------------------------------------
1980..................................              2.6             $3.4
1981..................................              3.4              4.8
1982..................................             12.0             28.3
1983..................................             13.6             32.1
1984..................................             15.2             35.4
1985..................................             16.2             38.2
1986..................................             15.5             37.8
1987..................................              7.3             14.1
1988..................................              6.4             11.9
1989..................................              5.8             10.8
1990..................................              5.2              9.9
1991..................................              4.7              9.0
1992..................................              4.5              8.7
1993..................................              4.4              8.5
1994..................................              4.3              8.4
1995..................................              4.3             8.3 
------------------------------------------------------------------------
Source: Internal Revenue Service, Statistics of Income, various years.  

    Upper-income taxpayers facing higher marginal tax rates 
receive more benefit per dollar of IRA deduction than do low-
income taxpayers facing lower marginal tax rates. When IRAs 
were available to all workers, the percentage of taxpayers 
contributing to an IRA was substantially higher among taxpayers 
with higher income. For example, in 1985, 13.6 percent of 
taxpayers with AGI between $10,000 and $30,000 contributed to 
an IRA compared with 74.1 percent of taxpayers with AGI between 
$75,000 and $100,000.
    The decline in IRA use between 1985 and 1990 among those 
with AGI between $10,000 and $30,000 appears to be larger than 
the reduction required by the change in law since the 
restrictions on deductible contributions apply only to a small 
fraction of taxpayers with AGI below $30,000.
    Eligibility percentages and the real value of the IRA 
contribution limits decline over time because present law does 
not index the contribution limits or the income eligibility 
limits for inflation. For example, the real value of a $2,000 
contribution has declined more than 30 percent since 1986 
because of inflation.
    Congress established IRAs to allow workers not covered by 
employer pension plans to have tax-advantaged retirement 
saving. Nonetheless, since 1981 IRA participation rates have 
been higher among those covered by an employer-provided pension 
plan than those without one, and many of those who are not 
covered by a pension plan do not contribute to an IRA. In 1987, 
10 percent of full-time private-sector earners without pension 
coverage contributed to an IRA, while 15 percent of those with 
coverage contributed (Woods, 1989, p. 9).

     EXCLUSION OF SOCIAL SECURITY AND RAILROAD RETIREMENT BENEFITS

                          Legislative History

    The exclusion from gross income for Social Security 
benefits was not initially established by statute. Prior to the 
Social Security Amendments of 1983, the exclusion was based on 
a series of administrative rulings issued by the Internal 
Revenue Service in 1938 and 1941.\3\
---------------------------------------------------------------------------
    \3\ See Internal Revenue Service, Internal Revenue Bulletin, 1938-
1, Income Tax Unit 3154, p. 114; 1938-2, Income Tax Unit 3229, p. 136; 
and 1941-1, Income Tax Unit 3447, p. 191.
---------------------------------------------------------------------------
    Under the Social Security Amendments of 1983, a portion of 
the Social Security benefits paid to higher income taxpayers is 
included in gross income. In 1993, the Omnibus Budget 
Reconciliation Act increased the amount of benefits subject to 
tax and increased the rate of tax for some benefit recipients.
    The exclusion from gross income of benefits paid under the 
Railroad Retirement System was enacted in the Railroad 
Retirement Act of 1935. A portion of the benefits payable under 
the Railroad Retirement System (generally, tier 1 benefits) is 
equivalent to Social Security benefits. The tax treatment of 
tier 1 railroad retirement benefits was modified in the Social 
Security Amendments of 1983 to conform to the tax treatment of 
Social Security benefits. Other railroad retirement benefits 
are taxable in the same manner as employer-provided retirement 
benefits. The Consolidated Omnibus Budget Reconciliation Act of 
1985 provided that tier 1 benefits are taxable in the same 
manner as Social Security benefits only to the extent that 
Social Security benefits otherwise would be payable. Other tier 
1 benefits are taxable in the same manner as all other railroad 
retirement benefits (for further details, see section 5).

                        Explanation of Provision

    For taxpayers whose modified adjusted gross income exceeds 
certain limits, a portion of Social Security and tier 1 
railroad retirement benefits is included in taxable income. 
Modified adjusted gross income is adjusted gross income plus 
interest on tax-exempt bonds plus 50 percent of Social Security 
and tier 1 railroad retirement benefits. A two-tier structure 
applies. The base tier is $25,000 for unmarried individuals and 
$32,000 for married couples filing joint returns, and zero for 
married persons filing separate returns who do not live apart 
at all times during the taxable year. The amount of benefits 
includable in income is the lesser of 50 percent of the Social 
Security and tier 1 railroad retirement benefits or 50 percent 
of the excess of the taxpayer's combined income over the base 
amount.
    The second tier applies to taxpayers with modified adjusted 
gross income of at least $34,000 (unmarried taxpayers) or 
$44,000 (married taxpayers filing joint returns). For these 
taxpayers, the amount of benefits includable in gross income is 
the lesser of 85 percent of Social Security benefits or the sum 
of 85 percent of the amount by which modified adjusted gross 
income exceeds the second-tier thresholds, and the smaller of 
the amount included under prior law or $4,500 (unmarried 
taxpayers) or $6,000 (married taxpayers filing jointly). The 
portion of tier 1 railroad retirement benefits potentially 
includable in taxable income under the above formula is the 
amount of benefits the taxpayer would have received if covered 
under Social Security. Pursuant to section 72(r) of the 
Internal Revenue Code of 1986, all other benefits payable under 
the Railroad Retirement System are includable in income when 
received to the extent they exceed employee contributions.

                          Effect of Provision

    About 23 percent of all Social Security recipients pay 
taxes on their benefits. This percentage is likely to increase 
over time because the thresholds are not adjusted annually for 
past inflation or other factors.

 EXCLUSION OF EMPLOYER CONTRIBUTION FOR MEDICAL INSURANCE PREMIUMS AND 
                              MEDICAL CARE

                          Legislative History

    In 1943, the Internal Revenue Service (IRS) ruled that 
employer contributions to group health insurance policies were 
not taxable to the employee. Employer contributions to 
individual health insurance policies, however, were declared to 
be taxable income in an IRS revenue ruling in 1953.
    Section 106 of the Internal Revenue Code, enacted in 1954, 
reversed the 1953 IRS ruling. As a result, employer 
contributions to all accident or health plans generally are 
excluded from gross income and therefore are not subject to 
tax. Under section 105 of the Internal Revenue Code, benefits 
received under an employer's accident or health plan generally 
are not included in the employee's income.
    In the Revenue Act of 1978, Congress added section 105(h) 
to tax the benefits payable to highly compensated employees 
under a self-insured medical reimbursement plan if the plan 
discriminated in favor of highly compensated employees.

                        Explanation of Provision

    Gross income of an employee generally excludes employer-
provided coverage under an accident or health plan. The 
exclusion applies to coverage provided to former employees, 
their spouses, or dependents. Amounts excluded include those 
received by an employee for personal injuries or sickness if 
the amounts are paid directly or indirectly to reimburse the 
employee for expenses incurred for medical care. However, this 
exclusion does not apply in the case of amounts paid to a 
highly compensated individual under a self-insured medical 
reimbursement plan if the plan violates the nondiscrimination 
rules of section 105(h).
    Present law permits employers to prefund medical benefits 
for retirees. Postretirement medical benefits may be prefunded 
by the employer in two basic ways: (1) through a separate 
account in a tax-qualified pension plan (sec. 401(h)); or (2) 
through a welfare benefit fund (secs. 419 and 419A). Generally, 
the amounts contributed are excluded from the income of the 
plan or participants. Although amounts held in a section 401(h) 
account are accorded tax-favored treatment similar to assets 
held in a pension trust, the benefits provided under a section 
401(h) account are required to be incidental to the retirement 
benefits provided by the plan. Amounts contributed to welfare 
benefit funds are subject to certain deduction limitations 
(secs. 419 and 419A). In addition, the fund is subject to 
income tax relating to any set-aside to provide postretirement 
medical benefits.

                          Effect of Provision

    The exclusion for employer-provided health coverage 
provides an incentive for compensation to be furnished to the 
employee in the form of health coverage, rather than in cash 
subject to current taxation. For example, an employer designing 
a compensation package for an employee would be indifferent 
between paying the employee one dollar in cash and purchasing 
one dollar's worth of health insurance for the employee.\4\ On 
the other hand, because the employee is likely to pay Federal 
and State income taxes and payroll taxes on cash compensation 
and no tax on health insurance contributions made on his 
behalf, the employee would likely prefer that some compensation 
be in the form of health insurance. Employees subject to tax at 
the highest marginal tax rates have the greatest incentive to 
receive compensation in nontaxable forms.
---------------------------------------------------------------------------
    \4\ To the extent the employer bears a portion of the payroll tax, 
the employer may actually prefer to provide compensation through health 
insurance (which is not subject to payroll tax).
---------------------------------------------------------------------------
    The tax preference that the exclusion provides is 
substantial and has resulted in widespread access to health 
coverage. A majority of the population now receives health 
insurance as a consequence of their own employment or of a 
family member's employment. In 1996, for 58 percent of the 
population, employment-based health insurance was the primary 
source of health coverage, while 5 percent purchased insurance 
privately, 13 percent received Medicare benefits, and 9 percent 
received Medicaid benefits. According to a special analysis of 
data from the Current Population Survey conducted by the CBO, 
15 percent of the population had no health insurance.
    Health coverage through employer-based plans tends to be 
more prevalent in the finance, government, manufacturing, and 
mining sectors of the economy, among medium and large firms, 
for more highly paid workers, and among those over age 30 (see 
table 13-9).

                        MEDICAL SAVINGS ACCOUNTS

    The Health Insurance Portability and Accountability Act of 
1996 included provisions for medical savings accounts (MSAs), 
effective for years beginning after December 31, 1996. Within 
limits, contributions to an MSA are deductible if made by an 
eligible individual and are excludable from income and 
employment taxes if made by the employer (other than 
contributions made through a cafeteria plan). Earnings on 
amounts in an MSA are not currently taxable. Distributions from 
an MSA for medical expenses are not includable in gross income. 
Distributions from an MSA that are not for medical expenses are 
includable in gross income and are subject to an additional tax 
of 15 percent, unless the distribution is made after death, 
disability, or age 65.
    Beginning in 1997, MSAs are available to employees covered 
under an employer-sponsored high deductible health plan of a 
small employer and to self-employed individuals covered under a 
high deductible health plan (regardless of the size of the 
entity for which the self-employed individual performs 
services). A small employer is defined as an employer with 50 
or fewer employees.
    In order to be eligible for an MSA contribution, an 
otherwise eligible individual must be covered under a high 
deductible health plan and no other health plan. A high 
deductible health plan is a plan with an annual deductible of 
at least $1,500 and no more than $2,250 in the case of 
individual coverage (and at least $3,000 and no more than 
$4,500 in the case of family coverage). The dollar limits are 
indexed for inflation. High deductible plans must also meet 
certain limits on out-of-pocket expenses.
    The number of taxpayers benefiting annually from an MSA 
contribution is limited to a threshold level (generally, 
750,000 taxpayers). If it is determined in a year that the 
threshold level has been exceeded (called a cutoff year), then, 
in general, for succeeding years during the 4-year pilot period 
1997-2000, only those individuals who (1) made an MSA 
contribution or had an employer MSA contribution for the year 
or a preceding year (i.e., are active MSA participants) or (2) 
are employed by a participating employer, would be eligible for 
an MSA contribution. In determining whether the threshold for 
any year has been exceeded, MSAs of previously uninsured 
individuals are not taken into account.
    After December 31, 2000, no new contributions may be made 
to MSAs except by or on behalf of an individual who previously 
had MSA contributions and employees who are employed by a 
participating employer. Self-employed individuals who made 
contributions to an MSA during the period 1997-2000 also may 
continue to make contributions after 2000.

  TABLE 13-9.--PRIMARY SOURCE OF HEALTH INSURANCE FOR WORKERS UNDER AGE 65 BY DEMOGRAPHIC CATEGORY, MARCH 1996  
----------------------------------------------------------------------------------------------------------------
                                                                  Percentage distribution by source of insurance
                                                       Number of -----------------------------------------------
                      Category                          workers    Own or                                       
                                                      (millions)    other   Individual      Public         No   
                                                                  employer    policy    insurance \1\  insurance
----------------------------------------------------------------------------------------------------------------
Industry:                                                                                                       
    Agriculture.....................................       3.0       45.4       15.5           3.6         35.5 
    Construction....................................       8.0       61.2        6.8           2.0         29.9 
    Finance.........................................       7.8       83.6        5.0           1.4         10.1 
    Government......................................       5.6       92.3        1.8           0.8          5.1 
    Manufacturing...................................      20.4       82.9        2.2           1.6         13.3 
    Mining..........................................       0.6       81.8        3.1           2.0         13.1 
    Retail trade....................................      18.0       63.3        5.4           4.7         26.7 
    Services:                                                                                                   
        Professional................................      28.6       83.0        4.5           1.9         10.7 
        Other.......................................      13.9       61.7        7.4           4.1         26.8 
    Transportation..................................       8.5       81.9        3.2           1.4         13.5 
    Wholesale trade.................................       4.7       78.6        4.8           1.4         15.2 
Wage rate \2\:                                                                                                  
    Below $5.00.....................................       5.4       50.2        4.5           6.8         38.5 
    $5.00-$9.99.....................................      39.1       68.7        3.8           3.6         24.0 
    $10.00-$14.99...................................      25.8       85.6        3.1           0.8         10.5 
    $15.00 or more..................................      29.6       92.9        1.8           0.1          5.2 
Family income as percentage of poverty level:                                                                   
    Under 100.......................................       8.9       25.6        5.0          20.1         49.2 
    100-199.........................................      19.4       52.6        5.9           5.9         35.6 
    200-299.........................................      22.3       72.3        5.5           1.9         20.3 
    300 or more.....................................      75.4       86.5        4.4           0.5          8.6 
Firm size (number of employees):                                                                                
    Fewer than 10...................................      25.2       51.0       14.1           4.0         30.9 
    10-24...........................................      11.7       63.7        5.7           3.5         27.0 
    25-99...........................................      16.1       74.0        3.1           3.2         19.8 
    100-499.........................................      17.6       81.2        2.0           2.5         14.4 
    500-999.........................................       7.5       82.9        2.4           2.6         12.1 
    1,000 or more...................................      48.0       85.8        1.8           2.4          9.9 
Age (years):                                                                                                    
    Under 30........................................      31.1       62.9        3.9           5.7         27.5 
    30-39...........................................      37.5       75.4        4.1           2.8         17.7 
    40-49...........................................      33.3       80.0        4.9           1.8         13.2 
    50-64...........................................      24.1       80.4        7.0           1.2         11.3 
                                                     -----------------------------------------------------------
        All workers.................................     126.0       74.5        4.9           3.0        17.7  
----------------------------------------------------------------------------------------------------------------
\1\ Public insurance includes Medicaid, Medicare, and coverage provided by the Department of Veterans Affairs.  
\2\ Wage is the hourly wage for hourly employees and earnings per week divided by hours worked for nonhourly    
  employees. The figures exclude individuals for whom an hourly wage could not be determined.                   
                                                                                                                
 Source: Congressional Budget Office estimates based on the March 1994 Current Population Survey.               

                            CAFETERIA PLANS

                          Legislative History

    Under present law, compensation generally is includable in 
gross income when received. An exception applies if an employee 
may choose between cash and certain employer-provided 
nontaxable benefits under a cafeteria plan.
    Prior to 1978, ERISA provided that an employer contribution 
made before January 1, 1977 to a cafeteria plan in existence on 
June 27, 1974, had to be included in an employee's gross income 
only to the extent that the employee actually elected taxable 
benefits. If a plan did not exist on June 27, 1974, the 
employer contribution was to be included in income to the 
extent the employee could have elected taxable benefits. The 
Revenue Act of 1978 set up permanent rules for plans that offer 
an election between taxable and nontaxable benefits.
    The Deficit Reduction Act of 1984 (Public Law 98-369) 
clarified the types of employer-provided benefits that could be 
provided through a cafeteria plan, added a 25-percent 
concentration test, and required annual reporting to the IRS by 
employers.
    The Tax Reform Act of 1986 also modified the rules relating 
to cafeteria plans in several respects.

                        Explanation of Provision

    A participant in a cafeteria plan (sec. 125) is not treated 
as having received taxable income solely because the 
participant had the opportunity to elect to receive cash or 
certain nontaxable benefits. In order to meet the requirements 
of section 125, the plan must be in writing, must include only 
employees (including former employees) as participants, and 
must satisfy certain nondiscrimination requirements.
    In general, a nontaxable benefit may be provided through a 
cafeteria plan if the benefit is excludable from the 
participant's gross income by reason of a specific provision of 
the Code. These include employer-provided health coverage, 
group-term life insurance coverage, and benefits under 
dependent care assistance programs. A cafeteria plan may not 
provide qualified scholarships or tuition reduction, 
educational assistance, miscellaneous employer-provided fringe 
benefits, or deferred compensation except through a qualified 
cash or deferred arrangement.
    If the plan discriminates in favor of highly compensated 
individuals regarding eligibility to participate, to make 
contributions, or to receive benefits under the plan, then the 
exclusion does not apply. For purposes of these 
nondiscrimination requirements, a highly compensated individual 
is an officer, a shareholder owning more than 5 percent of the 
employing firm, a highly compensated individual determined 
under the facts and circumstances of the case, or a spouse or 
dependent of the above individuals.

