TAX EXPENDITURES United States Federal Budget 2006

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TAX EXPENDITURES

19. TAX EXPENDITURES The Congressional Budget Act of 1974 (Public Law 93–344) requires that a list of ‘‘tax expenditures’’ be included in the budget. Tax expenditures are defined in the law as ‘‘revenue losses attributable to provisions of the Federal tax laws which allow a special exclusion, exemption, or deduction from gross income or which provide a special credit, a preferential rate of tax, or a deferral of liability.’’ These exceptions may be viewed as alternatives to other policy instruments, such as spending or regulatory programs. Identification and measurement of tax expenditures depends importantly on the baseline tax system against which the actual tax system is compared. The largest reported tax expenditures tend to be associated with the individual income tax. For example, sizeable deferrals, deductions and exclusions are provided for employer contributions for medical insurance, pension contributions and earnings, capital gains, and payments of State and local individual income and property taxes. Reported tax expenditures under the corporate income tax tend to be related to timing differences in the rate of cost recovery for various investments. As is discussed below, the extent to which these provisions are classified as tax expenditures varies according to the conceptual baseline used. Each tax expenditure estimate in this chapter was calculated assuming other parts of the tax code remained unchanged. The estimates would be different if all tax expenditures or major groups of tax expenditures were changed simultaneously because of potential interactions among provisions. For that reason, this chapter does not present a grand total for the estimated tax expenditures. Moreover, past tax changes entailing broad elimination of tax expenditures were generally accompanied by changes in tax rates or other basic provisions, so that the net effects on Federal revenues were considerably (if not totally) offset. Tax expenditures relating to the individual and corporate income taxes are estimated for fiscal years 2004–2010 using three methods of accounting: revenue effects, outlay equivalents, and present values. The present value approach provides estimates of the revenue effects for tax expenditures that generally involve deferrals of tax payments into the future. The section of the chapter on performance measures and economic effects presents information related to assessment of the effect of tax expenditures on the achievement of program performance goals. This section is a complement to the Government-wide performance plan required by the Government Performance and Results Act of 1993. The 2004 and 2005 Budgets included a thorough review of important ambiguities in the tax expenditure concept. In particular, this review focused on defining tax expenditures relative to a comprehensive income tax baseline, defining tax expenditures relative to a broad-based consumption tax baseline, and defining negative tax expenditures, i.e., provisions of current law that over-tax certain items or activities. A similar review is presented in the Appendix again this year. TAX EXPENDITURES IN THE INCOME TAX Tax Expenditure Estimates All tax expenditure estimates presented here are based upon current tax law enacted as of December 31, 2004. Expired or repealed provisions are not listed if their revenue effects result only from taxpayer activity occurring before fiscal year 2004. Due to the time required to estimate the large number of tax expenditures, the estimates are based on Mid-Session economic assumptions; exceptions are the earned income tax credit and child credit provisions, which involve outlay components and hence are updated to reflect the economic assumptions used elsewhere in the budget. The total revenue effects for tax expenditures for fiscal years 2004–2010 are displayed according to the budget’s functional categories in Table 19–1. Descriptions of the specific tax expenditure provisions follow the tables of estimates and the discussion of general features of the tax expenditure concept. As in prior years, two baseline concepts, the normal tax baseline and the reference tax law baseline, are used to identify tax expenditures. These baseline concepts are thoroughly discussed in Special Analysis G of the 1985 Budget, where the former is referred to as the pre-1983 method and the latter the post-1982 method. For the most part, the two concepts coincide. However, items treated as tax expenditures under the normal tax baseline, but not the reference tax law baseline, are indicated by the designation ‘‘normal tax method’’ in the tables. The revenue effects for these items are zero using the reference tax rules. The alternative baseline concepts are discussed in detail following the tables. Table 19–2 reports the respective portions of the total revenue effects that arise under the individual and corporate income taxes separately. The location of the estimates under the individual and corporate headings does not imply that these categories of filers benefit from the special tax provisions in proportion to the respective tax expenditure amounts shown. Rather, these breakdowns show the specific tax accounts through which 316 ANALYTICAL PERSPECTIVES the various provisions are cleared. The ultimate beneficiaries of corporate tax expenditures could be shareholders, employees, customers, or other providers of capital, depending on economic forces. Table 19–3 ranks the major tax expenditures by the size of their 2006–2010 revenue effect. Interpreting Tax Expenditure Estimates The estimates shown for individual tax expenditures in Tables 19–1, 19–2, and 19–3 do not necessarily equal the increase in Federal revenues (or the change in the budget balance) that would result from repealing these special provisions, for the following reasons. Eliminating a tax expenditure may have incentive effects that alter economic behavior. These incentives can affect the resulting magnitudes of the activity or of other tax provisions or Government programs. For example, if capital gains were taxed at ordinary rates, capital gain realizations would be expected to decline, potentially resulting in a decline in tax receipts. Such behavioral effects are not reflected in the estimates. Tax expenditures are interdependent even without incentive effects. Repeal of a tax expenditure provision can increase or decrease the tax revenues associated with other provisions. For example, even if behavior does not change, repeal of an itemized deduction could increase the revenue costs from other deductions because some taxpayers would be moved into higher tax brackets. Alternatively, repeal of an itemized deduction could lower the revenue cost from other deductions if taxpayers are led to claim the standard deduction instead of itemizing. Similarly, if two provisions were repealed simultaneously, the increase in tax liability could be greater or less than the sum of the two separate tax expenditures, because each is estimated assuming that the other remains in force. In addition, the estimates reported in Table 19–1 are the totals of individual and corporate income tax revenue effects reported in Table 19–2 and do not reflect any possible interactions between individual and corporate income tax receipts. For this reason, the estimates in Table 19–1 should be regarded as approximations. Present-Value Estimates The annual value of tax expenditures for tax deferrals is reported on a cash basis in all tables except Table 19–4. Cash-based estimates reflect the difference between taxes deferred in the current year and incoming revenues that are received due to deferrals of taxes from prior years. Although such estimates are useful as a measure of cash flows into the Government, they do not accurately reflect the true economic cost of these provisions. For example, for a provision where activity levels have changed, so that incoming tax receipts from past deferrals are greater than deferred receipts from new activity, the cash-basis tax expenditure estimate can be negative, despite the fact that in present-value terms current deferrals do have a real cost to the Government. Alternatively, in the case of a newly enacted deferral provision, a cash-based estimate can overstate the real effect on receipts to the Government because the newly deferred taxes will ultimately be received. Present-value estimates, which are a useful complement to the cash-basis estimates for provisions involving deferrals, are discussed below. Discounted present-value estimates of revenue effects are presented in Table 19–4 for certain provisions that involve tax deferrals or other long-term revenue effects. These estimates complement the cash-based tax expenditure estimates presented in the other tables. The present-value estimates represent the revenue effects, net of future tax payments, that follow from activities undertaken during calendar year 2004 which cause the deferrals or other long-term revenue effects. For instance, a pension contribution in 2004 would cause a deferral of tax payments on wages in 2004 and on pension earnings on this contribution (e.g., interest) in later years. In some future year, however, the 2004 pension contribution and accrued earnings will be paid out and taxes will be due; these receipts are included in the present-value estimate. In general, this conceptual approach is similar to the one used for reporting the budgetary effects of credit programs, where direct loans and guarantees in a given year affect future cash flows. Outlay Equivalents The concept of ‘‘outlay equivalents’’ is another theoretical measure of the budget effect of tax expenditures. It is the amount of budget outlays that would be required to provide the taxpayer the same after-tax income as would be received through the tax provision. The outlay-equivalent measure allows the cost of a tax expenditure to be compared with a direct Federal outlay on a more even footing. Outlay equivalents are reported in Table 19–5. 317 19. TAX EXPENDITURES Table 19–1. ESTIMATES OF TOTAL INCOME TAX EXPENDITURES (in millions of dollars) Total from corporations and individuals 2004 2005 2006 2007 2008 2009 2010 2006–10 National Defense 1 Exclusion of benefits and allowances to armed forces personnel ........................................................... 2,460 2,490 2,520 2,540 2,560 2,590 2,620 12,830 International affairs: 2 Exclusion of income earned abroad by U.S. citizens ............................................................................... 2,680 2,750 2,810 2,940 3,100 3,270 3,450 15,570 3 Exclusion of certain allowances for Federal employees abroad .............................................................. 850 900 950 1,000 1,050 1,100 1,160 5,260 4 Extraterritorial income exclusion ................................................................................................................ 5,500 5,170 4,270 1,820 220 40 20 6,370 5 Inventory property sales source rules exception ....................................................................................... 1,500 1,620 1,770 1,950 2,200 2,430 2,630 10,980 6 Deferral of income from controlled foreign corporations (normal tax method) ........................................ 