                          Effect of Provision

    The optimal compensation of employees (in a tax planning 
sense) would require that employers and employees arrive at the 
compensation package that provides the largest aftertax benefit 
to the employee at minimum aftertax cost to the employer (see 
Scholes & Wolfson, 1992, chapter 10). Both the potential 
taxation of compensation provided to employees and the 
deductibility of compensation provided by the employer would be 
considered. If only income taxes were considered, employers 
would be indifferent between the payment of $1 in salary or 
wages and the payment of $1 in fringe benefits to an employee, 
because both types of compensation are fully deductible. When 
the employer payments for FICA and FUTA taxes are considered, 
however, the employer might actually find it less costly to 
compensate an employee with a dollar's worth of fringe benefit 
not subject to FICA and FUTA taxes rather than a dollar of wage 
or salary payments that are subject to these taxes.
    The employee, however, would prefer to be compensated in 
the form that provides the highest aftertax value. An 
additional dollar of salary or wage paid to the employee will 
be subject to tax. If a fringe benefit is excludable from the 
employee's income, the employee pays no tax on receipt of the 
benefit. Consequently, the employee receives greater 
compensation via the fringe benefit. This differential 
treatment of salary or wage payments and excludable fringe 
benefits implies that compensation packages designed to 
minimize the joint tax liability of employers and employees 
could include substantial amounts of excludable fringe 
benefits.
    Employees may have different preferences about the 
allocation of their compensation. For example, an employee with 
no dependents may place little value on employer-provided life 
insurance. Cafeteria plans permit employees some discretion as 
to the provided benefits, and will tend to be preferred to 
benefit plans in which all employees of the firm receive the 
identical benefit package.
    Cafeteria plans are a growing part of compensation plans, 
particularly for larger employers. The Bureau of Labor 
Statistics estimated that in 1995, 55 percent of employees at 
large- and medium-sized firms were eligible for some type of 
cafeteria plan. This figure has grown from an estimated 5 
percent in 1986 (U.S. Bureau of Labor Statistics, 1993). 
Smaller firms generally do not offer cafeteria plans to their 
workers. For example, in 1994, only 19 percent of the workers 
in small, private establishments (nonfarm establishments with 
fewer than 100 employees) were eligible to participate in a 
cafeteria plan (U.S. Bureau of Labor Statistics, 1994). The 
lower figure for smaller firms reflects in part the less 
generous fringe benefit packages provided by smaller firms.
    Like any income exclusion, the exclusion from gross income 
for cafeteria plan benefits can lead to disparities in the tax 
system. Employees with the same total compensation can have 
taxable incomes that are substantially different because of the 
form in which compensation is received. The exclusion for 
cafeteria plan benefits also may be used in some cases to avoid 
the 7.5 percent of AGI floor on deductible medical expenses. 
The use of cafeteria plans reduces the aftertax cost of health 
care to employees using these plans, which could cause these 
employees to purchase a larger amount of health care services. 
On the other hand, cafeteria plans could encourage employers to 
increase the share of premiums, copayments, and deductibles 
paid by employees, resulting in increased employee awareness of 
the costs of their health plans. This incentive could result in 
reduced health care costs.

                     HEALTH CARE CONTINUATION RULES

                          Legislative History

    The Consolidated Omnibus Budget Reconciliation Act of 1985 
added sections 106(b), 162(i)(2), and 162(k) to the Internal 
Revenue Code under which certain group health plans are 
required to offer health coverage to certain employees and 
former employees, as well as to their spouses and dependents. 
Parallel requirements were added to title I of ERISA and the 
Public Health Services Act. If an employer failed to satisfy 
the health care continuation rules, the employer was denied a 
deduction for contributions to its group health plans and 
highly compensated employees were required to include in 
taxable income the employer-provided value of the coverage 
received under such plans.
    The Technical and Miscellaneous Revenue Act of 1988 made 
several changes to the health care continuation rules. Sections 
106(b), 162(i)(2), and 162(k) were repealed and replaced by 
section 4980B. Section 4980B imposes an excise tax on the 
employer or other responsible party who fails to satisfy the 
rules instead of denying deductions and the exclusion. The 
Health Insurance Portability and Accountability Act of 1996 
made some changes to the health care continuation rules in 
cases of disability.

                        Explanation of Provision

    The health care continuation rules in section 4980B require 
that an employer provide qualified beneficiaries with the 
opportunity to participate for a specified period in the 
employer's health plan after that participation otherwise would 
have terminated. If the employee elects such continuation 
coverage, the employee may be required to pay for the coverage. 
The amount the employee can be required to pay is subject to 
certain limits.
    The qualifying events that may trigger rights to 
continuation coverage are: (1) the death of the employee; (2) 
the voluntary or involuntary termination of the employee's 
employment (other than by reason of gross misconduct); (3) a 
reduction of the employee's hours; (4) the divorce or legal 
separation of the employee; (5) the employee becoming entitled 
to benefits under Medicare; and (6) a dependent child of the 
employee ceasing to be a dependent under the employer's plan. 
The maximum period of continuation coverage is 36 months, 
except in the case of termination of employment or reduction of 
hours for which the maximum period is 18 months. The 18-month 
period is extended to 29 months in certain cases involving the 
disability of the qualified beneficiary. Certain events, such 
as the failure by the qualified beneficiary to pay the required 
premium, may trigger an earlier cessation of the continuation 
coverage.
    A beneficiary has a prescribed period of time during which 
to elect continuation coverage after the employee receives 
notice from the plan administrator of the right to continuation 
coverage.

                     GROUP HEALTH PLAN REQUIREMENTS

    The Health Insurance Portability and Accountability Act of 
1996 imposes certain requirements regarding health coverage 
portability through limitations on preexisting condition 
exclusions, prohibitions on excluding individuals from coverage 
based on health status, and guaranteed renewability of health 
insurance coverage. An excise tax is imposed with respect to 
failures of a group health plan to comply with the 
requirements. The tax is usually imposed on the employer 
sponsoring the plan. The amount of the tax is generally equal 
to $100 per day for each day during which the failure occurs 
until the failure is corrected. The maximum tax that can be 
imposed is the lesser of 10 percent of the employer's payments 
during the taxable year in which the failure occurred under 
group health plans or $500,000. The Secretary of the Treasury 
may waive all or part of the tax to the extent that payment of 
the tax would be excessive relative to the failure involved 
(see discussion of health care continuation rules).

    TAX BENEFITS FOR ACCELERATED DEATH BENEFITS AND LONG-TERM CARE 
                               INSURANCE

                          Legislative History

Accelerated death benefits
    If a contract meets the definition of a life insurance 
contract, gross income does not include insurance proceeds that 
are paid pursuant to the contract by reason of the death of the 
insured (sec. 101(a)). In addition, the undistributed 
investment income (inside buildup) earned on premiums credited 
under the contract is not subject to current taxation to the 
owner of the contract. The exclusion under section 101 applies 
regardless of whether the death benefits are paid as a lump sum 
or otherwise.
    If a contract fails to be treated as a life insurance 
contract under section 7702(a), inside buildup on the contract 
is generally subject to tax (sec. 7702(g)).
    To qualify as a life insurance contract for Federal income 
tax purposes, a contract must be a life insurance contract 
under the applicable State or foreign law and must satisfy 
either of two alternative tests: (1) a cash value accumulation 
test, or (2) a test consisting of a guideline premium 
requirement and a cash value corridor requirement (sec. 
7702(a)). A contract satisfies the cash value accumulation test 
if the cash surrender value of the contract may not at any time 
exceed the net single premium that would have to be paid at 
such time to fund future benefits under the contract. A 
contract satisfies the guideline premium and cash value 
corridor tests if the premiums paid under the contract do not 
at any time exceed the greater of the guideline single premium 
or the sum of the guideline level premiums, and if the death 
benefit under the contract is not less than a varying statutory 
percentage of the cash surrender value of the contract.
Long-term care insurance
    Prior to the Health Insurance Portability and 
Accountability Act of 1996, tax law generally did not provide 
explicit rules relating to the tax treatment of long-term care 
insurance contracts or long-term care services. Thus, the 
treatment of long-term care contracts and services was unclear. 
Prior and present law provide rules relating to medical 
expenses and accident or health insurance.
    Amounts received by a taxpayer under accident or health 
insurance for personal injuries or sickness generally are 
excluded from gross income to the extent that the amounts 
received are not attributable to medical expenses that were 
allowed as a deduction for a prior taxable year (sec. 104).

                        Explanation of Provision

Accelerated death benefits
    The Health Insurance Portability and Accountability Act of 
1996 provides an exclusion from gross income as an amount paid 
by reason of the death of an insured for amounts received under 
a life insurance contract and for amounts received for the sale 
or assignment of a life insurance contract to a qualified 
viatical settlement provider, provided that the insured under 
the life insurance contract is either terminally ill or 
chronically ill.
    The exclusion does not apply in the case of an amount paid 
to any taxpayer other than the insured, if such taxpayer has an 
insurable interest by reason of the insured being a director, 
officer, or employee of the taxpayer, or by reason of the 
insured being financially interested in any trade or business 
carried on by the taxpayer.
    A terminally ill individual is defined as one who has been 
certified by a physician as having an illness or physical 
condition that reasonably can be expected to result in death 
within 24 months of the date of certification.
    A chronically ill individual has the same meaning as 
provided under the long-term care rules (see below). In the 
case of a chronically ill individual, the exclusion with 
respect to amounts paid under a life insurance contract and 
amounts paid in a sale or assignment to a viatical settlement 
provider applies if the payment received is for costs incurred 
by the payee (not compensated by insurance or otherwise) for 
qualified long-term care services for the insured person for 
the period, and two other requirements (similar to requirements 
applicable to long-term care insurance contracts) are met.
     The first requirement is that under the terms of the 
contract giving rise to the payment, the payment is not a 
payment or reimbursement of expenses reimbursable under 
Medicare (except where Medicare is a secondary payor under the 
arrangement, or the arrangement provides for per diem or other 
periodic payments without regard to expenses for qualified 
long-term care services). No provision of law shall be 
construed or applied so as to prohibit the offering of such a 
contract giving rise to such a payment on the basis that the 
contract coordinates its payments with those provided under 
Medicare. The second requirement is that the arrangement 
complies with the consumer protection provisions applicable to 
long-term care insurance contracts and issuers that are 
specified in Treasury regulations.
Long-term care insurance
    Exclusion of long-term care insurance proceeds.--The Health 
Insurance Portability and Accountability Act of 1996 provides 
that a long-term care insurance contract generally is treated 
as an accident and health insurance contract. Amounts (other 
than policyholder dividends or premium refunds) received under 
a long-term care insurance contract generally are excludable as 
amounts received for personal injuries and sickness, subject to 
a dollar cap on aggregate payments under per diem contracts. A 
reporting requirement applies to payors of excludable amounts.
    The amount of the dollar cap on aggregate payments under 
per diem contracts with respect to any one chronically ill 
individual (who is not also terminally ill) is $175 per day 
($63,875 annually) as indexed, reduced by the amount of 
reimbursements and payments received by anyone for the cost of 
qualified long-term care services for the chronically ill 
individual. If more than one payee receives payments with 
respect to any one chronically ill individual, then everyone 
receiving periodic payments with respect to the same insured is 
treated as one person for purposes of the dollar cap. The 
amount of the dollar cap is used first by the chronically ill 
person, and any remaining amount is to be allocated in 
accordance with Treasury regulations. If payments under such 
contracts exceed the dollar cap, then the excess is excludable 
only to the extent of actual costs (in excess of the dollar 
cap) incurred for long-term care services. Amounts in excess of 
the dollar cap, with respect to which no actual costs were 
incurred for long-term care services, are fully includable in 
income without regard to rules relating to return of basis 
under section 72. A grandfather rule applies to any per diem-
type contract issued to a policyholder on or before July 31, 
1996.
    Exclusion for employer-provided long-term care coverage.--A 
plan of an employer providing coverage under a long-term care 
insurance contract generally is treated as an accident and 
health plan. Thus, employer-provided long-term care coverage is 
generally excludable from income and wages and deductible by 
the employer. Employer-provided coverage under a long-term care 
insurance contract is not, however, excludable by an employee 
if provided through a cafeteria plan; similarly, expenses for 
long-term care services cannot be reimbursed under a flexible 
spending arrangement.
    Definition of long-term care insurance contract.--A long-
term care insurance contract is defined as any insurance 
contract that provides only coverage of qualified long-term 
care services and that meets other requirements. The other 
requirements are that: (1) the contract is guaranteed 
renewable; (2) the contract does not provide for a cash 
surrender value or other money that can be paid, assigned, 
pledged or borrowed; (3) refunds (other than refunds on the 
death of the insured or complete surrender or cancellation of 
the contract) and dividends under the contract may be used only 
to reduce future premiums or increase future benefits; and (4) 
the contract generally does not pay or reimburse expenses 
reimbursable under Medicare (except where Medicare is a 
secondary payor, or the contract makes per diem or other 
periodic payments without regard to expenses).
    A contract does not fail to be treated as a long-term care 
insurance contract solely because it provides for payments on a 
per diem or other periodic basis without regard to expenses 
incurred during the period.
    Medicare duplication rules.--No provision of law may be 
applied to prohibit the offering of a long-term care insurance 
contract on the basis that the contract coordinates its 
benefits with those provided under Medicare.
    Definition of qualified long-term care services.--Qualified 
long-term care services means necessary diagnostic, preventive, 
therapeutic, curing, treating, mitigating and rehabilitative 
services, and maintenance or personal care services that are 
required by a chronically ill individual and that are provided 
pursuant to a plan of care prescribed by a licensed health care 
practitioner.
    Chronically ill individual.--A chronically ill individual 
is one who has been certified within the previous 12 months by 
a licensed health care practitioner as: (1) being unable to 
perform (without substantial assistance) at least two 
activities of daily living for at least 90 days due to a loss 
of functional capacity; (2) having a similar level of 
disability as determined by the Secretary of the Treasury in 
consultation with the Secretary of Health and Human Services; 
or (3) requiring substantial supervision to protect such 
individual from threats to health and safety due to severe 
cognitive impairment. Activities of daily living are eating, 
toileting, transferring, bathing, dressing and continence. For 
purposes of determining whether an individual is chronically 
ill, the number of activities of daily living that are taken 
into account under the long-term care insurance contract may 
not be less than five.
    Expenses for long-term care services treated as medical 
expenses.--Unreimbursed expenses for qualified long-term care 
services provided to the taxpayer or the taxpayer's spouse or 
dependents are treated as medical expenses for purposes of the 
itemized deduction for medical expenses (subject to the 
present-law floor of 7.5 percent of adjusted gross income). For 
this purpose, amounts received under a long-term care insurance 
contract (regardless of whether the contract reimburses 
expenses or pays benefits on a per diem or other periodic 
basis) are treated as reimbursement for expenses actually 
incurred for medical care.
    For purposes of the deduction for medical expenses, 
qualified long-term care services do not include services 
provided to an individual by a relative or spouse (directly, or 
through a partnership, corporation, or other entity), unless 
the relative is a licensed professional with respect to such 
services, or by a related corporation (within the meaning of 
Code section 267(b) or 707(b)).
    Long-term care insurance premiums treated as medical 
expenses.--Long-term care insurance premiums that do not exceed 
specified dollar limits are treated as medical expenses for 
purposes of the itemized deduction for medical expenses.
    Consumer protection provisions.--Certain consumer 
protection provisions apply with respect to the terms of a 
long-term care insurance contract, for purposes of determining 
whether the contract is a qualified long-term care insurance 
contract. In addition, certain consumer protection provisions 
apply to issuers of long-term care insurance contracts.

  DEDUCTION FOR HEALTH INSURANCE EXPENSES OF SELF-EMPLOYED INDIVIDUALS

    Self-employed individuals may currently deduct 40 percent 
of their health insurance expenses for themselves and their 
spouses and dependents. The deduction also applies to certain 
long-term care premiums treated as medical expenses. Under the 
Taxpayer Relief Act of 1997, the deduction for health insurance 
of self-employed individuals will increase as follows: the 
deduction will be 45 percent in 1998 and 1999; 50 percent in 
2000 and 2001; 60 percent in 2002; 80 percent in 2003-5; 90 
percent in 2006; and 100 percent in 2007 and thereafter.

                     EXCLUSION OF MEDICARE BENEFITS

                          Legislative History

    The exclusion from income of Medicare benefits has never 
been expressly established by statute. A 1970 IRS ruling, Rev. 
Rul. 70-341, 1970-2 C.B. 31, provided that the benefits under 
part A of Medicare are not includable in gross income because 
they are disbursements made to further the social welfare 
objectives of the Federal Government. The Internal Revenue 
Service relied on a similar ruling, Rev. Rul. 70-217, 1970-1 
C.B. 13, with respect to the excludability of Social Security 
disability insurance benefits in reaching this conclusion. (For 
background on the exclusion of Social Security benefits, see 
above section on pension contributions.) Rev. Rul. 70-341 also 
held that benefits under part B of Medicare are excludable as 
amounts received through accident and health insurance (though 
the subsidized portion of part B also may be excluded under the 
same theory applicable to the exclusion of part A benefits).

                        Explanation of Provision

    Benefits under part A and part B of Medicare are excludable 
from the gross income of the recipient. In general, part A pays 
for certain inpatient hospital care, skilled nursing facility 
care, home health care, and hospice care for eligible 
individuals (generally the elderly and the disabled). Part B 
covers certain services of a physician and other medical 
services for elderly or disabled individuals who elect to pay 
the required premium.

                   DEDUCTIBILITY OF MEDICAL EXPENSES

                          Legislative History

    An itemized deduction for unreimbursed medical expenses 
above a specified floor has been allowed since 1942. From 1954 
through 1982, the floor under the medical expense deduction was 
3 percent of the taxpayer's adjusted gross income (AGI); a 
separate floor of 1 percent of AGI applied to expenditures for 
medicine and drugs.
    In the Tax Equity and Fiscal Responsibility Act of 1982 
(TEFRA), the floor was increased to 5 percent of AGI (effective 
for 1983 and thereafter) and was applied to the total of all 
eligible medical expenses, including prescription drugs and 
insulin. TEFRA made nonprescription drugs ineligible for the 
deduction and eliminated the separate floor for drug costs.
    The Tax Reform Act of 1986 increased the floor under the 
medical expense deduction to 7.5 percent of AGI, beginning in 
1987.

                        Explanation of Provision

    Individuals who itemize deductions may deduct amounts they 
pay during the taxable year, if not reimbursed by insurance or 
otherwise, for medical care of the taxpayer and of the 
taxpayer's spouse and dependents, to the extent that the total 
of such expenses exceeds 7.5 percent of AGI (sec. 213).
    Medical care expenses eligible include: (1) health 
insurance (including aftertax employee contributions to 
employer health plans); (2) diagnosis, treatment, or prevention 
of disease, or for the purpose of affecting any structure or 
function of the body; (3) transportation primarily for and 
essential to medical care; (4) lodging away from home primarily 
for and essential to medical care, up to $50 per night; and (5) 
prescription drugs and insulin.
    Expenses paid for the general improvement of health, such 
as fees for exercise programs, are not eligible for the 
deduction unless prescribed by a physician to treat a specific 
illness. A deduction is not allowed for cosmetic surgery or 
similar procedures that do not meaningfully promote the proper 
function of the body or treat disease. However, such expenses 
are deductible if the cosmetic procedure is necessary to 
correct a deformity arising from a congenital abnormality, an 
injury resulting from an accident, or disfiguring disease.
    Medical expenses are not subject to the general limitation 
on itemized deductions applicable to taxpayers with adjusted 
gross incomes above a certain limit ($121,200 for 1997 and 
adjusted annually for inflation).

                          Effect of Provision

    The Tax Code allows taxpayers to claim an itemized 
deduction if unreimbursed medical expenses absorb a substantial 
portion of income and thus adversely affect the taxpayer's 
ability to pay taxes. In order to limit the deduction to 
extraordinary expenses, medical expenses are deductible only to 
the extent that they exceed 7.5 percent of the taxpayer's AGI.
    Table 13-10 shows the effect on medical expense deductions 
of the increases in the floor on medical deductions. In the 
absence of those increases, one would have expected the number 
of taxpayers claiming the deduction to have increased because 
of inflation of medical costs. However, increasing the floor 
should reduce the number of taxpayers claiming the deduction 
because many taxpayers with relatively modest expenses no 
longer qualify. The average deduction in excess of the 7.5 
percent of AGI floor has increased substantially, from $769 in 
1980 to $5,039 in 1995. Both increases in the floor (to 5 
percent in 1983 and to 7.5 percent in 1987) substantially 
reduced the number of taxpayers claiming deductions.
    Taxpayers in higher tax rate brackets receive more of a 
benefit from each dollar of deductible medical expense than do 
taxpayers in lower tax rate brackets. However, because the 
floor automatically rises with a taxpayer's income, higher 
income taxpayers are able to deduct a smaller amount (if any) 
of medical expenses above their floor than are low-income 
taxpayers incurring the same aggregate amount of medical 
expenses.

               TABLE 13-10.--TAX RETURNS CLAIMING DEDUCTIBLE MEDICAL AND DENTAL EXPENSES, 1980-95               
----------------------------------------------------------------------------------------------------------------
                                                                            Returns claiming medical and dental 
                                                                            expenses in excess of the AGI floor 
                                                                 Total    --------------------------------------
                                                               number of                Expenses in             
                            Year                                returns     Number of    excess of     Average  
                                                               filed (in     returns      the AGI    amount over
                                                               millions)       (in       floor  (in   the floor 
                                                                            millions)    billions)              
----------------------------------------------------------------------------------------------------------------
1980........................................................         93.9         19.5        $15.0         $769
1981........................................................         95.4         21.4         17.9          836
1982........................................................         95.3         22.0         21.7          986
1983........................................................         96.3          9.7         18.1        1,859
1984........................................................         99.4         10.7         21.5        2,009
                                                                                                                
1985........................................................        101.7         10.8         22.9        2,127
1986........................................................        103.0         10.5         25.1        2,382
1987........................................................        107.0          5.4         17.2        3,202
1988........................................................        110.1          4.8         18.0        3,741
1989........................................................        112.1          5.1         20.9        4,079
                                                                                                                
1990........................................................        113.7          5.1         21.5        4,215
1991........................................................        114.7          5.3         23.7        4,444
1992........................................................        113.6          5.5         25.7        4,675
1993........................................................        114.6          5.5         26.5        4,829
1994........................................................        115.9          5.2         26.4        5,044
1995........................................................        118.2          5.4         27.0       5,039 
----------------------------------------------------------------------------------------------------------------
Source: Internal Revenue Service.                                                                               

    In 1995, approximately 5,351,000 taxpayers claimed itemized 
medical expenses in excess of the medical deductions floor (7.5 
percent of adjusted gross income). Of that number, 79 percent 
had incomes of less than $50,000 (see table 13-11). However, 
taxpayers with incomes over $50,000 received far more than half 
of the total tax savings attributable to medical expense 
deductions.

 TABLE 13-11.--DISTRIBUTION OF ITEMIZED DEDUCTIONS FOR MEDICAL EXPENSES,
                                  1995                                  
------------------------------------------------------------------------
                                  Average      Returns     Total amount 
 Income class (thousands) \1\    deduction   (thousands)  (billions) \2\
------------------------------------------------------------------------
0-$10.........................       $5,819          471           $2.7 
$10-$20.......................        5,736        1,140            6.5 
$20-$30.......................        3,799        1,035            3.9 
$30-$40.......................        4,015          888            3.6 
$40-$50.......................        4,086          679            2.8 
$50-$75.......................        4,992          790            3.9 
$75-$100......................        7,146          220            1.6 
$100-$200.....................       12,038          114            1.4 
$200 and over.................       38,442           13            0.5 
                               -----------------------------------------
     Total....................        5,039        5,351          27.0  
------------------------------------------------------------------------
\1\ The income concept is defined in the introduction to this chapter.  
\2\ Amounts in excess of the floor on itemized medical deductions (7.5  
  percent of adjusted gross income).                                    
                                                                        
 Source: Internal Revenue Service.                                      

                          EARNED INCOME CREDIT

                          Legislative History

    The earned income credit (EIC Code sec. 32), enacted in 
1975, generally equals a specified percentage of wages up to a 
maximum dollar amount. The maximum amount applies over a 
certain income range and then diminishes to zero over a 
specified phaseout range. The income ranges and percentages 
have been revised several times since original enactment, 
expanding the credit (see table 13-12).
    In 1987, the credit was indexed for inflation. In 1990 and 
again in 1993, Congress enacted substantial expansions of the 
credit. Auxiliary credits were added for very young children 
and for health insurance premiums paid on behalf of a 
qualifying child in 1990. These were repealed in 1993. Also in 
1993, eligibility for the credit was expanded to include 
childless workers. The Personal Responsibility and Work 
Opportunity Reconciliation Act of 1996 incorporated new rules 
relating to taxpayer identification numbers and the modified 
AGI phaseout of the credit in addition to amending the credit's 
unearned income test (described below). The Taxpayer Relief Act 
of 1997 also included provisions to improve compliance. The 
provisions: (1) deny the EIC for 10 years to taxpayers who 
fraudulently claimed the EIC, 2 years for EIC claims which are 
a result of reckless or intentional disregard of rules or 
regulations); (2) require EIC recertification for a taxpayer 
who is denied the EIC; (3) imposes due diligence requirements 
on paid preparers of returns involving the EIC; (4) requires 
information sharing between the Treasury Department and State 
and local governments regarding child support orders; and (5) 
allows expanded use of Social Security Administration records 
to enforce the tax laws, including the EIC. The Balanced Budget 
Act of 1997 also increased the IRS authorization to improve 
enforcement of the EIC.

                             TABLE 13-12.--EARNED INCOME CREDIT PARAMETERS, 1975-97                             
                                    [Dollar amounts unadjusted for inflation]                                   
----------------------------------------------------------------------------------------------------------------
                                                                 Mininum                        Phaseout range  
                                                        Credit    income            Phaseout -------------------
                    Calendar year                        rate      for    Maximum     rate                      
                                                      (percent)  maximum   credit  (percent)  Beginning   Ending
                                                                  credit                        income    income
----------------------------------------------------------------------------------------------------------------
1975-78.............................................     10.00    $4,000     $400     10.00     $4,000    $8,000
1979-84.............................................     10.00     5,000      500     12.50      6,000    10,000
1985-86.............................................     14.00     5,000      550     12.22      6,500    11,000
1987................................................     14.00     6,080      851     10.00      6,920    15,432
1988................................................     14.00     6,240      874     10.00      9,840    18,576
1989................................................     14.00     6,500      910     10.00     10,240    19,340
1990................................................     14.00     6,810      953     10.00     10,730    20,264
1991:                                                                                                           
  One child.........................................     16.70     7,140    1,192     11.93     11,250    21,250
  Two children......................................     17.30     7,140    1,235     12.36     11,250    21,250
1992:                                                                                                           
  One child.........................................     17.60     7,520    1,324     12.57     11,840    22,370
  Two children......................................     18.40     7,520    1,384     13.14     11,840    22,370
1993:                                                                                                           
  One child.........................................     18.50     7,750    1,434     13.21     12,200    23,050
  Two children......................................     19.50     7,750    1,511     13.93     12,200    23,050
1994:                                                                                                           
  No children.......................................      7.65     4,000      306      7.65      5,000     9,000
  One child.........................................     26.30     7,750    2,038     15.98     11,000    23,755
  Two children......................................     30.00     8,425    2,528     17.68     11,000    25,296
1995:                                                                                                           
  No children.......................................      7.65     4,100      314      7.65      5,130     9,230
  One child.........................................     34.00     6,160    2,094     15.98     11,290    24,396
  Two children......................................     36.00     8,640    3,110     20.22     11,290    26,673
1996:                                                                                                           
  No children.......................................      7.65     4,220      323      7.65      5,280     9,500
  One child.........................................     34.00     6,330    2,152     15.98     11,610    25,078
  Two children......................................     40.00     8,890    3,556     21.06     11,610    28,495
1997:                                                                                                           
  No children.......................................      7.65     4,340      332      7.65      5,430     9,770
  One child.........................................     34.00     6,500    2,210     15.98     11,930    25,750
  Two children......................................     40.00     9,140    3,656     21.06     11,930   29,290 
----------------------------------------------------------------------------------------------------------------
Source: Joint Committee on Taxation.                                                                            

                        Explanation of Provision

     The EIC is available to low-income working taxpayers. 
Three separate schedules apply.
     Taxpayers with one qualifying child may claim a credit in 
1997 of 34 percent of their earnings up to $6,500, resulting in 
a maximum credit of $2,210. The maximum credit is available for 
those with earnings between $6,500 and $11,930. At $11,930 of 
earnings the credit begins to phase down at a rate of 15.98 
percent of earnings above $11,930. The credit is phased down to 
0 at $25,750 of earnings.
     Taxpayers with more than one qualifying child may claim a 
credit in 1997 of 40 percent of earnings up to $9,140, 
resulting in a maximum credit of $3,656. The maximum credit is 
available for those with earnings between $9,140 and $11,930. 
At $11,930 of earnings the credit begins to phase down at a 
rate of 21.06 percent of earnings above $11,930. The credit is 
phased down to $0 at $29,290 of earnings.
     Taxpayers with no qualifying children may claim a credit 
if they are over age 24 and below age 65. The credit is 7.65 
percent of earnings up to $4,340, resulting in a maximum credit 
of $332. The maximum is available for those with incomes 
between $4,340 and $5,430. At $5,430 of earnings, the credit 
begins to phase down at a rate of 7.65 percent of earnings 
above that amount, resulting in a $0 credit at $9,770.
     All income thresholds are indexed for inflation annually. 
In order to be a qualifying child, an individual must satisfy a 
relationship test, a residency test, and an age test. The 
relationship test requires that the individual be a child, 
stepchild, a descendant of a child, or a foster or adopted 
child of the taxpayer. The residency test requires that the 
individual have the same place of abode as the taxpayer for 
more than half the taxable year. The household must be located 
in the United States. The age test requires that the individual 
be under 19 (24 for a full-time student) or be permanently and 
totally disabled.
     An individual is not eligible for the earned income credit 
if the aggregate amount of disqualified income of the taxpayer 
for the taxable year exceeds $2,200. This threshold is indexed. 
Disqualified income is the sum of:
 1. Interest (taxable and tax exempt),
 2. Dividends,
 3. Net rent and royalty income (if greater than zero),
 4. Capital gains net income, and
 5. Net passive income (if greater than zero) that is not self-
        employment income.
     For taxpayers with earned income (or modified AGI, if 
greater) in excess of the beginning of the phaseout range, the 
maximum earned income credit amount is reduced by the phaseout 
rate multiplied by the amount of earned income (or modified 
AGI, if greater) in excess of the beginning of the phaseout 
range. For taxpayers with earned income (or modified AGI, if 
greater) in excess of the end of the phaseout range, no credit 
is allowed.
     The definition of modified AGI used for phasing out the 
earned income credit disregards certain losses. The losses 
disregarded are:
 1. Net capital losses (if greater than zero),
 2. Net losses from trusts and estates,
 3. Net losses from nonbusiness rents and royalties, and
 4. Seventy-five percent of the net losses from businesses, 
        computed separately with respect to sole 
        proprietorships (other than in farming), sole 
        proprietorships in farming, and other businesses.
     The definition of modified AGI also includes tax-exempt 
interest and nontaxable distributions from pensions, annuities, 
and individual retirement accounts (but only if not called over 
into similar vehicles during the applicable rollover period).
     Individuals are ineligible for the credit if they do not 
include their taxpayer identification number and their 
qualifying child's number (and, if married, their spouse's 
taxpayer identification number) on their tax return. Solely for 
these purposes and for purposes of the present-law 
identification test for a qualifying child, a taxpayer 
identification number is defined as a Social Security number 
issued to an individual by the Social Security Administration 
other than a number issued under section 205(c)(2)(B)(i)(II) 
(or that portion of sec. 205(c)(2)(B)(i)(III) relating to it) 
of the Social Security Act regarding the issuance of a number 
to an individual applying for or receiving federally funded 
benefits.
     If an individual fails to provide a correct taxpayer 
identification number, such omission will be treated as a 
mathematical or clerical error by the Internal Revenue Service. 
Similarly, if an individual who claims the credit with respect 
to net earnings from self-employment fails to pay the proper 
amount of self-employment tax on such net earnings, the failure 
will be treated as a mathematical or clerical error for 
purposes of the amount of credit allowed.
     The EIC is relatively unique because it is a refundable 
tax credit; i.e., if the amount of the credit exceeds the 
taxpayer's Federal income tax liability, the excess is payable 
to the taxpayer as a direct transfer payment. In this sense, 
the EIC is like other Federal programs that provide poor and 
low-income families with public benefits. However, the EIC 
differs from other Federal programs in that its benefits 
require earnings.
     Under an advance payment system, available since 1979, 
eligible taxpayers may elect to receive the credit in their 
paychecks, rather than waiting to claim a refund on their tax 
return filed by April 15 of the following year. In 1993, 
Congress required that the IRS begin to notify eligible 
taxpayers of the advance payment option.