7,240 7,000 7,440 7,960 8,510 9,100 9,730 42,740 7 Deferred taxes for financial firms on certain income earned overseas ................................................... 2,130 2,190 2,260 960 .............. .............. .............. 3,220 General science, space, and technology 8 Expensing of research and experimentation expenditures (normal tax method) ..................................... –2,330 4,110 7,920 6,990 6,260 5,360 4,800 31,330 9 Credit for increasing research activities ..................................................................................................... 4,680 5,130 2,140 910 390 180 50 3,670 Energy 10 Expensing of exploration and development costs, fuels ........................................................................... 260 400 370 280 240 190 140 1,220 11 Excess of percentage over cost depletion, fuels ...................................................................................... 1,320 1,280 1,350 1,420 1,470 1,510 1,550 7,300 12 Alternative fuel production credit ................................................................................................................ 1,040 1,040 1,040 1,040 420 .............. .............. 2,500 13 Exception from passive loss limitation for working interests in oil and gas properties ........................... 20 20 20 20 20 20 20 100 14 Capital gains treatment of royalties on coal .............................................................................................. 70 70 80 80 100 70 60 390 15 Exclusion of interest on energy facility bonds ........................................................................................... 100 100 110 110 120 120 130 590 16 Enhanced oil recovery credit ...................................................................................................................... 330 340 340 350 360 370 390 1,810 17 New technology credit ............................................................................................................................... 330 470 620 700 800 820 690 3,630 18 Alcohol fuel credits 1 .................................................................................................................................. 30 30 30 30 40 40 40 180 19 Tax credit and deduction for clean-fuel burning vehicles ......................................................................... 70 70 50 –20 –70 –80 –60 –180 20 Exclusion of conservation subsidies provided by public utilities .............................................................. 100 100 100 100 90 90 90 470 Natural resources and environment 21 Expensing of exploration and development costs, nonfuel minerals ....................................................... 230 230 250 250 250 270 270 1,290 22 Excess of percentage over cost depletion, nonfuel minerals ................................................................... .............. .............. .............. .............. .............. .............. 10 10 23 Exclusion of interest on bonds for water, sewage, and hazardous waste facilities ................................ 500 530 570 600 630 650 680 3,130 24 Capital gains treatment of certain timber income ..................................................................................... 70 70 80 80 100 70 60 390 25 Expensing of multiperiod timber growing costs ......................................................................................... 340 350 370 380 400 410 430 1,990 26 Tax incentives for preservation of historic structures ............................................................................... 300 320 330 340 360 380 400 1,810 27 Expensing of capital costs with respect to complying with EPA sulfur regulations ................................ .............. 10 .............. 10 20 40 10 90 28 Exclusion of gain or loss on sale or exchange of certain brownfield sites ............................................. .............. .............. .............. –10 –30 –40 –40 –120 Agriculture 29 Expensing of certain capital outlays .......................................................................................................... 100 110 130 130 130 140 140 670 30 Expensing of certain multiperiod production costs .................................................................................... 50 60 70 70 80 80 80 380 31 Treatment of loans forgiven for solvent farmers ....................................................................................... 10 10 10 10 10 10 10 50 32 Capital gains treatment of certain income ................................................................................................. 670 730 760 820 990 720 580 3,870 33 Income averaging for farmers .................................................................................................................... 40 40 40 40 40 40 40 200 34 Deferral of gain on sale of farm refiners ................................................................................................... 10 10 10 20 20 20 20 90 35 Bio-Diesel tax credit .................................................................................................................................. .............. 30 30 10 .............. .............. .............. 40 Commerce and housing Financial institutions and insurance: 36 Exemption of credit union income ......................................................................................................... 1,270 1,330 1,390 1,440 1,510 1,570 1,640 7,550 37 Excess bad debt reserves of financial institutions ................................................................................ –20 –20 –10 –10 –10 .............. .............. –30 38 Exclusion of interest on life insurance savings ..................................................................................... 20,830 22,750 24,070 26,180 28,770 30,980 33,610 143,610 39 Special alternative tax on small property and casualty insurance companies .................................... 10 10 10 10 10 10 10 50 40 Tax exemption of certain insurance companies owned by tax-exempt organizations ........................ 180 190 210 220 230 250 260 1,170 41 Small life insurance company deduction ............................................................................................... 80 80 80 80 80 80 80 400 Housing: 42 Exclusion of interest on owner-occupied mortgage subsidy bonds ..................................................... 1,020 1,110 1,180 1,230 1,320 1,350 1,390 6,470 43 Exclusion of interest on rental housing bonds ...................................................................................... 360 390 410 420 460 470 480 2,240 44 Deductibility of mortgage interest on owner-occupied homes .............................................................. 61,450 68,870 76,030 81,990 88,990 95,770 102,760 445,540 45 Deductibility of State and local property tax on owner-occupied homes ............................................ 19,930 16,590 14,830 14,110 13,400 13,000 12,800 68,140 46 Deferral of income from post 1987 installment sales ........................................................................... 1,100 1,120 1,140 1,160 1,190 1,200 1,320 6,010 47 Capital gains exclusion on home sales ................................................................................................. 29,730 32,840 36,270 40,050 44,240 54,660 71,960 247,180 48 Exclusion of net imputed rental income on owner-occupied homes ................................................... 24,590 28,600 29,720 33,210 36,860 40,630 44,786 185,206 49 Exception from passive loss rules for $25,000 of rental loss .............................................................. 5,030 4,900 4,750 4,580 4,410 4,240 4,080 22,060 50 Credit for low-income housing investments .......................................................................................... 3,660 3,850 4,010 4,190 4,390 4,610 4,850 22,050 51 Accelerated depreciation on rental housing (normal tax method) ....................................................... 750 –156 –993 –1,846 –2,697 –3,961 –5,901 –15,398 Commerce: 52 Cancellation of indebtedness ................................................................................................................. 30 30 30 40 40 40 40 190 53 Exceptions from imputed interest rules ................................................................................................. 50 50 50 50 50 50 50 250 54 Capital gains (except agriculture, timber, iron ore, and coal) .............................................................. 25,150 27,200 28,370 30,450 36,840 26,900 21,630 144,190 55 Capital gains exclusion of small corporation stock ............................................................................... 160 210 250 300 350 390 430 1,720 318 ANALYTICAL PERSPECTIVES Table 19–1. ESTIMATES OF TOTAL INCOME TAX EXPENDITURES—Continued (in millions of dollars) Total from corporations and individuals 2004 2005 2006 2007 2008 2009 2010 2006–10 56 Step-up basis of capital gains at death ................................................................................................ 24,200 26,140 28,760 31,630 34,790 35,560 33,680 164,420 57 Carryover basis of capital gains on gifts .............................................................................................. 210 240 290 290 310 430 850 2,170 58 Ordinary income treatment of loss from small business corporation stock sale ................................. 50 50 50 50 50 50 50 250 59 Accelerated depreciation of buildings other than rental housing (normal tax method) ....................... –3,250 –4,180 –4,790 –6,940 –10,360 –14,740 –21,240 –58,060 60 Accelerated depreciation of machinery and equipment (normal tax method) ..................................... 44,690 –11,000 –37,830 –30,920 –27,950 –26,190 –25,760 –148,650 61 Expensing of certain small investments (normal tax method) ............................................................. 1,520 4,820 1,650 –490 –30 140 230 1,500 62 Amortization of start-up costs (normal tax method) ............................................................................. 80 50 .............. –40 –90 –140 –170 –440 63 Graduated corporation income tax rate (normal tax method) .............................................................. 2,450 3,190 3,730 3,820 3,920 4,020 4,140 19,630 64 Exclusion of interest on small issue bonds .......................................................................................... 450 490 510 540 580 590 610 2,830 65 Deduction for U.S. production activities ................................................................................................ .............. 3,270 5,420 8,750 11,230 11,670 15,860 52,930 66 Special rules for certain film and TV production .................................................................................. .............. 90 110 90 70 –40 –90 140 Transportation 67 Deferral of tax on shipping companies ...................................................................................................... 20 20 20 20 20 20 20 100 68 Exclusion of reimbursed employee parking expenses .............................................................................. 2,470 2,590 2,730 2,880 3,030 3,180 3,330 15,150 69 Exclusion for employer-provided transit passes ........................................................................................ 410 480 550 630 710 790 880 3,560 70 Tax credit for certain expenditures for maintaining railroad tracks .......................................................... .............. 