                 Interaction with Means-Tested Programs

    The treatment of the EIC for purposes of AFDC and food 
stamp benefit computations has varied since inception of the 
credit. When enacted in 1975, the credit was not considered 
income in determining AFDC and food stamp benefits, and the 
credit could not be received on an advance basis. From January 
1979 through September 1981, the credit was treated as earned 
income when actually received.
    From October 1981 to September 1984, the amount of the 
credit was treated as earned income and was imputed to the 
family even though it may not have been received as an advance 
payment. Pursuant to the Deficit Reduction Act of 1984, the 
credit was treated as earned income only when received, either 
as an advance payment or as a refund after the conclusion of 
the year.
    Under the Family Support Act of 1988, States generally were 
required to disregard any advance payment or refund of the EIC 
when calculating AFDC eligibility or benefits. However, the 
credit was counted against the gross income eligibility 
standard (185 percent of the State need standard) for both 
applicants and recipients.
    OBRA 1990 specified that, effective January 1, 1991, the 
EIC was not to be taken into account as income (for the month 
in which the payment is received or any following month) or as 
a resource (for the month in which the payment is received or 
the following month) for determining the eligibility or amount 
of benefit for AFDC, Medicaid, SSI, food stamps, or low-income 
housing programs.

                          Effect of Provision

    More than 18.5 million taxpayers are expected to take 
advantage of the EIC in 1997 (see table 13-13). Their claims 
are expected to total $26.8 billion, 81 percent of which will 
be refunded as direct payments to these families. As table 13-
13 also shows, approximately 69 percent of the tax relief or 
direct spending from the EIC accrues to taxpayers who file as 
singles or heads of households.
    Table 13-14 shows the total amount of earned income credit 
received for each of the calendar years since the inception of 
the program, the number of recipient families, the amount of 
the credit received as refunded payments, and the average 
amount of credit received per family.

            EXCLUSION OF PUBLIC ASSISTANCE AND SSI BENEFITS

                          Legislative History

    While there is no specific statutory authorization, a 
number of revenue rulings under Code section 61 have held that 
specific types of public assistance payments are excludable 
from gross income. Revenue rulings generally exclude government 
transfer payments from income because they are considered to be 
general welfare payments. In addition, taxing benefits provided 
in kind, rather than in cash, would require valuation of these 
benefits, which could create administrative difficulties.

                        Explanation of Provision

    The Federal Government provides tax-free public assistance 
benefits to individuals either by cash payments or by provision 
of certain goods and services at reduced cost or free of 
charge. Cash payments come mainly from the Aid to Families with 
Dependent Children (AFDC) and Supplemental Security Income 
(SSI) Programs. Inkind payments include food stamps, Medicaid, 
and housing assistance. None of these payments is subject to 
income tax.

                       DEPENDENT CARE TAX CREDIT

                          Legislative History

    Under section 21 of the Internal Revenue Code, taxpayers 
are allowed an income tax credit for certain employment-related 
expenses for dependent care. The Internal Revenue Code of 1954 
provided a deduction to gainfully employed women, widowers, and 
legally separated or divorced men for certain employment-
related dependent care expenses. The deduction was limited to 
$600 per year and phased out for families with incomes between 
$4,500 and $5,100.
    The Revenue Act of 1964 made husbands with incapacitated 
wives eligible for the dependent care deduction and raised the 
threshold for the income phaseout from $4,500 to $6,000.

                    TABLE 13-13.--DISTRIBUTION OF TAX PROVISIONS: EARNED INCOME CREDIT, 1997                    
----------------------------------------------------------------------------------------------------------------
                                          Joint returns         Head of household and          All returns      
                                   --------------------------      single returns      -------------------------
           Income class                                      --------------------------                         
                                       Number       Amount       Number       Amount       Number       Amount  
----------------------------------------------------------------------------------------------------------------
$0-$10,000........................          681         $924        4,495       $4,816        5,175       $5,740
$10,000-$20,000...................        1,615        3,592        4,824        9,270        6,439       12,862
$20,000-$30,000...................        2,038        2,873        3,067        3,900        5,106        6,773
$30,000-$40,000...................          920          711          730          602        1,650        1,313
$40,000-$50,000...................          112           93           18           18          130          111
$50,000-$75,000...................           29           35            5           12           33           47
$75,000 and over..................            0            0            0            0            0            0
                                   -----------------------------------------------------------------------------
      Total.......................        5,394        8,229       13,139       18,618       18,534       26,847
                                   -----------------------------------------------------------------------------
Percent distribution by type of                                                                                 
 return...........................         29.1         30.7         70.9         69.3        100.0       100.0 
----------------------------------------------------------------------------------------------------------------
Note.--Number of returns in thousands; amount of credit in millions.                                            
                                                                                                                
Source: Joint Committee on Taxation.                                                                            


            TABLE 13-14.--EARNED INCOME CREDIT: NUMBER OF RECIPIENTS AND AMOUNT OF CREDIT, 1975-2000            
----------------------------------------------------------------------------------------------------------------
                                                               Number of      Total       Refunded              
                                                               recipient    amount of   portions of    Average  
                            Year                                families      credit       credit     credit per
                                                              (thousands)   (millions)   (millions)     family  
----------------------------------------------------------------------------------------------------------------
1975........................................................        6,215       $1,250         $900         $201
1976........................................................        6,473        1,295          890          200
1977........................................................        5,627        1,127          880          200
1978........................................................        5,192        1,048          801          202
1979........................................................        7,135        2,052        1,395          288
1980........................................................        6,954        1,986        1,370          286
1981........................................................        6,717        1,912        1,278          285
1982........................................................        6,395        1,775        1,222          278
1983........................................................        7,368        1,795        1,289          224
1984........................................................        6,376        1,638        1,162          257
1985........................................................        7,432        2,088        1,499          281
1986........................................................        7,156        2,009        1,479          281
1987........................................................        8,738        3,391        2,930          450
1988........................................................       11,148        5,896        4,257          529
1989........................................................       11,696        6,595        4,636          564
1990........................................................       12,542        7,542        5,266          601
1991........................................................       13,665       11,105        8,183          813
1992........................................................       14,097       13,028        9,959          924
1993........................................................       15,117       15,537       12,028        1,028
1994 \1\....................................................       19,017       21,105       16,598        1,110
1995 \2\....................................................       19,335       25,956       20,829        1,342
1996 \2\....................................................       18,525       25,935       20,826        1,400
1997 \2\....................................................       18,652       26,919       21,684        1,443
1998 \2\....................................................       18,788       27,677       22,452        1,473
1999 \2\....................................................       18,954       28,728       23,416        1,516
2000 \2\....................................................       19,212       29,921       24,380       1,557 
----------------------------------------------------------------------------------------------------------------
\1\ Preliminary.                                                                                                
\2\ Projected.                                                                                                  
                                                                                                                
 Source: For 1975-94, Internal Revenue Service; for 1995-2000, Joint Committee on Taxation.                     

    The Revenue Act of 1971: (1) made any individual who 
maintained a household and was gainfully employed eligible for 
the deduction; (2) modified the definition of a dependent; (3) 
raised the deduction limit to $4,800 per year; (4) increased 
from $6,000 to $18,000 the income level at which the deduction 
began to phase out; (5) allowed the deduction for household 
services in addition to direct dependent care; and (6) limited 
the deduction with respect to services outside the taxpayer's 
household.
    The Tax Reduction Act of 1975 increased from $18,000 to 
$35,000 the income level at which the deduction began to be 
phased out.
    The Tax Reform Act of 1976 replaced the deduction with a 
nonrefundable credit. This change broadened eligibility to 
those who do not itemize deductions and provided relatively 
greater benefit to low-income taxpayers. In addition, the act 
eased the rules related to family status and simplified the 
computation.
    In the Economic Recovery Tax Act of 1981, Congress provided 
a higher ceiling on creditable expenses, a larger credit for 
low-income individuals, and modified rules relating to care 
provided outside the home.
    The Family Support Act of 1988 reduced to 13 the age of a 
child for whom the dependent care credit may be claimed, 
reduced the amount of eligible expenses by the amount of 
expenses excludable from that taxpayer's income under the 
dependent care exclusion, lowered from 5 to 2 the age at which 
a taxpayer identification number had to be submitted for 
children for whom the credit was claimed, and disallowed the 
credit unless the taxpayer reports on her tax return the 
correct name, address, and taxpayer identification number 
(generally, an employer identification number or a Social 
Security number) of the dependent care provider.
    The Small Business Protection Act of 1996 required a TIN 
for all children for whom a dependent care credit may be 
claimed.

                        Explanation of Provision

    A taxpayer may claim a nonrefundable credit against income 
tax liability for up to 30 percent of a limited amount of 
employment-related dependent care expenses. Eligible 
employment-related expenses are limited to $2,400 if there is 
one qualifying dependent or $4,800 if there are two or more 
qualifying dependents. Generally, a qualifying individual is a 
dependent under the age of 13 or a physically or mentally 
incapacitated dependent or spouse.
    Employment-related dependent care expenses are expenses for 
the care of a qualifying individual incurred to enable the 
taxpayer to be gainfully employed, other than expenses incurred 
for an overnight camp. For example, amounts paid for the 
services of a housekeeper generally qualify if such services 
are performed at least partly for the benefit of a qualifying 
individual; amounts paid for a chauffeur or gardener do not 
qualify.
    Expenses that may be taken into account in computing the 
credit generally may not exceed an individual's earned income 
or, in the case of married taxpayers, the earned income of the 
spouse with the lesser earnings. Thus, if one spouse is not 
working, no credit generally is allowed. Also, the amount of 
expenses eligible for the dependent care credit is reduced, 
dollar for dollar, by the amount of expenses excludable from 
that taxpayer's income under the dependent care exclusion 
(discussed below).
    The 30-percent credit rate is reduced, but not below 20 
percent, by 1 percentage point for each $2,000 (or fraction 
thereof) of adjusted gross income (AGI) above $10,000. Because 
married couples are required to file a joint return to claim 
the credit, a married couple's combined AGI is used for 
purposes of this computation.

                          Effect of Provision

    From 1976 to 1994, the number of families that claimed the 
dependent care credit increased from 2.7 to 6.0 million, the 
aggregate amount of credits claimed increased from $0.5 to $2.5 
billion, and the average amount of credit claimed per family 
increased from $206 to $420 (see table 13-15). In 1997, 6.1 
million families are expected to claim an average credit of 
$448, for a total of $2.7 billion.

 TABLE 13-15.--DEPENDENT CARE TAX CREDIT: NUMBER OF FAMILIES AND AMOUNT 
                           OF CREDIT, 1976-98                           
------------------------------------------------------------------------
                                    Number of                           
                                     returns     Aggregate     Average  
                                     claiming    amount of      credit  
               Year                 dependent      credit    claimed per
                                      credit      claimed       return  
                                   (thousands)   (millions)             
------------------------------------------------------------------------
1976.............................        2,660         $548         $206
1977.............................        2,910          521          179
1978.............................        3,431          654          191
1979.............................        3,833          793          207
1980.............................        4,231          956          226
1981.............................        4,578        1,148          251
1982.............................        5,004        1,501          300
1983.............................        6,367        2,051          322
1984.............................        7,456        2,649          351
1985.............................        8,417        3,127          372
1986.............................        8,950        3,398          380
1987.............................        8,520        3,438          404
1988.............................        9,023        3,813          423
1989.............................        6,028        2,440          405
1990.............................        6,144        2,549          415
1991.............................        5,896        2,521          427
1992.............................        5,980        2,527          433
1993.............................        6,090        2,559          419
1994.............................        6,012        2,526          420
1995.............................        5,964        2,518          445
1996.............................        6,003        2,663          444
1997 \1\.........................        6,063        2,714          448
1998 \2\.........................        6,124        2,770         452 
------------------------------------------------------------------------
\1\ Preliminary.                                                        
\2\ Projected.                                                          
                                                                        
 Source: Joint Committee on Taxation.                                   

    Changes made in the Family Support Act of 1988 reduced the 
use of the credit in 1989. The number of families who claimed 
the credit dropped by about one-third and the amount of credit 
claimed declined by $1.373 billion.
    Data for 1995 from the Internal Revenue Service show that 
about 13 percent of the benefit from the credit accrues to 
families with AGI of less than $20,000; about 47 percent to 
families with AGI between $20,000 and $50,000; and about 40 
percent to families with AGI above $50,000.

                HOPE CREDIT AND LIFETIME LEARNING CREDIT

    The Taxpayer Relief Act of 1997 established the HOPE credit 
and the lifetime learning credit as nonrefundable credits 
against Federal income tax liability for qualified tuition and 
fees required for the attendance of an eligible student at an 
eligible educational institution.
    The HOPE credit rate is 100 percent of the first $1,000 of 
qualified tuition and fees per eligible student per year, and 
50 percent of the next $1,000 of qualified tuition and fees per 
eligible student per year. The HOPE credit is available only 
for the first 2 years of postsecondary education. The qualified 
tuition and fees must be incurred on behalf of the taxpayer, 
the taxpayer's spouse, or a dependent. Charges and fees 
associated with meals, lodging, books, student activities, 
athletics, insurance, transportation, and similar personal, 
living, or family expenses are not eligible for the credit. An 
eligible student for purposes of the HOPE credit is a student 
enrolled in a degree, certificate, or other program on at least 
a half-time basis. Eligible educational institutions are 
defined by reference to section 481 of the Higher Education Act 
of 1965. Such institutions generally are accredited 
postsecondary educational institutions offering credit toward a 
bachelor's degree, an associate's degree, or another recognized 
postsecondary credential. Certain proprietary institutions and 
postsecondary vocational institutions are also eligible 
educational institutions. The HOPE credit is effective for 
expenses paid after December 31, 1997, for education furnished 
in academic periods beginning after such date. For taxable 
years beginning after 2001, the $1,500 maximum HOPE credit 
amount will be indexed for inflation.
    The lifetime learning credit rate is 20 percent of up to 
$5,000 in qualified tuition and fees for a maximum credit of 
$1,000. For expenses paid after December 31, 2002, up to 
$10,000 in qualified tuition and fees will be eligible for the 
20-percent credit, for a maximum credit of $2,000. In contrast 
to the HOPE credit, the lifetime learning credit is available 
for an unlimited number of years of education. Also in contrast 
to the HOPE credit, which requires a half-time or greater 
enrollment status, the lifetime learning credit is available 
with respect to any course of instruction at an eligible 
educational institution to acquire or improve job skills, 
regardless of enrollment status. Qualified tuition and fees are 
defined in the same manner as under the HOPE credit provisions. 
As with the HOPE credit, eligible students are the taxpayer, 
the taxpayer's spouse, or a dependent. In contrast to the HOPE 
credit, the maximum amount of the lifetime learning credit that 
may be claimed on a taxpayer's return will not vary with the 
number of students in the taxpayer's family. The lifetime 
learning credit is effective for expenses paid after June 30, 
1998, for education furnished in academic periods beginning 
after such date. The maximum lifetime learning credit amount is 
not indexed for inflation.
    Eligibility for the HOPE credit and the lifetime learning 
credit is phased out ratably for taxpayers with modified AGI 
between $40,000 and $50,000 ($80,000 and $100,000 for joint 
returns). These phaseout ranges are indexed for inflation for 
taxable years beginning after 2001. For a taxable year, a 
taxpayer may elect with respect to an eligible student either 
the HOPE credit, the lifetime learning credit, or the exclusion 
from gross income for certain distributions from an education 
IRA. For purposes of both the HOPE credit and the lifetime 
learning credit, if a parent claims a child as a dependent, 
then only the parent may claim the credit.