70 140 150 110 50 30 480 Community and regional development 71 Investment credit for rehabilitation of structures (other than historic) ...................................................... 40 40 40 40 40 40 40 200 72 Exclusion of interest for airport, dock, and similar bonds ........................................................................ 850 930 980 1,030 1,100 1,130 1,170 5,410 73 Exemption of certain mutuals’ and cooperatives’ income ......................................................................... 60 60 60 70 70 70 70 340 74 Empowerment zones, Enterprise communities, and Renewal communities ............................................ 1,080 1,120 1,210 1,340 1,480 1,740 1,130 6,900 75 New markets tax credit .............................................................................................................................. 290 430 610 830 870 790 670 3,770 76 Expensing of environmental remediation costs ......................................................................................... 80 70 20 –10 –10 –20 –10 –30 77 Deferral of capital gains with respect of dispositions of transmission property ....................................... .............. –490 –620 –530 –230 100 360 –920 Education, training, employment, and social services Education: 78 Exclusion of scholarship and fellowship income (normal tax method) ................................................ 1,320 1,400 1,460 1,530 1,600 1,680 1,750 8,020 79 HOPE tax credit .................................................................................................................................... 3,320 3,410 3,220 3,320 3,350 3,420 3,580 16,890 80 Lifetime Learning tax credit ................................................................................................................... 2,190 2,130 2,080 2,310 2,340 2,380 2,450 11,560 81 Education Individual Retirement Accounts ............................................................................................ 110 140 190 240 300 370 440 1,540 82 Deductibility of student-loan interest ...................................................................................................... 760 780 800 810 820 830 840 4,100 83 Deduction for higher education expenses ............................................................................................. 1,280 1,830 1,840 .............. .............. .............. .............. 1,840 84 State prepaid tuition plans ..................................................................................................................... 210 490 650 740 830 920 1,010 4,150 85 Exclusion of interest on student-loan bonds ......................................................................................... 290 310 340 350 370 380 390 1,830 86 Exclusion of interest on bonds for private nonprofit educational facilities ........................................... 970 1,050 1,120 1,180 1,250 1,290 1,330 6,170 87 Credit for holders of zone academy bonds .......................................................................................... 90 110 130 130 140 140 140 680 88 Exclusion of interest on savings bonds redeemed to finance educational expenses ......................... 10 10 20 20 20 20 20 100 89 Parental personal exemption for students age 19 or over ................................................................... 3,200 2,670 2,110 1,840 1,630 1,450 1,340 8,370 90 Deductibility of charitable contributions (education) .............................................................................. 3,690 3,420 3,680 4,030 4,260 4,550 4,870 21,390 91 Exclusion of employer-provided educational assistance ....................................................................... 530 560 590 620 650 690 720 3,270 92 Special deduction for teacher expenses ............................................................................................... 150 160 150 .............. .............. .............. .............. 150 93 Discharge of student loan indebtedness ............................................................................................... .............. 20 20 20 20 20 20 100 Training, employment, and social services: 94 Work opportunity tax credit .................................................................................................................... 280 250 280 190 60 30 10 570 95 Welfare-to-work tax credit ...................................................................................................................... 60 60 80 60 20 10 .............. 170 96 Employer provided child care exclusion ................................................................................................ 600 620 810 930 970 1,010 1,060 4,780 97 Employer-provided child care credit ...................................................................................................... .............. 8 10 10 10 10 10 50 98 Assistance for adopted foster children .................................................................................................. 290 310 350 380 420 460 500 2,110 99 Adoption credit and exclusion ................................................................................................................ 450 500 540 560 570 580 600 2,850 100 Exclusion of employee meals and lodging (other than military) .......................................................... 810 850 890 930 970 1,010 1,060 4,860 101 Child credit 2 .......................................................................................................................................... 22,400 32,710 32,810 32,900 32,860 32,790 32,670 164,030 102 Credit for child and dependent care expenses ..................................................................................... 2,990 3,140 2,810 1,900 1,800 1,710 1,630 9,850 103 Credit for disabled access expenditures ............................................................................................... 30 40 40 40 40 50 50 220 104 Deductibility of charitable contributions, other than education and health .......................................... 27,370 29,670 32,550 34,500 36,790 39,410 42,210 185,460 105 Exclusion of certain foster care payments ............................................................................................ 440 440 440 450 450 460 470 2,270 106 Exclusion of parsonage allowances ...................................................................................................... 430 460 480 510 540 580 610 2,720 Health 107 Exclusion of employer contributions for medical insurance premiums and medical care ....................... 102,250 112,160 125,690 139,060 152,560 166,190 176,740 760,240 108 Self-employed medical insurance premiums ............................................................................................. 3,330 3,780 4,330 4,800 5,260 5,760 6,250 26,400 109 Medical Savings Accounts/Health Savings Accounts ................................................................................ 620 1,050 1,830 2,650 3,510 3,960 3,910 15,860 110 Deductibility of medical expenses .............................................................................................................. 7,380 8,590 9,140 9,970 11,100 11,890 12,670 54,770 111 Exclusion of interest on hospital construction bonds ................................................................................ 1,870 2,020 2,160 2,260 2,400 2,470 2,550 11,840 112 Deductibility of charitable contributions (health) ........................................................................................ 3,090 3,350 3,670 3,890 4,150 4,450 4,770 20,930 113 Tax credit for orphan drug research .......................................................................................................... 180 210 230 260 290 330 360 1,470 114 Special Blue Cross/Blue Shield deduction ................................................................................................ 400 390 360 390 340 370 430 1,890 115 Tax credit for health insurance purchased by certain displaced and retired individuals 3 ...................... 50 60 40 40 40 50 50 220 319 19. TAX EXPENDITURES Table 19–1. ESTIMATES OF TOTAL INCOME TAX EXPENDITURES—Continued (in millions of dollars) Total from corporations and individuals 2004 2005 2006 2007 2008 2009 2010 2006–10 Income security 116 Exclusion of railroad retirement system benefits ....................................................................................... 400 400 400 400 400 400 400 2,000 117 Exclusion of workers’ compensation benefits ............................................................................................ 5,490 5,730 5,940 6,100 6,300 6,520 6,730 31,590 118 Exclusion of public assistance benefits (normal tax method) ................................................................... 410 430 450 470 490 510 480 2,400 119 Exclusion of special benefits for disabled coal miners ............................................................................. 60 50 50 50 40 40 40 220 120 Exclusion of military disability pensions ..................................................................................................... 100 100 110 110 110 120 120 570 Net exclusion of pension contributions and earnings: 121 Employer plans ...................................................................................................................................... 46,970 50,330 51,050 52,570 47,530 45,310 44,570 241,030 122 401(k) plans ........................................................................................................................................... 47,730 45,870 48,140 51,800 56,140 60,930 66,400 283,410 123 Individual Retirement Accounts ............................................................................................................. 7,450 7,340 7,310 6,990 6,680 6,220 5,650 32,850 124 Low and moderate income savers credit .............................................................................................. 970 1,100 1,170 700 .............. .............. .............. 1,870 125 Keogh plans ........................................................................................................................................... 8,830 9,380 9,980 10,650 11,610 12,650 13,780 58,670 Exclusion of other employee benefits: 126 Premiums on group term life insurance ................................................................................................ 2,070 2,090 2,110 2,110 2,150 2,180 2,200 10,750 127 Premiums on accident and disability insurance .................................................................................... 260 280 290 300 310 320 330 1,550 128 Small business retirement plan credit ........................................................................................................ 80 100 120 140 150 150 140 700 129 Income of trusts to finance supplementary unemployment benefits ........................................................ 20 20 20 20 20 20 20 100 130 Special ESOP rules ................................................................................................................................... 1,920 2,060 2,220 2,400 2,580 2,780 3,000 12,980 131 Additional deduction for the blind .............................................................................................................. 