           QUALIFIED STATE TUITION PROGRAMS AND EDUCATION IRAs

     The Taxpayer Relief Act of 1997 modified section 529 of 
the Tax Code, which governs the tax treatment of qualified 
State tuition programs. Section 529 was enacted as part of the 
Small Business Job Protection Act of 1996, and provides tax-
exempt status and deferral of tax on earnings of qualified 
State tuition programs. The Taxpayer Relief Act of 1997 also 
provides that taxpayers may establish education IRAs.
     Qualified State tuition programs are programs established 
and maintained by a State under which persons may: (1) purchase 
tuition credits on behalf of a designated beneficiary that 
entitle the beneficiary to a waiver or payment of qualified 
higher education expenses of the beneficiary; or (2) make 
contributions to an account that is established for the purpose 
of meeting qualified higher education expense of a designated 
beneficiary. Qualified higher education expenses are defined as 
tuition, fees, books, supplies, and equipment required for the 
enrollment of or attendance at a college or university (or 
certain vocational schools). The Taxpayer Relief Act of 1997 
expanded the definition of qualified expenses to include room 
and board expenses. Contributions to State tuition programs are 
not deductible. Earnings on qualified State tuition programs 
are includable in income only when ultimately distributed. 
Distributions from a qualified State tuition program also 
entitle the distributee to claim either the HOPE or the 
lifetime learning credit with respect to education expenses 
paid with such distributions, assuming the other requirements 
for claiming the HOPE credit or the lifetime learning credit 
are satisfied. There are no income limits for participation in 
qualified State tuition programs, though contributions must be 
limited by the program to amounts no greater than an amount 
necessary to provide for the education of the beneficiary. The 
program must also impose a more than de minimis penalty on 
earnings not used for qualified expenses.
     An education IRA is a trust or custodial account created 
exclusively for the purpose of paying qualified higher 
education expenses of a named beneficiary. Contributions to an 
education IRA are not deductible; earnings on contributions are 
not currently includable in income. Contributions to education 
IRAs are limited to $500 per year per beneficiary. However, no 
contribution may be made by any person to an education IRA 
established on behalf of a beneficiary during any taxable year 
in which any contributions are made by anyone to a qualified 
State tuition program on behalf of the same beneficiary. The 
contribution limit is phased out ratably for contributors with 
modified AGI between $95,000 and $110,000 ($150,000 and 
$160,000 for joint returns). Qualified expenses are the same as 
those for the qualified State tuition programs, with the 
exception that room and board expenses are qualified expenses 
only if the student is enrolled on at least a half-time basis. 
Withdrawals of earnings from education IRAs are excludable from 
income provided that such withdrawals are used to pay for 
qualified higher education expenses. If the earnings are not 
used for qualified expenses, they are includable in income and 
are also subject to an additional 10-percent penalty tax. A 
taxpayer may not simultaneously claim an exclusion from income 
for distributions from an education IRA and claim either the 
HOPE credit or the lifetime learning credit.

                     STUDENT LOAN INTEREST DEDUCTION

     The Taxpayer Relief Act of 1997 provided for the above-
the-line deductibility of interest on qualified education 
loans. The deduction is allowed only with respect to interest 
paid during the first 60 months in which interest payments are 
required. A qualified education loan is generally defined as 
any indebtedness incurred to pay for the qualified higher 
education expenses of the taxpayer, the taxpayer's spouse, or 
any dependent of the taxpayer as of the time the indebtedness 
was incurred in attending either postsecondary educational 
institutions and certain vocational schools defined by 
reference to section 481 of the Higher Education Act of 1965, 
or institutions conducting internship or residency programs 
leading to a degree or certificate from an institution of 
higher education, a hospital, or a health care facility 
conducting postgraduate training. Qualified higher education 
expenses are defined as the student's cost of attendance as 
defined in section 472 of the Higher Education Act of 1965 
(generally, tuition, fees, room and board, and related 
expenses), reduced by: (1) any amount excluded under section 
135 (i.e., U.S. saving bonds used to pay higher education 
tuition and fees); (2) any amount distributed from an education 
IRA and excluded from gross income; and (3) the amount of any 
scholarship or fellowship grants excludable from gross income 
under section 117, as well as any other tax-free education 
benefits, such as employer-provided educational assistance that 
is excludable from the employee's gross income under section 
127.
     The maximum deduction is phased in gradually, with a 
$1,000 maximum in 1998, $1,500 in 1999, $2,000 in 2000, and 
$2,500 in 2001. The maximum deduction is not indexed for 
inflation, and the deduction is phased out ratably for 
individual taxpayers with modified AGI of $40,000-$55,000 
($60,000-$75,000 for joint returns). These income ranges will 
be indexed for inflation occurring after the year 2002, and 
rounded down to the closest multiple of $5,000. This provision 
is effective for interest payments due and paid after December 
31, 1997, on any qualified education loan.

             EXCLUSION FOR EMPLOYER-PROVIDED DEPENDENT CARE

                          Legislative History

    The value of certain employer-provided dependent care is 
excluded from the employee's gross income. The Economic 
Recovery Tax Act of 1981 added this exclusion (sec. 129) and 
amended Code sections 3121(a)(18) and 3306(b)(13) to exclude 
such employer-provided dependent care from wages for purposes 
of the Federal Insurance Contributions Act (FICA) and the 
Federal Unemployment Tax Act (FUTA). The Tax Reform Act of 1986 
modified the nondiscrimination rules and limited the exclusion 
to $5,000 a year ($2,500 in the case of a separate return by a 
married individual). The Family Support Act of 1988 required 
the amount of employer-provided dependent care excluded from 
the taxpayer's income to reduce, dollar for dollar, the amount 
of expenses eligible for the dependent care tax credit.

                        Explanation of Provision

    Amounts paid or incurred by an employer for dependent care 
assistance provided to an employee generally are excluded from 
the employee's gross income if the assistance is furnished 
under a program meeting certain requirements. These 
requirements include that the program be described in writing, 
satisfy certain nondiscrimination rules, and provide for 
notification to all eligible employees. The type of dependent 
care eligible for the exclusion is the same as the type 
eligible for the dependent care credit.
    The dependent care exclusion is limited to $5,000 per year 
except that a married taxpayer filing a separate return may 
exclude only $2,500. Amounts excluded from gross income 
generally are excludable from wages for employment tax 
purposes. Dependent care expenses excluded from income are not 
eligible for the dependent care tax credit.

                          Effect of Provision

    The exclusion provides an incentive to taxpayers with 
expenses for dependent care to seek compensation in the form of 
dependent care assistance rather than in cash subject to 
taxation. This incentive is of greater value to employees in 
higher tax brackets.
    Many employees covered by the exclusion for employer-
provided dependent care also are eligible to use the dependent 
care tax credit. While the limitations on the exclusion and the 
credit differ, the credit generally is less valuable than the 
exclusion for taxpayers who are above the 15-percent tax 
bracket.
    According to a survey of private firms with 100 or more 
workers conducted by the U.S. Bureau of Labor Statistics 
(1993), nearly one-tenth of full-time workers at these firms 
were eligible for child care benefits provided by the employer 
in the form of on-site or near-site child care facilities or 
through direct reimbursement of employee expenses. A more 
prevalent form of providing dependent care benefits is through 
reimbursement accounts, which may cover other nontaxable fringe 
benefits, such as out-of-pocket health care expenses, in 
addition to dependent care. Slightly over one-third of full-
time employees at large- and medium-sized firms were eligible 
for such accounts in 1991.

                      WORK OPPORTUNITY TAX CREDIT

    The work opportunity tax credit is available on an elective 
basis for employers hiring individuals from one or more of 
eight targeted groups. The targeted groups are: (1) families 
eligible to receive benefits under the Title IV-A Temporary 
Assistance for Needy Families Program (TANF; the successor to 
the Aid to Families with Dependent Children Program); (2) 
qualified ex-felons; (3) vocational rehabilitation referrals; 
(4) qualified summer youth employees; (5) qualified veterans; 
(6) youths who reside in an empowerment zone or enterprise 
community; (7) families receiving food stamps; and (8) persons 
receiving certain Supplemental Security Income (SSI) benefits.
    The credit generally is equal to 40 percent (25 percent for 
employment of 400 hours or less) of qualified wages. Qualified 
wages consist of wages attributable to service rendered by a 
member of a targeted group during the 1-year period beginning 
with the day the individual begins work for the employer. For a 
vocational rehabilitation referral, however, the period will 
begin on the day the individual begins work for the employer on 
or after the beginning of the individual's vocational 
rehabilitation plan as under prior law.
    Generally, no more than $6,000 of wages during the first 
year of employment is permitted to be taken into account with 
respect to any individual. Thus, the maximum credit per 
individual is $2,400. With respect to qualified summer youth 
employees, the maximum credit is 40 percent of up to $3,000 of 
qualified first-year wages, for a maximum credit of $1,200.
    In general, an individual is not to be treated as a member 
of a targeted group unless: (1) on or before the day the 
individual begins work for the employer, the employer received 
in writing a certification from the designated local agency 
that the individual is a member of a specific targeted group; 
or (2) on or before the day the individual is offered work with 
the employer, a prescreening notice is completed with respect 
to that individual by the employer and within 21 days after the 
individual begins work for the employer, the employer submits 
such notice, signed by the employer and the individual under 
penalties of perjury, to the designated local agency as part of 
a written request for certification. The prescreening notice 
will contain the information provided to the employer by the 
individual that forms the basis of the employer's belief that 
the individual is a member of a targeted group.
    No credit is allowed for wages paid unless the eligible 
individual is employed by the employer for at least 120 hours. 
The credit percentage is 25 percent for employment of 400 hours 
or less, assuming that the minimum employment period is 
satisfied with respect to that employee. For employment of more 
than 400 hours, the credit percentage is 40 percent.
    The credit is effective for wages paid or incurred to a 
qualified individual who begins work for an employer after 
September 30, 1996, and before July 1, 1998.

                       WELFARE-TO-WORK TAX CREDIT

     The Code provides to employers a tax credit on the first 
$20,000 of eligible wages paid to qualified long-term family 
assistance (TANF) recipients during the first 2 years of 
employment. The credit is 35 percent of the first $10,000 of 
eligible wages in the first year of employment and 50 percent 
of the first $10,000 of eligible wages in the second year of 
employment. The maximum credit is $8,500 per qualified 
employee.
     Qualified long-term family assistance recipients are: (1) 
members of a family that has received TANF benefits for at 
least 18 consecutive months ending on the hiring date; (2) 
members of a family that has received TANF benefits for a total 
of at least 18 months (whether or not consecutive) after the 
date of enactment of this credit if they are hired within 2 
years after the date that the 18-month total is reached; and 
(3) members of a family who are no longer eligible for TANF 
because of either Federal or State time limits, if they are 
hired within 2 years after the Federal or State time limits 
made the family ineligible for family assistance.
     Eligible wages include cash wages paid to an employee plus 
amounts paid by the employer for the following: (1) educational 
assistance excludable under a section 127 program (or that 
would be excludable but for the expiration of sec. 127); (2) 
health plan coverage for the employee, but not more than the 
applicable premium defined under section 4980B(f)(4); and (3) 
dependent care assistance excludable under section 129.
     The welfare to work credit is effective for wages paid or 
incurred to a qualified individual who begins work for an 
employer on or after January 1, 1998 and before May 1, 1999.

 EXCLUSION OF WORKERS' COMPENSATION AND SPECIAL BENEFITS FOR DISABLED 
                              COAL MINERS

                          Legislative History

    Workers' compensation benefits generally are not taxable 
under section 104(a)(1) of the Internal Revenue Code of 1986. 
Workers' compensation benefits are treated as Social Security 
benefits to the extent that they reduce Social Security 
benefits received (see above). This exclusion from gross income 
was first codified in the Revenue Act of 1918. The Ways and 
Means Committee report for that act suggests that such payments 
were not subject to tax even prior to the 1918 act.
    Payments made to coal miners or their survivors for death 
or disability resulting from pneumoconiosis (black lung 
disease) under the Federal Coal Mine Health and Safety Act of 
1969 (as amended) are excluded from gross income. Payments made 
as a result of claims filed before December 31, 1972 originally 
were excluded from Federal income tax by the Federal Coal Mine 
Health and Safety Act of 1969. Later payments are excluded from 
gross income because they are considered to be in the nature of 
workers' compensation (Rev. Rul. 72-400, 1972-2 C.B. 75).

                        Explanation of Provision

    Gross income does not include amounts received as workers' 
compensation for personal injuries or sickness. This exclusion 
also applies to benefits paid under a workers' compensation act 
to a survivor of a deceased employee.
    Benefits for disabled coal miners (black lung benefits) are 
not includable in gross income.
    There are two types of black lung programs. The first 
involves Federal payments to coal miners and their survivors 
due to death or disability, payable for claims filed before 
July 1, 1973 (December 31, 1973, in the case of survivors). 
This program provided total annual payments of around $672 
million to approximately 143,000 beneficiaries in December 1995 
(Social Security Administration, 1996).
    The second program requires coal mine operators to ensure 
payment of black lung benefits for claims filed on or after 
July 1, 1973 (December 31, 1973, in the case of survivors) in a 
federally mandated workers' compensation program. Benefits 
include medical treatment as well as cash payments. These 
benefits are paid from a trust fund financed by an excise tax 
on coal production if there is no responsible operator (an 
operator for whom the miner worked for at least 1 year) or if 
the responsible operator is in default. This program provided 
total annual payments of around $610 million to approximately 
156,550 claimants in 1986 (U.S. Department of Labor, 1989, 
tables 3 & 6).

        ADDITIONAL STANDARD DEDUCTION FOR THE ELDERLY AND BLIND

                          Legislative History

    From 1954 through 1986, an additional personal exemption 
was allowed for a taxpayer or a spouse who was 65 years or 
older at the close of the year. An additional personal 
exemption also was allowed for a taxpayer or a spouse who was 
blind.
    The Tax Reform Act of 1986 repealed the additional personal 
exemption for the elderly and blind and replaced it with an 
additional standard deduction amount. These additional standard 
deduction amounts are adjusted for inflation.

                        Explanation of Provision

    The additional standard deduction amount for the elderly or 
the blind is $800 in 1997 for an elderly or a blind individual 
who is married (whether filing jointly or separately) or is a 
surviving spouse, and $1,600 for such an individual who is both 
elderly and blind. The additional amount is $1,000 for a head 
of household who is elderly or blind ($2,000, if both), and for 
a single individual (i.e., an unmarried individual other than a 
surviving spouse or head of household) who is elderly or blind.
    The definitions of elderly and blind status have not been 
changed since 1954. An elderly person is an individual who is 
at least 65 years of age. Blindness is defined in terms of the 
ability to correct a deficiency in distance vision or the 
breadth of the area of vision. An individual is blind only if 
central vision acuity is not better than 20/200 in the better 
eye with correcting lenses, or if visual acuity is better than 
20/200 but is accompanied by a limitation in the fields of 
vision such that the widest diameter of the visual field 
subtends an angle no greater than 20 degrees.

                          Effect of Provision

    The additional standard deduction increases the tax 
threshold for elderly and blind taxpayers. For example, the 
additional amount is $1,600 for two elderly individuals filing 
a joint return, raising the tax threshold in 1997 from $12,200 
to $13,800.
    In 1995, about 10.8 million taxpayers claimed the extra 
standard deduction. About 85 percent of the 10.8 million 
beneficiaries had incomes of less than $40,000.

      TAX CREDIT FOR THE ELDERLY AND CERTAIN DISABLED INDIVIDUALS

                          Legislative History

    The present tax credit for individuals who are age 65 or 
over, or who have retired on permanent and total disability, 
was enacted in the Social Security Amendments of 1983 (Code 
sec. 22). This credit replaced the previous credit for the 
elderly, which had been enacted in the Tax Reform Act of 1976. 
Prior to that provision, the tax law provided a retirement 
income credit, which initially was enacted in the Internal 
Revenue Code of 1954.

                        Explanation of Provision

    Individuals who are age 65 or older may claim a 
nonrefundable income tax credit equal to 15 percent of a base 
amount. The credit also is available to an individual, 
regardless of age, who is retired on disability and who was 
permanently and totally disabled at retirement. For this 
purpose, an individual is considered permanently and totally 
disabled if he is unable to engage in any substantial gainful 
activity by reason of any medically determinable physical or 
mental impairment that can be expected to result in death, or 
that has lasted or can be expected to last for a continuous 
period of not less than 12 months. The individual must furnish 
proof of disability to the IRS.
    The maximum base amount for the credit is $5,000 for 
unmarried elderly or disabled individuals and for married 
couples filing a joint return if only one spouse is eligible; 
$7,500 for married couples filing a joint return with both 
spouses eligible; or $3,750 for married couples filing separate 
returns. For a nonelderly, disabled individual the initial base 
amount is the lesser of the applicable specified amount or the 
individual's disability income for the year. Consequently, the 
maximum credit available is $750 (15 percent of $5,000), $1,125 
(15 percent of $7,500), or $562.50 (15 percent of $3,750).
    The maximum base amount is reduced by the amount of certain 
nontaxable income of the taxpayer, such as nontaxable pension 
and annuity income or nontaxable Social Security, railroad 
retirement, or veterans' nonservice-related disability 
benefits. In addition, the base amount is reduced by one-half 
of the taxpayer's AGI in excess of certain limits: $7,500 for a 
single individual, $10,000 for married taxpayers filing a joint 
return, or $5,000 for married taxpayers filing separate 
returns. These computational rules reflect that the credit is 
designed to provide tax benefits to individuals who receive 
only taxable retirement or disability income, or who receive a 
combination of taxable retirement or disability income plus 
Social Security benefits that generally are comparable to the 
tax benefits provided to individuals who receive only Social 
Security benefits (including Social Security disability 
benefits).

                          Effect of Provision

    In 1995, $48 million in elderly and disabled credit was 
claimed. Though the number of families claiming the credit has 
fallen significantly, the average credit granted has been 
relatively stable since the credit was modified by the Social 
Security Amendments of 1983, as shown in table 13-16.

       TABLE 13-16.--CREDIT FOR THE ELDERLY AND DISABLED, 1976-96       
------------------------------------------------------------------------
                                    Number of                           
                                     families      Total                
                                       that      amount of     Average  
               Year                  received      credit     credit per
                                      credit     (millions)     return  
                                   (thousands)                          
------------------------------------------------------------------------
1976.............................        1,011         $206         $204
1977.............................          569           93          163
1978.............................          689          145          210
1979.............................          607          132          217
1980.............................          562          135          240
1981.............................          474          124          262
1982.............................          483          131          271
1983.............................          423          116          275
1984.............................          475          107          225
1985.............................          460          106          230
1986.............................          430           86          200
1987.............................          354           67          189
1988.............................          357           69          193
1989.............................          320           65          202
1990.............................          342           63          183
1991.............................          285           57          200
1992.............................          240           51          213
1993.............................          223           49          220
1994.............................          222           47          210
1995 \1\.........................          252           48          191
1996 \2\.........................          193           40         206 
------------------------------------------------------------------------
\1\ Preliminary.                                                        
\2\ Projected.                                                          
                                                                        
 Source: Joint Committee on Taxation.                                   

                   TAX PROVISIONS RELATED TO HOUSING

                         Owner-Occupied Housing

Legislative history
    Deductibility of mortgage interest.--Prior to the Tax 
Reform Act of 1986, all interest payments on indebtedness 
incurred for personal use (e.g., to purchase consumption goods) 
were deductible in computing taxable income. The 1986 act 
amended section 163(h) of the Internal Revenue Code to disallow 
deductions for all personal interest except for interest on 
indebtedness secured by a first or second home.
    In the Omnibus Budget Reconciliation Act of 1987, Congress 
further restricted the deductibility of mortgage interest. Only 
two classes of interest were distinguished as deductible: 
interest on acquisition indebtedness and interest on home 
equity indebtedness. Acquisition indebtedness, defined as 
indebtedness secured by a residence and used to acquire or 
improve the residence by which it is secured, was limited to 
$1,000,000 ($500,000 in the case of a married individual filing 
a separate return). Home equity indebtedness, defined as any 
nonacquisition indebtedness secured by a residence (for 
example, a home equity loan), was limited to the lesser of 
$100,000 ($50,000 for married taxpayers filing separately) or 
the excess of the fair market value of the residence over the 
acquisition indebtedness.
    Exclusion of capital gains for certain taxpayers.--In the 
Revenue Act of 1964, Congress introduced section 121 of the 
Internal Revenue Code of 1954, which permitted a one-time 
exclusion of all or part of the gain on the sale of a principal 
residence by older individuals. This exclusion was limited to 
homeowners who had lived in the property as a principal 
residence for 5 out of the last 8 years before the property's 
sale or exchange. Furthermore, full exclusion was permitted 
only for houses that sold for $20,000 or less.
    The parameters of this exclusion have been modified and 
expanded a number of times. Most recently, the Taxpayer Relief 
Act of 1997 significantly expanded the exclusion (e.g., the age 
55 requirement was repealed).
Explanation of provisions
    Homeowners may deduct a number of expenses related to 
housing as itemized deductions in computing taxable income. 
These include payments of interest on qualified residence debt, 
certain interest on home equity loans, certain payments of 
points (i.e., up front interest payments) on the purchase of a 
house, and payments of real property taxes. Interest on 
acquisition debt of $1,000,000 or less is fully deductible, as 
is any interest on debt secured by a residence that was 
incurred on or before October 13, 1987. Interest on home equity 
indebtedness of $100,000 is fully deductible for regular tax 
purposes, as long as the total amount of debt (acquisition plus 
home equity indebtedness) does not exceed the fair market value 
of the house. Interest on home equity indebtedness exceeding 
$100,000 (and incurred after October 13, 1987) or exceeding the 
difference between the fair market value of the home and the 
acquisition indebtedness is not deductible. Interest paid on 
home equity loans is generally not deductible in computing the 
alternative minimum tax.
     Under present law, a taxpayer generally is able to exclude 
up to $250,000 ($500,000 if married filing a joint return) of 
gain realized on the sale or exchange of a principal residence. 
The exclusion is allowed each time a taxpayer selling or 
exchanging a principal residence meets the eligibility 
requirements, but generally no more frequently than once every 
2 years.
     To be eligible for the exclusion, a taxpayer must have 
owned the residence and occupied it as a principal residence 
for at least 2 of the 5 years prior to the sale or exchange. A 
taxpayer who fails to meet these requirements by reason of a 
change of place of employment, health, or other unforeseen 
circumstances is able to exclude the fraction of the $250,000 
($500,000 if married filing a joint return) equal to the 
fraction of 2 years that these requirements are met.
Effects of provisions
    Preliminary tax return information for 1995 indicates that 
28 million taxpayers claimed the deduction for mortgage 
interest. Reliable data are not yet available on how many 
claimed the one-time exclusion.
    The favorable treatment of owner-occupied housing may 
affect both the home ownership rate and the share of total 
investment in housing in the United States.
    The home ownership tax provisions may benefit neighborhoods 
because they encourage home ownership and home improvement. The 
United States has maintained a high rate of home ownership--65 
percent of all American households own the homes they live in 
(U.S. Bureau of the Census, 1995, p. 733, table 1225).
    The tax advantages for owner-occupied housing encourage 
people to invest in homes instead of taxable business 
investments. This shift may reduce investment in business 
assets in the United States. One study suggested that housing 
capital is 25 percent higher and other capital is 12 percent 
lower than it would be if tax policy provided equal treatment 
for all forms of capital (Mills, 1987). Currently, about one-
third of net private investment goes into owner-occupied 
housing, so even a modest shift of investment to other assets 
could have sizable effects.

                       Low-Income Housing Credit

Legislative history
    The low-income rental housing tax credit was first enacted 
in the Tax Reform Act of 1986. The Omnibus Budget 
Reconciliation Act of 1989 substantially modified the credit. 
The Omnibus Budget Reconciliation Act of 1993 modified the 
credit again and made it permanent.
Explanation of provision
    A tax credit may be claimed by owners of residential rental 
property used for low-income rental housing. The credit is 
claimed annually, generally for a period of 10 years. New 
construction and rehabilitation expenditures for low-income 
housing projects are eligible for a maximum 70-percent present 
value credit, claimed annually for 10 years. The acquisition 
cost of existing projects that meet the substantial 
rehabilitation requirements and the cost of newly constructed 
projects receiving other Federal subsidies are eligible for a 
maximum 30-percent present value credit, also claimed annually 
for 10 years. These credit percentages are adjusted monthly 
based on an Applicable Federal Rate.
    The credit amount is based on the qualified basis of the 
housing units serving the low-income tenants. A residential 
rental project will qualify for the credit only if: (1) 20 
percent or more of the aggregate residential rental units in 
the project are occupied by individuals with 50 percent or less 
of area median income; or (2) 40 percent or more of the 
aggregate residential rental units in the project are occupied 
by individuals with 60 percent or less of area median income. 
These income figures are adjusted for family size. Maximum 
rents that may be charged families in units on which a credit 
is claimed depend on the number of bedrooms in the unit. The 
rent limitation is 30 percent of the qualifying income of a 
family deemed to have a size of 1.5 persons per bedroom (e.g., 
a two-bedroom unit has a rent limitation based on the 
qualifying income for a family of three).
    Credit eligibility also depends on the existence of a 30-
year extended low-income use agreement for the property. If 
property on which a low-income housing credit is claimed ceases 
to qualify as low-income rental housing or is disposed of 
before the end of a 15-year credit compliance period, a portion 
of the credit may be recaptured. The 30-year extended use 
agreement creates a State law right to enforce low-income use 
for an additional 15 years after the initial 15-year recapture 
period.
    In order for a building to be a qualified low-income 
building, the building owner generally must receive a credit 
allocation from the appropriate credit authority. An exception 
is provided for property that is substantially financed with 
the proceeds of tax-exempt bonds subject to the State's 
private-activity bond volume limitation. The low-income housing 
credit is allocated by State or local government authorities 
subject to an annual limitation for each State based on State 
population. The annual credit allocation per State is $1.25 per 
resident.
Effect of provision
    Comprehensive data from tax returns concerning the low-
income housing tax credit are unavailable. Table 13-17 presents 
data from a survey of State credit allocating agencies. These 
data indicate that annual allocation of available credit 
authority generally has been 67 percent or greater. Year-to-
year variations in credit allocation probably reflect changes 
in Federal law affecting the credit and changing economic 
conditions affecting the construction and housing markets. For 
example, 1990 was the first year following substantial 
modification to the credit and included a temporary period 
during which State credit allocating agencies were limited to 
allocating authority of $0.9375 per capita rather than the 
$1.25 per capita of present and prior law.

   TABLE 13-17.--ALLOCATION OF THE LOW-INCOME HOUSING CREDIT, 1987-96   
------------------------------------------------------------------------
                                    Authority    Allocated    Allocated 
              Years                 (millions)   (millions)   (percent) 
------------------------------------------------------------------------
1987.............................       $313.1        $62.9         20.1
1988.............................        311.5        209.8         67.4
1989.............................        314.2        307.2         97.8
1990.............................        317.7        213.1         67.0
1991 \1\.........................        497.3        400.6         80.6
1992 \1\.........................        476.8        332.7         70.0
1993 \1\.........................        546.4        424.7         77.7
1994 \1\.........................        523.7        495.5         94.7
1995 \1\.........................        432.6        410.9         95.0
1996 \1\.........................        391.6        379.9        97.0 
------------------------------------------------------------------------
\1\ Increased authority includes credits unallocated from prior years   
  carried over to the current year.                                     
                                                                        
 Source: Survey of State allocating agencies conducted by the National  
  Council of State Housing Agencies (1996).                             

    An allocation percentage of less than 100 percent does not 
imply that some credits available for allocation to low-income 
housing projects go unused. Since 1990, States are permitted to 
carry forward unused credit subsequently made available for 
allocation by other States. Thus, the amount allocated in any 1 
year could be less than the States' authority, but such 
authority may ultimately be allocated.

             TAX CREDIT AND EXCLUSION FOR ADOPTION EXPENSES

    The Small Business Job Protection Act of 1996 (Public Law 
104-188), signed into law on August 20, 1996, includes two tax 
provisions designed to reduce economic barriers to adoption. 
First, a tax credit of up to $5,000 (or $6,000 in the case of 
families adopting special-needs children from the United 
States) is created to help defray one-time adoption expenses. 
The credit is phased out for families with incomes above 
$75,000, and is unavailable to families with incomes above 
$115,000. Second, employees may receive an income tax exclusion 
of up to $5,000 per child (or $6,000 in the case of special-
needs children) for employer-provided adoption assistance. The 
effective date for both provisions is January 1, 1997. The 
credit for foreign special-needs adoptions and the exclusion 
are not available after December 31, 2001.

                            CHILD TAX CREDIT

     The Taxpayer Relief Act of 1997 provided for a $500 ($400 
for taxable year 1998) tax credit for each qualifying child 
under the age of 17. A qualifying child is defined as an 
individual for whom the taxpayer can claim a dependency 
exemption and who is a son or daughter of the taxpayer (or a 
descendant of either), a stepson or stepdaughter of the 
taxpayer, or an eligible foster child of the taxpayer. For 
taxpayers with modified adjusted gross income in excess of 
certain thresholds, the allowable child credit is phased out.
     Generally, the maximum amount of the child credit for each 
taxable year cannot exceed the excess of the taxpayer's regular 
tax liability over the taxpayer's tentative minimum tax 
liability (determined without regard to the alternative minimum 
foreign tax credit). In the case of a taxpayer with three or 
more qualifying children, the maximum amount of the child 
credit for each taxable year cannot exceed the greater of: (1) 
the general rule (described above), or (2) an amount equal to 
the excess of the sum of the taxpayer's regular income tax 
liability (net of applicable credits other than the earned 
income credit) and the employee share of FICA (and one-half of 
the taxpayer's SECA tax liability, if applicable) reduced by 
the earned income credit. In the case of a taxpayer with three 
or more qualifying children, the excess of the amount allowed 
in (2) over the amount computed in (1) is a refundable credit.
     For taxpayers with modified AGI in excess of certain 
thresholds, the child credit is phased out. The phaseout rate 
is $50 for each $1,000 of modified AGI (or fraction thereof) in 
excess of the threshold. For these purposes modified AGI is 
computed by increasing the taxpayer's AGI by the amount 
otherwise excluded under Code sections 911, 931, and 933 
(relating to the exclusion of income of U.S. citizens or 
residents living abroad; residents of Guam, American Samoa, and 
the Northern Mariana Islands; and residents of Puerto Rico, 
respectively). For married taxpayers filing joint returns, the 
threshold is $110,000. For taxpayers filing single or head of 
household returns, the threshold is $75,000. For married 
taxpayers filing separate returns, the threshold is $55,000. 
These thresholds are not indexed for inflation.

THE EFFECT OF TAX PROVISIONS ON THE INCOME AND TAXES OF THE ELDERLY AND 
                                THE POOR

    Tables 13-18 and 13-19 present values of the personal 
exemptions, standard deductions, additional standard deductions 
for the elderly and the blind, and taxable income brackets for 
1990-2002. The figures for 1998-2002 are based on Congressional 
Budget Office projections. As might be expected, the value to 
taxpayers of personal exemptions, standard deductions, and 
additional standard deductions for the elderly and the blind 
grows steadily over the 10-year period.

          Hypothetical Tax Calculations for Selected Families

    Table 13-20 presents examples of tax liabilities for 
hypothetical taxpayers. The table presents 1997 Federal income 
and payroll tax burdens. The worker is assumed to bear both the 
employer and employee shares of FICA tax (7.65 percent for 
each). Taxpayers claim the earned income credit, if eligible, 
and they claim the standard deduction, except where noted in 
the footnotes. Income sources are listed in the table's 
footnotes for each example.

                      Tax Treatment of the Elderly

    Present law contains several provisions that reduce, or in 
some cases eliminate, the burden of Federal income tax on 
senior citizens. These provisions are: the exemption from 
income taxation of some or all of an individual's Social 
Security benefits; a tax credit for certain taxpayers who do 
not receive substantial Social Security income; and an 
additional standard deduction for taxpayers age 65 and older. 
These are described in detail in preceding portions of this 
section.
    As a result of these favorable tax provisions, the tax 
threshold (the level of income, excluding Social Security, at 
which tax liability is incurred) for elderly taxpayers is very 
close to or above the poverty level. For example, in 1996, a 
single elderly individual with $5,000 in Social Security 
benefits can have up to $7,200 in other income without 
incurring tax liability (or total income of $12,200). An 
elderly married couple filing jointly with $5,000 in excluded 
Social Security benefits has a tax threshold of $13,500 (or 
total income of $18,500). By comparison, the poverty levels in 
1995 for a single elderly person and an elderly couple were 
$7,309 and $9,221, respectively (U.S. Bureau of the Census, 
1995). Table 13-21 displays similar information for other years 
and for varying amounts of Social Security benefits.