30 40 40 40 40 40 40 200 132 Additional deduction for the elderly ........................................................................................................... 1,700 1,810 1,960 1,940 1,900 1,930 1,950 9,680 133 Tax credit for the elderly and disabled ...................................................................................................... 20 20 20 20 10 10 10 70 134 Deductibility of casualty losses .................................................................................................................. 550 250 270 280 290 300 320 1,460 135 Earned income tax credit 4 ......................................................................................................................... 4,890 4,980 5,420 5,170 5,290 5,480 5,600 26,960 Social Security Exclusion of social security benefits 136 Social Security benefits for retired workers .......................................................................................... 19,200 19,480 19,770 20,470 20,900 21,260 23,720 106,120 137 Social Security benefits for disabled ..................................................................................................... 3,580 3,740 3,870 4,110 4,290 4,500 4,910 21,680 138 Social Security benefits for dependents and survivors ........................................................................ 4,140 4,120 3,990 4,030 3,880 3,920 4,060 19,880 Veterans benefits and services 139 Exclusion of veterans death benefits and disability compensation .......................................................... 3,300 3,560 3,750 4,030 4,190 4,360 4,520 20,850 140 Exclusion of veterans pensions ................................................................................................................. 110 120 120 120 120 130 140 630 141 Exclusion of GI bill benefits ....................................................................................................................... 130 150 160 170 180 190 200 900 142 Exclusion of interest on veterans housing bonds ..................................................................................... 50 50 50 60 60 60 60 290 General purpose fiscal assistance 143 Exclusion of interest on public purpose State and local bonds ............................................................... 26,150 26,530 26,610 26,350 27,140 27,950 28,790 136,840 144 Deductibility of nonbusiness state and local taxes other than on owner-occupied homes ..................... 45,290 39,090 34,620 32,890 31,850 31,760 32,120 163,240 145 Tax credit for corporations receiving income from doing business in U.S. possessions ........................ 1,000 900 500 50 .............. .............. .............. 550 Interest 146 Deferral of interest on U.S. savings bonds ............................................................................................... 50 50 50 50 60 70 70 300 Addendum: Aid to State and local governments Deductibility of: Property taxes on owner-occupied homes ............................................................................................ 19,930 16,590 14,830 14,110 13,400 13,000 12,800 68,140 Nonbusiness State and local taxes other than on owner-occupied homes ........................................ 45,290 39,090 34,620 32,890 31,850 31,760 32,120 163,240 Exclusion of interest on State and local bonds for: Public purposes ..................................................................................................................................... 26,150 26,530 26,610 26,350 27,140 27,950 28,790 136,840 Energy facilities ..................................................................................................................................... 100 100 110 110 120 120 130 590 Water, sewage, and hazardous waste disposal facilities ..................................................................... 500 530 570 600 630 650 680 3,130 Small-issues ........................................................................................................................................... 450 490 510 540 580 590 610 2,830 Owner-occupied mortgage subsidies ..................................................................................................... 1,020 1,110 1,180 1,230 1,320 1,350 1,390 6,470 Rental housing ....................................................................................................................................... 360 390 410 420 460 470 480 2,240 Airports, docks, and similar facilities ..................................................................................................... 850 930 980 1,030 1,100 1,130 1,170 5,410 Student loans ......................................................................................................................................... 290 310 340 350 370 380 390 1,830 Private nonprofit educational facilities ................................................................................................... 970 1,050 1,120 1,180 1,250 1,290 1,330 6,170 Hospital construction .............................................................................................................................. 1,870 2,020 2,160 2,260 2,400 2,470 2,550 11,840 Veterans’ housing .................................................................................................................................. 50 50 50 60 60 60 60 290 Credit for holders of zone academy bonds ............................................................................................... 90 110 130 130 140 140 140 680 1 In addition, the partial exemption from the excise tax and excise credits for alcohol fuels result in a reduction in excise tax receipts (in millions of dollars) as follows: 2004 $1,450; 2005 $1,490; 2006 $1,550; 2007 $1,590; 2008 $1,620; 2009 $1,650; and 2010 $1,680. 2 The figures in the table indicate the effect of the child tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2004 $8,857; 2005 $13,516; 2006 $13,180; 2007 $12,549; 2008 $12,040; 2009 $11,693 and 2010 $11,364 3 In addition to the receipts shown, there are outlays of $70 million in 2004, $90 million in 2005, $100 million in 2006, $120 million in 2007, $130 million in 2008, and $140 million in 2009 and $150 million in 2010 projected. 4 The figures in the table indicate the effect of the earned income tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2004 $33,134;2005 $33,790; 2006 $34,132; 2007 $34,481; 2008 $34,723; 2009 $35,517; and 2010 $36,099. Note: Provisions with estimates denoted normal tax method have no revenue loss under the reference tax law method. All estimates have been rounded to the nearest $10 million. Provisions with estimates that rounded to zero in each year are not included in the table. 320 ANALYTICAL PERSPECTIVES Table 19–2. ESTIMATES OF TAX EXPENDITURES FOR THE CORPORATE AND INDIVIDUAL INCOME TAXES (in millions of dollars) Corporations Individuals 2004 2005 2006 2007 2008 2009 2010 2006–10 2004 2005 2006 2007 2008 2009 2010 2006–10 National Defense 1 Exclusion of benefits and allowances to armed forces personnel ........................ ............ ............ ................ ................ ................ ................ ................ ................ 2,460 2,490 2,520 2,540 2,560 2,590 2,620 12,830 International affairs: 2 Exclusion of income earned abroad by U.S. citizens .......................................... ............ ............ ................ ................ ................ ................ ................ ................ 2,680 2,750 2,810 2,940 3,100 3,270 3,450 15,570 3 Exclusion of certain allowances for Federal employees abroad ......................... ............ ............ ................ ................ ................ ................ ................ ................ 850 900 950 1000 1050 1100 1160 5,260 4 Extraterritorial income exclusion ............... 5,500 5,170 4,270 1,820 220 40 20 6,370 ................ ................ ................ ................ ................ ................ ................ ................ 5 Inventory property sales source rules exception ................................................... 1,500 1,620 1,770 1,950 2,200 2,430 2,630 10,980 ................ ................ ................ ................ ................ ................ ................ ................ 6 Deferral of income from controlled foreign corporations (normal tax method) ........ 7,240 7,000 7,440 7,960 8,510 9,100 9,730 42,740 ................ ................ ................ ................ ................ ................ ................ ................ 7 Deferred taxes for financial firms on certain income earned overseas ............... 2,130 2,190 2,260 960 ................ ................ ................ 3,220 ................ ................ ................ ................ ................ ................ ................ ................ General science, space, and technology 8 Expensing of research and experimentation expenditures (normal tax method) .......................................................... –2,280 4,010 7,770 6,850 6,140 5,250 4,700 30,710 –50 100 150 140 120 110 100 620 9 Credit for increasing research activities ... 4,630 5,080 2,100 910 390 180 50 3,630 50 50 40 ................ ................ ................ ................ 40 Energy 10 Expensing of exploration and development costs, fuels ................................... 230 350 320 240 210 160 120 1,050 30 50 50 40 30 30 20 170 11 Excess of percentage over cost depletion, fuels ....................................................... 1,210 1,180 1,240 1,310 1,350 1,390 1,430 6,720 110 100 110 110 120 120 120 580 12 Alternative fuel production credit .............. 1,000 1,000 1,000 1,000 400 ................ ................ 2,400 40 40 40 40 20 ................ ................ 100 13 Exception from passive loss limitation for working interests in oil and gas properties ...................................................... ............ ............ ................ ................ ................ ................ ................ ................ 20 20 20 20 20 20 20 100 14 Capital gains treatment of royalties on coal ........................................................ ............ ............ ................ ................ ................ ................ ................ ................ 70 70 80 80 100 70 60 390 15 Exclusion of interest on energy facility bonds ..................................................... 20 20 20 20 20 20 20 100 80 80 90 90 100 100 110 490 16 Enhanced oil recovery credit .................... 300 310 310 320 330 340 350 1,650 30 30 30 30 30 30 40 160 17 New technology credit ............................... 330 470 620 700 800 820 690 3,630 ................ ................ ................ ................ ................ ................ ................ ................ 18 Alcohol fuel credits 1 .................................. 20 20 20 20 30 30 30 130 10 10 10 10 10 10 10 50 19 Tax credit and deduction for clean-fuel burning vehicles .................................... 20 30 40 20 –10 –20 –10 20 50 40 10 –40 –60 –60 –50 –200 20 Exclusion of conservation subsidies provided by public utilities .......................... ............ ............ ................ ................ ................ ................ ................ ................ 100 100 100 100 90 90 90 470 Natural resources and environment 21 Expensing of exploration and development costs, nonfuel minerals ................ 210 210 230 230 230 250 250 1,190 20 20 20 20 20 20 20 100 22 Excess of percentage over cost depletion, nonfuel minerals .................................... ............ ............ ................ ................ ................ ................ 10 10 ................ ................ ................ ................ ................ ................ ................ ................ 23 Exclusion of interest on bonds for water, sewage, and hazardous waste facilities 110 110 110 120 120 120 130 600 390 420 460 480 510 530 550 2,530 24 Capital gains treatment of certain timber income ................................................... ............ ............ ................ ................ ................ ................ ................ ................ 70 70 80 80 100 70 60 390 25 Expensing of multiperiod timber growing costs ...................................................... 230 240 250 260 280 290 300 1,380 110 110 120 120 120 120 130 610 26 Tax incentives for preservation of historic structures ............................................... 230 240 250 260 270 290 300 1,370 70 80 80 80 90 90 100 440 27 Expensing of capital costs with respect to complying with EPA sulfur regulations ............ 10 ................ 10 20 40 10 90 ................ ................ ................ ................ ................ ................ ................ ................ 28 Exclusion of gain or loss on sale or exchange of certain brownfield sites ....... ............ ............ ................ –10 –20 –30 –30 –90 ................ ................ ................ ................ –10 –10 –10 –30 Agriculture 29 Expensing of certain capital outlays ......... 20 20 20 20 20 20 20 100 80 90 110 110 110 120 120 570 30 Expensing of certain multiperiod production costs ............................................... 10 10 10 10 10 10 10 50 40 50 60 60 70 70 70 330 31 Treatment of loans forgiven for solvent farmers ................................................... ............ ............ ................ ................ ................ ................ ................ ................ 10 10 10 10 10 10 10 50 32 Capital gains treatment of certain income ............ ............ ................ ................ ................ ................ ................ ................ 670 730 760 820 990 720 580 3,870 33 Income averaging for farmers ................... ............ ............ ................ ................ ................ ................ ................ ................ 40 40 40 40 40 40 40 200 34 Deferral of gain on sale of farm refiners 10 10 10 20 20 20 20 90 ................ ................ ................ ................ ................ ................ ................ ................ 35 Bio-Diesel tax credit .................................. ............ ............ ................ ................ ................ ................ ................ ................ ................ 30 30 10 ................ ................ ................ 40 Commerce and housing Financial institutions and insurance: 36 Exemption of credit union income ........ 1,270 1,330 1,390 1,440 1,510 1,570 1,640 7,550 ................ ................ ................ ................ ................ ................ ................ ................ 37 Excess bad debt reserves of financial institutions ......................................... –20 –20 –10 –10 –10 ................ ................ –30 ................ ................ ................ ................ ................ ................ ................ ................ 38 Exclusion of interest on life insurance savings .............................................. 2,010 2,180 2,270 2,570 2,880 3,070 3,330 14,120 18,820 20,570 21,800 23,610 25,890 27,910 30,280 129,490 39 Special alternative tax on small property and casualty insurance companies .................................................... 10 10 10 10 10 10 10 50 ................ ................ ................ ................ ................ ................ ................ ................ 40 Tax exemption of certain insurance companies owned by tax-exempt organizations ........................................ 180 190 210 220 230 250 260 1,170 ................ ................ ................ ................ ................ ................ ................ ................ 41 Small life insurance company deduction ..................................................... 80 80 80 80 80 80 80 400 ................ ................ ................ ................ ................ ................ ................ ................ Housing: 321 19. TAX EXPENDITURES Table 19–2. ESTIMATES OF TAX EXPENDITURES FOR THE CORPORATE AND INDIVIDUAL INCOME TAXES—Continued (in millions of dollars) Corporations Individuals 2004 2005 2006 2007 2008 2009 2010 2006–10 2004 2005 2006 2007 2008 2009 2010 2006–10 42 Exclusion of interest on owner-occupied mortgage subsidy bonds .......... 220 230 230 240 250 250 260 1,230 800 880 950 990 1,070 1,100 1,130 5,240 43 Exclusion of interest on rental housing bonds ................................................. 80 80 80 80 90 90 90 430 280 310 330 340 370 380 390 1,810 44 Deductibility of mortgage interest on owner-occupied homes ..................... ............ ............ ................ ................ ................ ................ ................ ................ 61,450 68,870 76,030 81,990 88,990 95,770 102,760 445,540 45 Deductibility of State and local property tax on owner-occupied homes ......... ............ ............ ................ ................ ................ ................ ................ ................ 19,930 16,590 14,830 14,110 13,400 13,000 12,800 68,140 46 Deferral of income from post 1987 installment sales .................................. 290 290 300 300 310 310 320 1,540 810 830 840 860 880 890 1,000 4,470 47 Capital gains exclusion on home sales ............ ............ ................ ................ ................ ................ ................ ................ 29,730 32,840 36,270 40,050 44,240 54,660 71,960 247,180 48 Exclusion of net imputed rental income on owner-occupied homes ............... ............ ............ ................ ................ ................ ................ ................ ................ 24,590 28,600 29,720 33,210 36,860 40,630 44,786 185,206 49 Exception from passive loss rules for $25,000 of rental loss ....................... ............ ............ ................ ................ ................ ................ ................ ................ 5,030 4,900 4,750 4,580 4,410 4,240 4,080 22,060 50 Credit for low-income housing investments ................................................. 2,930 3,080 3,210 3,350 3,510 3,690 3,880 17,640 730 770 800 840 880 920 970 4,410 51 Accelerated depreciation on rental housing (normal tax method) ........... –10 –50 –100 –140 –200 –280 –390 –1,100 760 –110 –900 –1,700 –2,500 –3,690 –5,510 –14,300 Commerce: 52 Cancellation of indebtedness ................ ............ ............ ................ ................ ................ ................ ................ ................ 30 30 30 40 40 40 40 190 53 Exceptions from imputed interest rules ............ ............ ................ ................ ................ ................ ................ ................ 50 50 50 50 50 50 50 250 54 Capital gains (except agriculture, timber, iron ore, and coal) .................... ............ ............ ................ ................ ................ ................ ................ ................ 25,150 27,200 28,370 30,450 36,840 26,900 21,630 144,190 55 Capital gains exclusion of small corporation stock ................................... ............ ............ ................ ................ ................ ................ ................ ................ 160 210 250 300 350 390 430 1,720 56 Step-up basis of capital gains at death ............ ............ ................ ................ ................ ................ ................ ................ 24,200 26,140 28,760 31,630 34,790 35,560 33,680 164,420 57 Carryover basis of capital gains on gifts .................................................... ............ ............ ................ ................ ................ ................ ................ ................ 210 240 290 290 310 430 850 2,170 58 Ordinary income treatment of loss from small business corporation stock sale .................................................... ............ ............ ................ ................ ................ ................ ................ ................ 50 50 50 50 50 50 50 250 59 Accelerated depreciation of buildings other than rental housing (normal tax method) ....................................... –2,980 –3,850 –4,340 –6,170 –9,220 –12,620 –17,320 –49,670 –280 –330 –450 –760 –1,140 –2,110 –3,930 –8,390 60 Accelerated depreciation of machinery and equipment (normal tax method) 37,080 –8,780 –32,880 –26,480 –23,310 –21,260 –20,290 –124,220 7,610 –2,220 –4,950 –4,440 –4,640 –4,930 –5,470 –24,430 61 Expensing of certain small investments (normal tax method) ......................... 680 1,780 680 –390 –140 –30 –10 110 840 3,040 970 –100 110 170 240 1,390 62 Amortization of start-up costs (normal tax method) ....................................... 70 40 ................ –40 –80 –120 –150 –390 10 10 ................ ................ –10 –20 –20 –50 63 Graduated corporation income tax rate (normal tax method) ......................... 2,450 3,190 3,730 3,820 3,920 4,020 4,140 19,630 ................ ................ ................ ................ ................ ................ ................ ................ 64 Exclusion of interest on small issue bonds ................................................. 100 100 100 100 110 110 110 530 350 390 410 440 470 480 500 2,300 65 Deduction for U.S. production activities ............ 2,560 4,330 7,110 9,130 9,470 12,860 42,900 ................ 710 1,090 1,640 2,100 2,200 3,000 10,030 66 Special rules for certain film and TV production .......................................... ............ 70 90 70 60 –30 –70 120 ................ 20 20 20 10 –10 –20 20 Transportation 67 Deferral of tax on shipping companies .... 20 20 20 20 20 20 20 100 ................ ................ ................ ................ ................ ................ ................ ................ 68 Exclusion of reimbursed employee parking expenses ......................................... ............ ............ ................ ................ ................ ................ ................ ................ 2,470 2,590 2,730 2,880 3,030 3,180 3,330 15,150 69 Exclusion for employer-provided transit passes ................................................... ............ ............ ................ ................ ................ ................ ................ ................ 410 480 550 630 710 790 880 3,560 70 Tax credit for certain expenditures for maintaining railroad tracks .................... ............ 70 140 150 110 50 30 480 ................ ................ ................ ................ ................ ................ ................ ................ Community and regional development 71 Investment credit for rehabilitation of structures (other than historic) .............. 20 20 20 20 20 20 20 100 20 20 20 20 20 20 20 100 72 Exclusion of interest for airport, dock, and similar bonds ......................................... 180 190 190 200 210 210 220 1,030 670 740 790 830 890 920 950 4,380 73 Exemption of certain mutuals’ and cooperatives’ income ................................ 60 60 60 70 70 70 70 340 ................ ................ ................ ................ ................ ................ ................ ................ 74 Empowerment zones, Enterprise communities, and Renewal communities ......... 280 290 310 340 370 420 190 1,630 800 830 900 1,000 1,110 1,320 940 5,270 75 New markets tax credit ............................. 70 110 150 210 220 200 170 950 220 320 460 620 650 590 500 2,820 76 Expensing of environmental remediation costs ...................................................... 70 60 20 –10 –10 –20 –10 –30 10 10 ................ ................ ................ ................ ................ ................ 77 Deferral of capital gains with respect of dispositions of transmission property ... ............ –490 –620 –530 –230 100 360 –920 ................ ................ ................ ................ ................ ................ ................ ................ Education, training, employment, and social services Education: 78 Exclusion of scholarship and fellowship income (normal tax method) ............ ............ ............ ................ ................ ................ ................ ................ ................ 1,320 1,400 1,460 1,530 1,600 1,680 1,750 8,020 79 HOPE tax credit .................................... ............ ............ ................ ................ ................ ................ ................ ................ 3,320 3,410 3,220 3,320 3,350 3,420 3,580 16,890 80 Lifetime Learning tax credit .................. ............ ............ ................ ................ ................ ................ ................ ................ 2,190 2,130 2,080 2,310 2,340 2,380 2,450 11,560 81 Education Individual Retirement Accounts ................................................ ............ ............ ................ ................ ................ ................ ................ ................ 110 140 190 240 300 370 440 1,540 82 Deductibility of student-loan interest .... ............ ............ ................ ................ ................ ................ ................ ................ 760 780 800 810 820 830 840 4,100 83 Deduction for higher education expenses ............................................... ............ ............ ................ ................ ................ ................ ................ ................ 1,280 1,830 1,840 ................ ................ ................ ................ 1,840 84 State prepaid tuition plans .................... ............ ............ ................ ................ ................ ................ ................ ................ 210 490 650 740 830 920 1,010 4,150 85 Exclusion of interest on student-loan bonds ................................................. 60 60 70 70 70 70 70 350 230 250 270 280 300 310 320 1,480 322 ANALYTICAL PERSPECTIVES Table 19–2. ESTIMATES OF TAX EXPENDITURES FOR THE CORPORATE AND INDIVIDUAL INCOME TAXES—Continued (in millions of dollars) Corporations Individuals 2004 2005 2006 2007 2008 2009 2010 2006–10 2004 2005 2006 2007 2008 2009 2010 2006–10 86 Exclusion of interest on bonds for private nonprofit educational facilities .. 210 210 220 230 230 240 250 1,170 760 840 900 950 1020 1050 1080 5,000 87 Credit for holders of zone academy bonds ................................................. 90 110 130 130 140 140 140 680 ................ ................ ................ ................ ................ ................ ................ ................ 88 Exclusion of interest on savings bonds redeemed to finance educational expenses ............................................... ............ ............ ................ ................ ................ ................ ................ ................ 10 10 20 20 20 20 20 100 89 Parental personal exemption for students age 19 or over ....................... ............ ............ ................ ................ ................ ................ ................ ................ 3,200 2,670 2,110 1,840 1,630 1,450 1,340 8,370 90 Deductibility of charitable contributions (education) ........................................ 510 540 560 590 620 660 700 3,130 3,180 2,880 3,120 3,440 3,640 3,890 4,170 18,260 91 Exclusion of employer-provided educational assistance ........................... ............ ............ ................ ................ ................ ................ ................ ................ 530 560 590 620 650 690 720 3,270 92 Special deduction for teacher expenses ............................................... ............ ............ ................ ................ ................ ................ ................ ................ 150 160 150 ................ ................ ................ ................ 150 93 Discharge of student loan indebtedness ................................................... ............ ............ ................ ................ ................ ................ ................ ................ ................ 20 20 20 20 20 20 100 Training, employment, and social services: 94 Work opportunity tax credit ................... 240 210 240 160 50 30 10 490 40 40 40 30 10 ................ ................ 80 95 Welfare-to-work tax credit ..................... 50 50 70 50 20 10 ................ 150 10 10 10 10 ................ ................ ................ 20 96 Employer provided child care exclusion ............ ............ ................ ................ ................ ................ ................ ................ 600 620 810 930 970 1010 1060 4,780 97 Employer-provided child care credit ..... ............ 8 10 10 10 10 10 50 ................ ................ ................ ................ ................ ................ ................ ................ 98 Assistance for adopted foster children ............ ............ ................ ................ ................ ................ ................ ................ 290 310 350 380 420 460 500 2,110 99 Adoption credit and exclusion .............. ............ ............ ................ ................ ................ ................ ................ ................ 450 500 540 560 570 580 600 2,850 100 Exclusion of employee meals and lodging (other than military) ............. ............ ............ ................ ................ ................ ................ ................ ................ 810 850 890 930 970 1,010 1,060 4,860 101 Child credit 2 .......................................... ............ ............ ................ ................ ................ ................ ................ ................ 22,400 32,710 32,810 32,900 32,860 32,790 32,670 164,030 102 Credit for child and dependent care expenses ........................................... ............ ............ ................ ................ ................ ................ ................ ................ 2,990 3,140 2,810 1,900 1,800 1,710 1,630 9,850 103 Credit for disabled access expenditures .................................................. 10 10 10 10 10 20 20 70 20 30 30 30 30 30 30 150 104 Deductibility of charitable contributions, other than education and health ...... 1,170 1,230 1,290 1,360 1,430 1,500 1,570 7,150 26,200 28,440 31,260 33,140 35,360 37,910 40,640 178,310 105 Exclusion of certain foster care payments ................................................. ............ ............ ................ ................ ................ ................ ................ ................ 440 440 440 450 450 460 470 2,270 106 Exclusion of parsonage allowances ..... ............ ............ ................ ................ ................ ................ ................ ................ 430 460 480 510 540 580 610 2,720 Health 107 Exclusion of employer contributions for medical insurance premiums and medical care ................................................. ............ ............ ................ ................ ................ ................ ................ ................ 102,250 112,160 125,690 139,060 152,560 166,190 176,740 760,240 108 Self-employed medical insurance premiums .................................................... ............ ............ ................ ................ ................ ................ ................ ................ 3,330 3,780 4,330 4,800 5,260 5,760 6,250 26,400 109 Medical Savings Accounts/Health Savings Accounts ................................................ ............ ............ ................ ................ ................ ................ ................ ................ 620 1,050 1,830 2,650 3,510 3,960 3,910 15,860 110 Deductibility of medical expenses ............. ............ ............ ................ ................ ................ ................ ................ ................ 7,380 8,590 9,140 9,970 11,100 11,890 12,670 54,770 111 Exclusion of interest on hospital construction bonds .............................................. 400 410 430 440 450 460 480 2,260 1,470 1,610 1,730 1,820 1,950 2,010 2,070 9,580 112 Deductibility of charitable contributions (health) ................................................... 150 160 160 170 180 190 200 900 2,940 3,190 3,510 3,720 3,970 4,260 4,570 20,030 113 Tax credit for orphan drug research ........ 180 210 230 260 290 330 360 1,470 ................ ................ ................ ................ ................ ................ ................ ................ 114 Special Blue Cross/Blue Shield deduction 400 390 360 390 340 370 430 1,890 ................ ................ ................ ................ ................ ................ ................ ................ 115 Tax credit for health insurance purchased by certain displaced and retired individuals 3 ...................................................... ............ ............ ................ ................ ................ ................ ................ ................ 50 60 40 40 40 50 50 220 Income security 116 Exclusion of railroad retirement system benefits .................................................. ............ ............ ................ ................ ................ ................ ................ ................ 400 400 400 400 400 400 400 2,000 117 Exclusion of workers’ compensation benefits ........................................................ ............ ............ ................ ................ ................ ................ ................ ................ 5,490 5,730 5,940 6,100 6,300 6,520 6,730 31,590 118 Exclusion of public assistance benefits (normal tax method) .............................. ............ ............ ................ ................ ................ ................ ................ ................ 410 430 450 470 490 510 480 2,400 119 Exclusion of special benefits for disabled coal miners ............................................ ............ ............ ................ ................ ................ ................ ................ ................ 