        TABLE 13-18.--ACTUAL PERSONAL EXEMPTIONS, STANDARD DEDUCTIONS, AND TAXABLE INCOME LEVELS, 1990-97       
----------------------------------------------------------------------------------------------------------------
 Exemption, deduction, or income                                                                                
              level                 1990      1991      1992      1993      1994      1995      1996      1997  
----------------------------------------------------------------------------------------------------------------
Personal exemptions.............    $2,050    $2,150    $2,300    $2,350    $2,450    $2,500    $2,550    $2,650
Standard deductions:                                                                                            
    Joint.......................     5,450     5,700     6,000     6,200     6,350     6,550     6,700     6,900
    Single......................     3,250     3,400     3,600     3,700     3,800     3,900     4,000     4,150
    Head of household...........     4,750     5,000     5,250     5,450     5,600     5,750     5,900     6,050
Additional standard deductions                                                                                  
 for elderly/blind:                                                                                             
    Joint (each individual).....       650       650       700       700       750       750       800       800
    Single/head of household....       800       850       900       900       950       950     1,000     1,000
Taxable income levels:                                                                                          
  Joint returns:                                                                                                
    15-percent rate ends at.....    32,450    34,000    35,800    36,900    38,000    39,000    40,100    41,200
    28-percent rate ends at.....    78,400    82,150    86,500    89,150    91,850    94,250    96,900    99,600
    31-percent rate ends at.....  ........  ........  ........   140,000   140,000   143,600   147,700   151,750
  Single returns:                                                                                               
    15-percent rate ends at.....    19,450    20,350    21,450    22,100    22,750    23,350    24,000    24,650
    28-percent rate ends at.....    47,050    49,300    51,900    53,500    55,100    56,550    58,150    59,750
    31-percent rate ends at.....  ........  ........  ........   115,000   115,000   117,950   121,300   124,650
  Heads of household:                                                                                           
    15-percent rate ends at.....    26,050    27,300    28,750    29,600    30,500    31,250    32,150    33,050
    28-percent rate ends at.....    67,200    70,450    74,150    76,400    78,700    80,750    83,050    85,350
    31-percent rate ends at.....  ........  ........  ........   127,500   127,500   130,800   134,500   138,200
    39.6-percent rate ends at...  ........  ........  ........   250,000   250,000   256,500   263,750  271,050 
----------------------------------------------------------------------------------------------------------------
Source: Congressional Budget Office.                                                                            


                         TABLE 13-19.--PROJECTED PERSONAL EXEMPTIONS, STANDARD DEDUCTIONS, AND TAXABLE INCOME LEVELS, 1998-2007                         
--------------------------------------------------------------------------------------------------------------------------------------------------------
        Exemption, deduction, or income level           1998      1999      2000      2001      2002      2003      2004      2005      2006      2007  
--------------------------------------------------------------------------------------------------------------------------------------------------------
Personal exemptions.................................    $2,700    $2,800    $2,900    $2,950    $3,050    $3,150    $3,250    $3,350    $3,450    $3,550
Standard deductions:                                                                                                                                    
    Joint...........................................     7,100     7,300     7,550     7,750     8,000     8,250     8,500     8,750     9,000     9,300
    Single..........................................     4,250     4,400     4,500     4,650     4,800     4,950     5,100     5,250     5,400     5,550
    Head of household...............................     6,250     6,450     6,650     6,800     7,050     7,250     7,450     7,700     7,900     8,150
Additional standard deductions for elderly/blind:                                                                                                       
    Joint (each individual).........................       850       850       900       900       950       950     1,000     1,050     1,050     1,100
    Single/head of household........................     1,050     1,100     1,100     1,150     1,200     1,200     1,250     1,300     1,350     1,350
Taxable income levels:                                                                                                                                  
  Joint returns:                                                                                                                                        
    15-percent rate ends at.........................    42,400    43,650    44,950    46,250    47,650    49,100    50,550    52,100    53,700    55,350
    28-percent rate ends at.........................   102,500   105,500   108,600   111,800   115,150   118,600   122,200   125,900   129,750   133,750
    31-percent rate ends at.........................   156,200   160,750   165,500   170,400   175,450   180,750   186,200   191,850   197,750   203,850
  Single returns:                                                                                                                                       
    15-percent rate ends at.........................    25,400    26,150    26,900    27,700    28,550    29,400    30,250    31,200    32,150    33,150
    28-percent rate ends at.........................    61,500    63,300    65,150    67,100    69,100    71,150    73,300    75,550    77,850    80,250
    31-percent rate ends at.........................   128,300   132,050   135,950   139,950   144,150   148,450   152,950   157,600   162,450   167,450
  Heads of household:                                                                                                                                   
    15-percent rate ends at.........................    34,000    35,000    36,050    37,100    38,200    39,350    40,550    41,800    43,050    44,400
    28-percent rate ends at.........................    87,850    90,400    93,050    95,800    98,650   101,650   104,700   107,900   111,200   114,650
    31-percent rate ends at.........................   142,250   146,400   150,700   155,150   159,800   164,000   169,550   174,750   180,100   185,650
    39.6-percent rate ends at.......................   278,900   287,050   295,550   304,300   313,350   322,750   332,500   342,650   353,150  364,050 
--------------------------------------------------------------------------------------------------------------------------------------------------------
Source: Congressional Budget Office.                                                                                                                    


      TABLE 13-20.--EXAMPLES OF FEDERAL INCOME AND PAYROLL TAX LIABILITIES OF HYPOTHETICAL TAXPAYERS, 1997      
----------------------------------------------------------------------------------------------------------------
                                                                                       Overall        Overall   
                                                     Income    FICA tax  Total tax  effective tax   marginal tax
          Type of filing unit and income              tax     liability  liability       rate           rate    
                                                   liability                        (percent) \1\  (percent) \1\
----------------------------------------------------------------------------------------------------------------
Joint filer--3 exemptions: \2\                                                                                  
     $10,000.....................................    -$2,210     $1,530      -$680         -6.3           14.2  
     $30,000.....................................      2,273      4,590      6,863         21.3           28.1  
    $50,000 \3\..................................      4,808      7,650     12,458         23.1           28.1  
    $100,000 \4\.................................     14,818     11,010     25,828         24.5           30.5  
Head of household--2 exemptions: \2\                                                                            
    $10,000......................................     -2,210      1,530       -680         -6.3           14.2  
    $30,000......................................      2,798      4,590      7,388         22.9           28.1  
    $50,000 \3\..................................      5,420      7,650     13,070         24.3           40.2  
    $100,000 \4\.................................     16,620     11,010     27,630         26.2           30.5  
Elderly couple filing joint return:                                                                             
    $10,000 \5\..................................          0          0          0          0.0        \6\ 0.0  
    $30,000 \7\..................................        630          0        630          2.1       \8\ 15.0  
    $50,000 \9\..................................      4,530      1,530      6,060         11.9           40.0  
Elderly single filer:                                                                                           
    $10,000 \10\.................................          0          0          0          0.0        \6\ 0.0  
    $30,000 \11\.................................      2,205          0      2,205          7.4      \12\ 22.5  
    $50,000 \13\.................................      8,297      3,060     11,357         22.0          40.2   
----------------------------------------------------------------------------------------------------------------
\1\ The average tax rate is total tax liability divided by income plus the employer share of FICA. The marginal 
  rate computations also count the employer share of FICA tax as income to the employee (for both payroll and   
  income tax purposes). Unless otherwise noted, all calculations assume the taxpayer takes the standard         
  deduction rather than itemized deductions.                                                                    
\2\ Assumes one child, one earner, and all income is wage income.                                               
\3\ Assumes taxpayer claims itemized deductions of $10,000.                                                     
\4\ Assumes taxpayer claims itemized deductions of $20,000.                                                     
\5\ All income is Social Security.                                                                              
\6\ If the marginal dollar of income is assumed to consist of wage income, the marginal tax rate would be 14.2  
  percent. This represents the FICA tax liability on this income.                                               
\7\ Of the total, $12,000 is Social Security, $12,000 is a taxable pension, and $6,000 is taxable interest.     
\8\ If the marginal dollar of income is assumed to consist of wage income, the marginal tax rate would be 28.1  
  percent, representing both the income tax liability and the FICA tax liability on this income.                
\9\ Same as above plus additional $10,000 of taxable interest and $10,000 of wages.                             
\10\ Of the total, $7,500 is Social Security and $2,500 is taxable pension.                                     
\11\ Of the total, $7,500 is Social Security, $7,500 is taxable pension, and $15,000 is taxable interest.       
\12\ If the marginal dollar of income is assumed to consist of wage income, the marginal tax rate would be 35.1 
  percent, representing both the income tax liability (22.5-percent marginal rate reflects the inclusion of 50  
  cents of Social Security benefits as taxable for each additional dollar of AGI) and the FICA tax liability on 
  this income.                                                                                                  
\13\ Same as above plus $20,000 of wages.                                                                       
                                                                                                                
 Source: Joint Committee on Taxation.                                                                           


TABLE 13-21.--INCOME TAX THRESHOLDS FOR ELDERLY INDIVIDUALS WITH VARIOUS
              AMOUNTS OF SOCIAL SECURITY INCOME, 1990-2007              
------------------------------------------------------------------------
                                   Amount of Social Security income     
   Year and filing status    -------------------------------------------
                                 None      $2,500     $5,000     $7,500 
------------------------------------------------------------------------
1990:                                                                   
  Single....................     $9,900     $8,233     $6,100     $6,100
  Joint.....................     15,567     13,900     12,233     10,850
1991:                                                                   
  Single....................     10,100      8,433      6,400      6,400
  Joint.....................     15,867     14,200     12,533     11,300
1992:                                                                   
  Single....................     10,367      8,700      6,800      6,800
  Joint.....................     16,333     14,667     13,000     12,000
1993:                                                                   
  Single....................     10,467      8,800      6,950      6,950
  Joint.....................     16,533     14,867     13,200     12,300
1994:                                                                   
  Single....................     10,633      8,967      7,200      7,200
  Joint.....................     16,833     15,167     13,500     12,750
1995:                                                                   
  Single....................     10,733      9,067      7,350      7,350
  Joint.....................     17,033     15,367     13,700     13,050
1996:                                                                   
  Single....................     10,867      9,200      7,550      7,550
  Joint.....................     17,267     15,600     13,933     13,400
1997:                                                                   
  Single....................     11,033      9,367      7,800      7,800
  Joint.....................     17,533     15,867     14,200     13,800
1998 \1\:                                                               
  Single....................     11,167      9,500      8,000      8,000
  Joint.....................     17,800     16,133     14,467     14,200
1999 \1\:                                                               
  Single....................     11,367      9,700      8,300      8,300
  Joint.....................     18,067     16,400     14,733     14,600
2000 \1\:                                                               
  Single....................     11,500      9,833      8,500      8,500
  Joint.....................     18,433     16,767     15,100     15,150
2001 \1\:                                                               
  Single....................     11,667     10,000      8,750      8,750
  Joint.....................     18,633     16,967     15,300     15,450
2002 \1\:                                                               
  Single....................     11,867     10,200      9,050      9,050
  Joint.....................     19,000     17,333     15,667     16,000
2003 \1\:                                                               
  Single....................     12,033     10,367      9,300      9,300
  Joint.....................     19,300     17,633     15,967     16,450
2004 \1\:                                                               
  Single....................     12,233     10,567      9,600      9,600
  Joint.....................     19,667     18,000     16,333     17,000
2005 \1\:                                                               
  Single....................     12,433     10,767      9,900      9,900
  Joint.....................     20,033     18,367     16,700     17,550
2006 \1\:                                                               
  Single....................     12,633     10,967     10,200     10,200
  Joint.....................     20,333     18,667     17,000     18,000
2007 \1\:                                                               
  Single....................     12,800     11,133     10,450     10,450
  Joint.....................     20,733     19,067     17,400    18,600 
------------------------------------------------------------------------
\1\ Projections.                                                        
                                                                        
Source: Congressional Budget Office.                                    

    The combination of these tax provisions means that an 
estimated 51 percent of elderly individuals will have no tax 
liability for 1998 (see table 13-22).

                Distribution of Family Income and Taxes

    Table 13-22 presents estimates of the distribution of 
families and individuals by the Federal individual income tax 
rate brackets for calendar year 1998. As shown in the bottom 
panel, almost 33 million families pay no Federal income taxes. 
There are 55 million families with 134 million individuals who 
are in the 15-percent bracket. These families on average had 
income of $37,645 and paid Federal taxes of $2,474 per family. 
There are approximately 4 million families that face marginal 
income tax rates of 31 percent or above.
    Table 13-23 is a more complicated version of table 13-22. 
It illustrates for various types of wage earners the additional 
(marginal) Federal tax these wage earners will pay if they earn 
one more dollar of wages. For purposes of this table, marginal 
tax rates include both Federal income and payroll taxes. The 
majority of single wage earners have income below $30,000 per 
year and face marginal tax rates of 20.0-24.9 percent. In 
addition, the phaseout of certain deductions or exclusions 
under the Code (e.g., the personal exemption phaseout) and the 
overall limitation on itemized deductions also have the effect 
of imposing additional dollars of tax liability on a taxpayer 
as the taxpayer's income increases. Hence, effective marginal 
tax rates can exceed the sum of the statutory individual income 
tax rate and payroll tax rate.

     TABLE 13-22.--DISTRIBUTION OF FAMILIES AND PERSONS BY MARGINAL FEDERAL INCOME TAX RATE, PROJECTED 1998     
----------------------------------------------------------------------------------------------------------------
                                                       Families  (in       Persons  (in           Families      
                                                         thousands)         thousands)    ----------------------
                                                    --------------------------------------              Average 
    Family type and marginal tax rate (percent)                                              Average    Federal 
                                                      Number   Percent   Number   Percent    pretax      income 
                                                                                             income       tax   
----------------------------------------------------------------------------------------------------------------
With children:                                                                                                  
    0..............................................     9,916     25.4    37,446     24.8     $11,804    -$1,407
    15.............................................    20,041     51.3    77,591     51.4      45,735      2,623
    28.............................................     7,674     19.6    30,211     20.0      98,722     11,377
    31.............................................       783      2.0     3,085      2.0     179,456     29,126
    36.............................................       361      0.9     1,510      1.0     265,265     50,216
    39.6...........................................       304      0.8     1,274      0.8     749,899    201,894
                                                    ------------------------------------------------------------
        Total......................................    39,078    100.0   151,116    100.0      57,707      5,838
                                                    ============================================================
With aged head:                                                                                                 
    0..............................................    11,273     50.5    16,269     45.5      15,292         -7
    15.............................................     8,038     36.0    13,937     39.0      38,222      2,054
    28.............................................     2,325     10.4     4,303     12.0      86,015     10,327
    31.............................................       436      2.0       716      2.0     150,662     24,454
    36.............................................       175      0.8       331      0.9     293,016     57,054
    39.6...........................................        93      0.4       174      0.5     997,948    202,334
                                                    ------------------------------------------------------------
        Total......................................    22,339    100.0    35,729    100.0      39,799      3,575
                                                    ============================================================
Other families:                                                                                                 
    0..............................................     9,592     18.4    12,231     14.9       6,978       -110
    15.............................................    26,942     51.5    42,531     51.8      32,422      2,567
    28.............................................    13,291     25.4    22,976     28.0      75,353      9,749
    31.............................................     1,544      3.0     2,528      3.1     141,044     23,018
    36.............................................       551      1.1     1,058      1.3     254,622     50,215
    39.6...........................................       355      0.7       748      0.9     905,846    223,378
                                                    ------------------------------------------------------------
        Total......................................    52,275    100.0    82,073    100.0      50,145      6,506
                                                    ============================================================
All families:                                                                                                   
    0..............................................    30,780     27.1    65,946     24.5      11,578       -490
    15.............................................    55,021     48.4   134,059     49.9      38,118      2,512
    28.............................................    23,290     20.5    57,490     21.4      84,117     10,343
    31.............................................     2,763      2.4     6,330      2.4     153,445     24,975
    36.............................................     1,087      1.0     2,899      1.1     264,333     51,316
    39.6...........................................       751      0.7     2,195      0.8     854,156    212,091
                                                    ------------------------------------------------------------
        Total......................................   113,692    100.0   268,918    100.0      50,711     5,700 
----------------------------------------------------------------------------------------------------------------
Source: Congressional Budget Office tax simulation model.                                                       