60 50 50 50 40 40 40 220 120 Exclusion of military disability pensions ... ............ ............ ................ ................ ................ ................ ................ ................ 100 100 110 110 110 120 120 570 Net exclusion of pension contributions and earnings: 121 Employer plans ..................................... ............ ............ ................ ................ ................ ................ ................ ................ 46,970 50,330 51,050 52,570 47,530 45,310 44,570 241,030 122 401(k) plans .......................................... ............ ............ ................ ................ ................ ................ ................ ................ 47,730 45,870 48,140 51,800 56,140 60,930 66,400 283,410 123 Individual Retirement Accounts ............ ............ ............ ................ ................ ................ ................ ................ ................ 7,450 7,340 7,310 6,990 6,680 6,220 5,650 32,850 124 Low and moderate income savers credit .................................................. ............ ............ ................ ................ ................ ................ ................ ................ 970 1,100 1,170 700 ................ ................ ................ 1,870 125 Keogh plans .......................................... ............ ............ ................ ................ ................ ................ ................ ................ 8,830 9,380 9,980 10,650 11,610 12,650 13,780 58,670 Exclusion of other employee benefits: 126 Premiums on group term life insurance ............ ............ ................ ................ ................ ................ ................ ................ 2,070 2,090 2,110 2,110 2,150 2,180 2,200 10,750 127 Premiums on accident and disability insurance .............................................. ............ ............ ................ ................ ................ ................ ................ ................ 260 280 290 300 310 320 330 1,550 128 Small business retirement plan credit ...... 40 50 60 70 80 80 70 360 40 50 60 70 70 70 70 340 129 Income of trusts to finance supplementary unemployment benefits ......................... ............ ............ ................ ................ ................ ................ ................ ................ 20 20 20 20 20 20 20 100 130 Special ESOP rules ................................... 1600 1720 1870 2030 2190 2390 2610 11,090 320 340 350 370 390 390 390 1,890 131 Additional deduction for the blind ............. ............ ............ ................ ................ ................ ................ ................ ................ 30 40 40 40 40 40 40 200 132 Additional deduction for the elderly .......... ............ ............ ................ ................ ................ ................ ................ ................ 1,700 1,810 1,960 1,940 1,900 1,930 1,950 9,680 133 Tax credit for the elderly and disabled .... ............ ............ ................ ................ ................ ................ ................ ................ 20 20 20 20 10 10 10 70 134 Deductibility of casualty losses ................. ............ ............ ................ ................ ................ ................ ................ ................ 550 250 270 280 290 300 320 1,460 135 Earned income tax credit 4 ........................ ............ ............ ................ ................ ................ ................ ................ ................ 4,893 4,983 5,423 5,168 5,287 5,480 5,597 26,955 323 19. TAX EXPENDITURES Table 19–2. ESTIMATES OF TAX EXPENDITURES FOR THE CORPORATE AND INDIVIDUAL INCOME TAXES—Continued (in millions of dollars) Corporations Individuals 2004 2005 2006 2007 2008 2009 2010 2006–10 2004 2005 2006 2007 2008 2009 2010 2006–10 Social Security Exclusion of social security benefits 136 Social Security benefits for retired workers .............................................. ............ ............ ................ ................ ................ ................ ................ ................ 19,200 19,480 19,770 20,470 20,900 21,260 23,720 106,120 137 Social Security benefits for disabled .... ............ ............ ................ ................ ................ ................ ................ ................ 3,580 3,740 3,870 4,110 4,290 4,500 4,910 21,680 138 Social Security benefits for dependents and survivors .................................... ............ ............ ................ ................ ................ ................ ................ ................ 4,140 4,120 3,990 4,030 3,880 3,920 4,060 19,880 Veterans benefits and services 139 Exclusion of veterans death benefits and disability compensation ......................... ............ ............ ................ ................ ................ ................ ................ ................ 3,300 3,560 3,750 4,030 4,190 4,360 4,520 20,850 140 Exclusion of veterans pensions ................ ............ ............ ................ ................ ................ ................ ................ ................ 110 120 120 120 120 130 140 630 141 Exclusion of GI bill benefits ...................... ............ ............ ................ ................ ................ ................ ................ ................ 130 150 160 170 180 190 200 900 142 Exclusion of interest on veterans housing bonds ..................................................... 10 10 10 10 10 10 10 50 40 40 40 50 50 50 50 240 General purpose fiscal assistance 143 Exclusion of interest on public purpose State and local bonds ........................... 6,210 6,390 6,580 6,780 6,990 7,190 7,410 34,950 19,940 20,140 20,030 19,570 20,150 20,760 21,380 101,890 144 Deductibility of nonbusiness state and local taxes other than on owner-occupied homes ............................................ ............ ............ ................ ................ ................ ................ ................ ................ 45,290 39,090 34,620 32,890 31,850 31,760 32,120 163,240 145 Tax credit for corporations receiving income from doing business in U.S. possessions ................................................. 1,000 900 500 50 ................ ................ ................ 550 ................ ................ ................ ................ ................ ................ ................ ................ Interest 146 Deferral of interest on U.S. savings bonds ..................................................... ............ ............ ................ ................ ................ ................ ................ ................ 50 50 50 50 60 70 70 300 Addendum: Aid to State and local governments Deductibility of: Property taxes on owner-occupied homes ................................................ ............ ............ ................ ................ ................ ................ ................ ................ 19,930 16,590 14,830 14,110 13,400 13,000 12,800 68,140 Nonbusiness State and local taxes other than on owner-occupied homes ................................................ ............ ............ ................ ................ ................ ................ ................ ................ 45,290 39,090 34,620 32,890 31,850 31,760 32,120 163,240 Exclusion of interest on State and local bonds for: Public purposes ..................................... 6,210 6,390 6,580 6,780 6,990 7,190 7,410 34,950 19,940 20,140 20,030 19,570 20,150 20,760 21,380 101,890 Energy facilities ..................................... 20 20 20 20 20 20 20 100 80 80 90 90 100 100 110 490 Water, sewage, and hazardous waste disposal facilities ............................... 110 110 110 120 120 120 130 600 390 420 460 480 510 530 550 2,530 Small-issues .......................................... 100 100 100 100 110 110 110 530 350 390 410 440 470 480 500 2,300 Owner-occupied mortgage subsidies ... 220 230 230 240 250 250 260 1,230 800 880 950 990 1,070 1,100 1,130 5,240 Rental housing ...................................... 80 80 80 80 90 90 90 430 280 310 330 340 370 380 390 1,810 Airports, docks, and similar facilities .... 180 190 190 200 210 210 220 1,030 670 740 790 830 890 920 950 4,380 Student loans ........................................ 60 60 70 70 70 70 70 350 230 250 270 280 300 310 320 1,480 Private nonprofit educational facilities .. 210 210 220 230 230 240 250 1,170 760 840 900 950 1,020 1,050 1,080 5,000 Hospital construction ............................. 400 410 430 440 450 460 480 2,260 1,470 1,610 1,730 1,820 1,950 2,010 2,070 9,580 Veterans’ housing ................................. 10 10 10 10 10 10 10 50 40 40 40 50 50 50 50 240 Credit for holders of zone academy bonds ..................................................... 90 110 130 130 140 140 140 680 ................ ................ ................ ................ ................ ................ ................ ................ 1 In addition, the partial exemption from the excise tax and excise credits for alcohol fuels result in a reduction in excise tax receipts (in millions of dollars) as follows: 2004 $1,450; 2005 $1,490; 2006 $1,550; 2007 $1,590; 2008 $1,620; 2009 $1,650; and 2010 $1,680. 2 The figures in the table indicate the effect of the child tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2004 $8,857; 2005 $13,516; 2006 $13,180; 2007 $12,549; 2008 $12,040; 2009 $11,693 and 2010 $11,364 3 In addition to the receipts shown, there are outlays of $70 million in 2004, $90 million in 2005, $100 million in 2006, $120 million in 2007, $130 million in 2008, and $140 million in 2009 and $150 million in 2010 projected. 4 The figures in the table indicate the effect of the earned income tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2004 $33,134;2005 $33,790; 2006 $34,132; 2007 $34,481; 2008 $34,723; 2009 $35,517; and 2010 $36,099. Note: Provisions with estimates denoted normal tax method have no revenue loss under the reference tax law method. All estimates have been rounded to the nearest $10 million. Provisions with estimates that rounded to zero in each year are not included in the table. 324 ANALYTICAL PERSPECTIVES Table 19–3. INCOME TAX EXPENDITURES RANKED BY TOTAL 2006–2010 PROJECTED REVENUE EFFECTS (in millions of dollars) Provision 2006 2006–10 Exclusion of employer contributions for medical insurance premiums and medical care ................................................. 125,690 760,240 Deductibility of mortgage interest on owner-occupied homes ............................................................................................ 76,030 445,540 Net exclusion of pension contributions and earnings: 401(k) plans .................................................................................. 48,140 283,410 Capital gains exclusion on home sales ............................................................................................................................... 36,270 247,180 Net exclusion of pension contributions and earnings: Employer plans ............................................................................. 51,050 241,030 Deductibility of charitable contributions, other than education and health ......................................................................... 32,550 185,460 Exclusion of net imputed rental income on owner-occupied homes .................................................................................. 