                           TABLE 13-23.--DISTRIBUTION OF EARNERS \1\ BY INCOME AND MARGINAL TAX RATES ON WAGES, PROJECTED 1998                          
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                 Income in thousands of 1998 dollars                                    
                                                     ------------------------------------------------------------------------------------------    All  
     Family type and marginal tax rate (percent)        Less                                                                                     incomes
                                                       than 10    10-20     20-30     30-40     40-50     50-75    75-100    100-200    200+            
--------------------------------------------------------------------------------------------------------------------------------------------------------
Single earners:                                                                                                                                         
    Less than 0.....................................     2,305       193         8         2         0         2         0         0         0     2,511
    0-4.9...........................................     1,502        75        12         0         0         0         0         0         0     1,589
    5.0-9.9.........................................     4,525       782        13         0         0         0         0         0         0     5,319
    10-14.9.........................................         0         0         0         0         0         0         0         0         0         0
    15.0-19.9.......................................       877        32         0         0         0         0         0         0         0       908
    20-24.9.........................................     1,949     9,966     8,468     3,519       530        64         0         0         0    24,496
    25.0-29.9.......................................         0       346         5         0         1       217       237         9         0       815
    30-34.9.........................................     1,589       336         6         0         0        54       343       365         0     2,694
    35.0-39.9.......................................         0     1,070       879     2,466     2,538     2,552       154       120        74     9,853
    40-44.9.........................................         0       486       853        40         0         0         0        17       102     1,498
    45.0-49.9.......................................         0         0         0         0         0         0         0        10        18        28
                                                     ---------------------------------------------------------------------------------------------------
        Total.......................................    12,747    13,285    10,245     6,027     3,070     2,889       734       521       195    49,712
                                                     ===================================================================================================
    Mean marginal tax rate..........................       5.6      23.3      25.7      28.1      33.4      34.8      32.5      35.0      41.2      21.5
    Mean marginal income tax rate...................      -2.1      15.7      18.0      20.4      25.8      27.8      29.8      32.7      39.2      14.0
    Mean marginal Social Security tax rate..........       7.6       7.6       7.6       7.6       7.6       7.1       2.8       2.3       2.1       7.5
                                                     ===================================================================================================
 Married earners:                                                                                                                                       
    Less than 0.....................................       919       252        41         6         1         0         0         0         0     1,219
    0-4.9...........................................       139        49        21         5         2         0         0         0         0       216
    5.0-9.9.........................................       639     1,057       123        47         2         0         0         0         0     1,868
    10-14.9.........................................         0         0         0         0         0         0         0         0         0         0
    15.0-19.9.......................................       158        60        18         7         6        59         3         0         0       311
    20-24.9.........................................         0     1,217     3,420     9,300     9,515    12,489        67         5         0    36,013
    25.0-29.9.......................................         0     1,208       468        28         6       229     1,365     1,421         0     4,726
    30-34.9.........................................         0         5         4       109       184        21         8     1,587        38     1,957
    35.0-39.9.......................................         0       451     1,132        61        32     8,577     8,566     5,215       112    24,147
    40-44.9.........................................         4       147     2,697       171         6         6         1       159     1,285     4,477
    45.0-49.9.......................................         4         0         0         2         2         0         2        59       703       773
                                                     ---------------------------------------------------------------------------------------------------
        Total.......................................     1,863     4,446     7,926     9,736     9,757    21,381    10,012     8,446     2,139    75,707
                                                     ===================================================================================================
    Mean marginal tax rate..........................     -11.0      20.0      31.9      23.1      22.8      27.9      34.7      34.7      43.2      27.7
    Mean marginal income tax rate...................     -18.7      12.4      24.3      15.5      15.2      20.4      27.9      29.3      39.5      20.6
    Mean marginal Social Security tax rate..........       7.6       7.6       7.6       7.6       7.6       7.6       6.8       5.3       3.7       7.1
                                                     ===================================================================================================
Earners with children:                                                                                                                                  
    Less than 0.....................................     3,000       419        48         8         0         1         0         0         0     3,476
    0-4.9...........................................         2        22        19         2         2         0         0         0         0        47
    5.0-9.9.........................................       763     1,281        44        35         1         0         0         0         0     2,125
    10-14.9.........................................         0         0         0         0         0         0         0         0         0         0
    15.0-19.9.......................................         0         0         0         2         1        52         3         0         0        58
    20-24.9.........................................         0       468     1,054     6,377     6,095     8,519        56         1         0    22,570
    25.0-29.9.......................................         0     1,545       469        28         4       168       982       791         0     3,988
    30-34.9.........................................         0         0         0        26        20         9         8       926        13     1,001
    35.0-39.9.......................................         0     1,213     1,631        47        64     3,781     4,651     2,590        89    14,065
    40-44.9.........................................         0       597     3,409       207         6         6         1        96       652     4,975
    45.0-49.9.......................................         0         0         0         2         2         0         0        36       279       320
                                                     ---------------------------------------------------------------------------------------------------
        Total.......................................     3,765     5,544     6,673     6,735     6,196    12,535     5,700     4,439     1,033    52,623
                                                     ===================================================================================================
    Mean marginal tax rate..........................     -22.6      22.8      37.2      23.3      22.8      26.7      34.4      34.5      43.1      25.0
    Mean marginal income tax rate...................     -30.2      15.2      29.6      15.7      15.2      19.1      27.9      29.4      39.7      17.8
    Mean marginal Social Security tax rate..........       7.6       7.6       7.6       7.6       7.6       7.5       6.6       5.1       3.4       7.2
                                                     ===================================================================================================
All earners ages 21-64 without Social Security                                                                                                          
 earnings:                                                                                                                                              
    Less than 0.....................................     3,224       446        49         8         1         2         0         0         0     3,730
    0-4.9...........................................     1,641       125        33         5         2         0         0         0         0     1,805
    6.0-9.9.........................................     5,163     1,838       136        47         2         0         0         0         0     7,187
    10-14.9.........................................         0         0         0         0         0         0         0         0         0         0
    15.0-19.9.......................................     1,035        91        18         7         6        59         3         0         0     1,220
    20-24.9.........................................     1,949    11,182    11,888    12,819    10,045    12,552        67         5         0    60,509
    25.0-29.9.......................................         0     1,555       473        28         8       446     1,602     1,430         0     5,541
    30-34.9.........................................     1,589       340        11       109       184        75       351     1,952        38     4,651
    35.0-39.9.......................................         0     1,521     2,011     2,527     2,570    11,129     8,720     5,335       186    34,000
    40-44.9.........................................         4       633     3,550       211         6         6         1       176     1,388     5,975
    45.0-49.9.......................................         4         0         0         2         2         0         2        69       721       801
                                                     ---------------------------------------------------------------------------------------------------
        Total.......................................    14,610    17,732    18,170    15,763    12,827    24,270    10,746     8,968     2,333   125,419
                                                     ===================================================================================================
    Mean marginal tax rate..........................       3.5      22.5      28.4      25.0      25.4      28.8      34.6      34.7      43.0      25.2
    Mean marginal income tax rate...................      -4.2      14.8      20.8      17.4      17.7      21.2      28.1      29.5      39.5      18.0
    Mean marginal Social Security tax rate..........       7.6       7.6       7.6       7.6       7.6       7.5       6.5       5.2       3.5      7.3 
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ In thousands.                                                                                                                                       
                                                                                                                                                        
 Source: Congressional Budget Office tax simulation model.                                                                                              

              Federal Tax Treatment of Families in Poverty

    During the 1970s and early 1980s, inflation gradually 
increased the tax burdens of the poor and lowered the real 
income level at which a poor family became liable for income 
taxation. Legislation passed by Congress reversed or slowed 
this trend, but in the absence of indexing, inflation during 
this period gradually offset these legislative efforts. One 
measure of this trend is the degree to which the income at 
which a poor family begins to pay income taxes (termed the tax 
threshold, or the tax entry point) exceeds or falls below the 
poverty threshold. A second measure is the actual amount of tax 
liability incurred by a family with income at the poverty line.
    Table 13-24 shows the income tax threshold, the poverty 
level, and the tax threshold as a percent of the poverty level 
for a married couple with two children in selected years. These 
figures demonstrate that before 1975 a family of four was 
generally liable for Federal income tax if the family's income 
was significantly below the poverty line. In 1975, following 
the enactment of the EIC, a 

   TABLE 13-24.--RELATIONSHIP BETWEEN INCOME TAX THRESHOLD AND POVERTY  
          LEVEL FOR A FAMILY OF FOUR, SELECTED YEARS 1959-2007          
------------------------------------------------------------------------
                                                                 Tax    
                                                              threshold 
                                    Income tax    Poverty        as a   
               Year                 threshold      level      percent of
                                                               poverty  
                                                                level   
------------------------------------------------------------------------
1959.............................       $2,667       $2,978         89.7
1960.............................        2,667        3,022         88.3
1965.............................        3,000        3,223         93.1
1970.............................        3,600        3,968         90.7
1975.............................        6,692        5,500        121.7
1980.............................        8,626        8,414        102.5
1984.............................        8,783       10,610         82.8
1990.............................       16,296       13,359        122.0
1991.............................       17,437       13,924        125.2
1992.............................       18,548       14,335        129.4
1993.............................       19,187       14,763        130.0
1994.............................       21,098       14,625        144.3
1995.............................       22,362       15,570        143.6
1996.............................       23,672       16,020        147.8
1997.............................       24,386       16,479        148.0
1998.............................       25,039       16,969        147.6
1999.............................       25,798       17,470        147.7
2000.............................       26,006       17,980        148.0
2001.............................       27,333       18,521        147.6
2002.............................       28,170       19,072        147.7
2003.............................       29,035       19,654        147.7
2004.............................       29,923       20,257        147.7
2005.............................       30,833       20,880        147.7
2006.............................       31,760       21,523        147.6
2007.............................       32,742       22,187       147.6 
------------------------------------------------------------------------
Source: Congressional Budget Office.                                    

family of four incurred no tax liability until its income 
exceeded the poverty threshold by 22 percent. Over the next 
decade this margin eroded; by 1984, a poor family of four 
incurred income tax liability when its income was 17 percent 
below the poverty line. By 1993, changes in the tax law 
resulted in no tax liability for a typical family of four until 
its income exceeded the poverty threshold by nearly 30 percent.
    Table 13-25 shows the income tax burden and payroll tax 
burden of households with incomes at the poverty line for 
families of different sizes. As a result of the refundable EIC, 
the table reflects that many individuals receive a substantial 
credit that more than offsets total income, and in many cases 
Social Security, taxes paid.

 TABLE 13-25.--POVERTY LEVELS, TAX THRESHOLDS, AND FEDERAL TAX AMOUNTS FOR DIFFERENT FAMILY SIZES WITH EARNINGS 
                                      EQUAL TO THE POVERTY LEVEL, 1991-2007                                     
----------------------------------------------------------------------------------------------------------------
                                                                             Family size                        
          Poverty or tax measure and year          -------------------------------------------------------------
                                                       1        2         3          4          5          6    
----------------------------------------------------------------------------------------------------------------
Poverty level:                                                                                                  
    1991..........................................   $6,932   $8,865   $10,860    $13,924    $16,456    $18,587 
    1992..........................................    7,143    9,137    11,186     14,335     16,592     19,137 
    1993..........................................    7,363    9,414    11,522     14,763     17,449     19,718 
    1994..........................................    7,547    9,661    11,821     15,141     17,900     20,235 
    1995..........................................    7,759    9,924    12,150     15,570     18,022     20,786 
    1996..........................................    7,982   10,211    12,501     16,020     18,542     21,386 
    1997..........................................    8,211   10,504    12,859     16,479     19,074     21,999 
    1998..........................................    8,456   10,816    13,242     16,969     19,641     22,654 
    1999..........................................    8,705   11,135    13,632     17,470     20,220     23,322 
    2000..........................................    8,959   11,460    14,030     17,980     20,811     24,003 
    2001..........................................    9,229   11,805    14,453     18,521     21,437     24,725 
    2002..........................................    9,504   12,157    14,883     19,072     22,075     25,461 
    2003..........................................    9,794   12,528    15,337     19,654     22,749     26,238 
    2004..........................................   10,094   12,912    15,807     20,257     23,446     27,043 
    2005..........................................   10,404   13,309    16,293     20,880     24,167     27,874 
    2006..........................................   10,725   13,719    16,795     21,523     24,912     28,733 
    2007..........................................   11,055   14,142    17,313     22,187     25,680     29,619 
Income tax threshold:                                                                                           
    1991..........................................    5,550   10,000    16,179     17,437     18,616     19,794 
    1992..........................................    5,900   10,600    17,217     18,548     19,774     21,000 
    1993..........................................    6,050   10,900    17,841     19,187     20,405     21,624 
    1994..........................................    7,179   11,250    18,887     21,098     22,222     23,347 
    1995..........................................    7,356   11,550    19,387     22,362     23,426     24,491 
    1996..........................................    7,546   11,800    19,884     23,672     24,733     25,793 
    1997..........................................    7,800   12,200    20,488     24,386     25,488     26,590 
    1998..........................................    7,994   12,500    21,031     25,039     26,162     27,285 
    1999..........................................    8,257   12,900    21,678     25,798     26,963     28,128 
    2000..........................................    8,494   13,350    22,355     26,606     27,813     29,019 
    2001..........................................    8,735   13,650    22,956     27,333     28,561     29,788 
    2002..........................................    9,008   14,100    23,670     28,170     29,439     30,708 
    2003..........................................    9,289   14,550    24,400     29,035     30,345     31,656 
    2004..........................................    9,573   15,000    25,141     29,923     31,274     32,626 
    2005..........................................    9,860   15,450    25,902     30,833     32,226     33,620 
    2006..........................................   10,154   15,900    26,691     31,760     33,195     34,630 
    2007..........................................   10,451   16,400    27,515     32,742     34,219     35,696 
Income tax at poverty level:                                                                                    
    1991..........................................      207        0    -1,192       -905       -591       -328 
    1992..........................................      187        0    -1,324     -1,053       -711       -422 
    1993..........................................      197        0    -1,434     -1,154       -780       -464 
    1994..........................................       83        0    -1,907     -1,795     -1,308       -895 
    1995..........................................       91        0    -1,957     -2,245     -1,749     -1,190 
    1996..........................................       99        0    -2,010     -2,627     -2,096     -1,497 
    1997..........................................       93        0    -2,065     -2,698     -2,152     -1,535 
    1998..........................................      105        0    -2,119     -2,770     -2,208     -1,573 
    1999..........................................      101        0    -2,182     -2,849     -2,270     -1,616 
    2000..........................................      105        0    -2,246     -2,935     -2,339     -1,667 
    2001..........................................      112        0    -2,312     -3,023     -2,409     -1,717 
    2002..........................................      112        0    -2,382     -3,112     -2,479     -1,766 
    2003..........................................      114        0    -2,453     -3,203     -2,552     -1,817 
    2004..........................................      118        0    -2,525     -3,299     -2,627     -1,870 
    2005..........................................      123        0    -2,601     -3,399     -2,706     -1,926 
    2006..........................................      129        0    -2,683     -3,500     -2,786     -1,982 
    2007..........................................      137        0    -2,765     -3,609     -2,874     -2,044 
Payroll tax at poverty level:                                                                                   
    1991..........................................      530      678       831      1,065      1,259      1,422 
    1992..........................................      547      699       856      1,098      1,298      1,466 
    1993..........................................      563      720       881      1,129      1,335      1,508 
    1994..........................................      577      739       904      1,158      1,369      1,548 
    1995..........................................      594      759       929      1,191      1,379      1,590 
    1996..........................................      611      781       956      1,226      1,418      1,636 
    1997..........................................      628      804       984      1,261      1,459      1,683 
    1998..........................................      647      827     1,013      1,298      1,503      1,733 
    1999..........................................      666      852     1,043      1,336      1,547      1,784 
    2000..........................................      685      877     1,073      1,375      1,592      1,836 
    2001..........................................      706      903     1,106      1,417      1,640      1,891 
    2002..........................................      727      930     1,139      1,459      1,689      1,948 
    2003..........................................      749      958     1,173      1,504      1,740      2,007 
    2004..........................................      772      988     1,209      1,550      1,794      2,069 
    2005..........................................      796    1,018     1,246      1,597      1,849      2,132 
    2006..........................................      820    1,049     1,285      1,647      1,906      2,198 
    2007..........................................      846    1,082     1,324      1,697      1,965      2,266 
Combined tax at poverty level:                                                                                  
    1991..........................................      738      678      -362        160        668      1,094 
    1992..........................................      734      699      -467         45        587      1,044 
    1993..........................................      760      720      -552        -25        555      1,044 
    1994..........................................      661      739    -1,003       -637         62        653 
    1995..........................................      685      759    -1,027     -1,054       -371        400 
    1996..........................................      709      781    -1,054     -1,402       -678        139 
    1997..........................................      721      804    -1,081     -1,437       -692        148 
    1998..........................................      751      827    -1,106     -1,472       -705        160 
    1999..........................................      767      852    -1,140     -1,512       -723        168 
    2000..........................................      791      877    -1,173     -1,560       -747        169 
    2001..........................................      818      903    -1,207     -1,607       -769        175 
    2002..........................................      839      930    -1,244     -1,652       -790        182 
    2003..........................................      864      958    -1,280     -1,700       -811        191 
    2004..........................................      890      988    -1,316     -1,749       -834        199 
    2005..........................................      919    1,018    -1,355     -1,801       -857        207 
    2006..........................................      950    1,049    -1,398     -1,853       -881        216 
    2007..........................................      983    1,082    -1,441     -1,912       -909        222 
Combined tax at poverty level as a percent of                                                                   
 poverty level:                                                                                                 
    1991..........................................     10.6      7.6      -3.3        1.1        4.1        5.9 
    1992..........................................     10.3      7.7      -4.2        0.3        3.5        5.5 
    1993..........................................     10.3      7.7      -4.8       -0.2        3.2        5.3 
    1994..........................................      8.8      7.7      -8.5       -4.2        0.3        3.2 
    1995..........................................      8.8      7.7      -8.5       -6.8       -2.1        1.9 
    1996..........................................      8.9      7.7      -8.4       -8.8       -3.7        0.6 
    1997..........................................      8.8      7.7      -8.4       -8.7       -3.6        0.7 
    1998..........................................      8.9      7.7      -8.4       -8.7       -3.6        0.7 
    1999..........................................      8.8      7.7      -8.4       -8.7       -3.6        0.7 
    2000..........................................      8.8      7.7      -8.4       -8.7       -3.6        0.7 
    2001..........................................      8.9      7.7      -8.3       -8.7       -3.6        0.7 
    2002..........................................      8.8      7.7      -8.4       -8.7       -3.6        0.7 
    2003..........................................      8.8      7.7      -8.3       -8.6       -3.6        0.7 
    2004..........................................      8.8      7.7      -8.3       -8.6       -3.6        0.7 
    2005..........................................      8.8      7.7      -8.3       -8.6       -3.5        0.7 
    2006..........................................      8.9      7.7      -8.3       -8.6       -3.5        0.8 
    2007..........................................      8.9      7.7      -8.3       -8.6       -3.5       0.7  
----------------------------------------------------------------------------------------------------------------
Source: Congressional Budget Office.                                                                            

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