29,720 185,206 Step-up basis of capital gains at death .............................................................................................................................. 28,760 164,420 Child credit ........................................................................................................................................................................... 32,810 164,030 Deductibility of nonbusiness State and local taxes other than on owner-occupied homes .............................................. 34,620 163,240 Capital gains (except agriculture, timber, iron ore, and coal) ............................................................................................ 28,370 144,190 Exclusion of interest on life insurance savings ................................................................................................................... 24,070 143,610 Exclusion of interest on public purpose State and local bonds ......................................................................................... 26,610 136,840 Social Security benefits for retired workers ......................................................................................................................... 19,770 106,120 Deductibility of State and local property tax on owner-occupied homes ........................................................................... 14,830 68,140 Net exclusion of pension contributions and earnings: Keough plans ................................................................................ 9,980 58,670 Deductibility of medical expenses ....................................................................................................................................... 9,140 54,770 Deduction for U.S. production activities .............................................................................................................................. 5,420 52,930 Deferral of income from controlled foreign corporations (normal tax method) .................................................................. 7,440 42,740 Net exclusion of pension contributions and earnings: Individual Retirement Accounts .................................................... 7,310 32,850 Exclusion of workers’ compensation benefits ...................................................................................................................... 5,940 31,590 Expensing of research and experimentation expenditures (normal tax method) .............................................................. 7,920 31,330 Earned income tax credit .................................................................................................................................................... 5,423 26,955 Self-employed medical insurance premiums ....................................................................................................................... 4,330 26,400 Exception from passive loss rules for $25,000 of rental loss ............................................................................................ 4,750 22,060 Credit for low-income housing investments ......................................................................................................................... 4,010 22,050 Social Security benefits for disabled .................................................................................................................................. 3,870 21,680 Deductibility of charitable contributions (education) ............................................................................................................ 3,680 21,390 Deductibility of charitable contributions (health) .................................................................................................................. 3,670 20,930 Exclusion of veterans death benefits and disability compensation .................................................................................... 3,750 20,850 Social Security benefits for dependents and survivors ....................................................................................................... 3,990 19,880 Graduated corporation income tax rate (normal tax method) ............................................................................................ 3,730 19,630 HOPE tax credit .................................................................................................................................................................. 3,220 16,890 Medical Savings Accounts / Health Savings Accounts ...................................................................................................... 1,830 15,860 Exclusion of income earned abroad by U.S. citizens ......................................................................................................... 2,810 15,570 Exclusion of reimbursed employee parking expenses ........................................................................................................ 2,730 15,150 Special ESOP rules ............................................................................................................................................................. 2,220 12,980 Exclusion of benefits and allowances to armed forces personnel ..................................................................................... 2,520 12,830 Exclusion of interest on hospital construction bonds .......................................................................................................... 2,160 11,840 Lifetime Learning tax credit ................................................................................................................................................. 2,080 11,560 Inventory property sales source rules exception ................................................................................................................. 1,770 10,980 Premiums on group term life insurance .............................................................................................................................. 2,110 10,750 Credit for child and dependent care expenses ................................................................................................................... 2,810 9,850 Additional deduction for the elderly .................................................................................................................................... 1,960 9,680 Parental personal exemption for students age 19 or over ................................................................................................. 2,110 8,370 Exclusion of scholarship and fellowship income (normal tax method) .............................................................................. 1,460 8,020 Exemption of credit union income ...................................................................................................................................... 1,390 7,550 Excess of percentage over cost depletion, fuels ................................................................................................................ 1,350 7,300 Empowerment zones, Enterprise communities, and Renewal communities ...................................................................... 1,210 6,900 Exclusion of interest on owner-occupied mortgage subsidy bonds ................................................................................... 1,180 6,470 Extraterritorial income exclusion ......................................................................................................................................... 4,270 6,370 Exclusion of interest on bonds for private nonprofit educational facilities ......................................................................... 1,120 6,170 Deferral of income from post 1987 installment sales ......................................................................................................... 1,140 6,010 Exclusion of interest for airport, dock, and similar bonds .................................................................................................. 980 5,410 Exclusion of certain allowances for Federal employees abroad ........................................................................................ 950 5,260 Exclusion of employee meals and lodging (other than military) ........................................................................................ 890 4,860 Employer provided child care exclusion .............................................................................................................................. 810 4,780 State prepaid tuition plans .................................................................................................................................................. 650 4,150 Deductibility of student-loan interest ................................................................................................................................... 800 4,100 Capital gains treatment of certain income ........................................................................................................................... 760 3,870 New markets tax credit ....................................................................................................................................................... 610 3,770 Credit for increasing research activities .............................................................................................................................. 2,140 3,670 New technology credit ......................................................................................................................................................... 620 3,630 Exclusion for employer-provided transit passes .................................................................................................................. 550 3,560 Exclusion of employer-provided educational assistance ..................................................................................................... 590 3,270 Deferred taxes for financial firms on certain income earned overseas ............................................................................. 2,260 3,220 Exclusion of interest on bonds for water, sewage, and hazardous waste facilities .......................................................... 570 3,130 Adoption credit and exclusion ............................................................................................................................................. 540 2,850 Exclusion of interest on small issue bonds ......................................................................................................................... 510 2,830 325 19. TAX EXPENDITURES Table 19–3. INCOME TAX EXPENDITURES RANKED BY TOTAL 2006–2010 PROJECTED REVENUE EFFECTS— Continued (in millions of dollars) Provision 2006 2006–10 Exclusion of parsonage allowances .................................................................................................................................... 480 2,720 Alternative fuel production credit ........................................................................................................................................ 1,040 2,500 Exclusion of public assistance benefits (normal tax method) ............................................................................................ 450 2,400 Exclusion of certain foster care payments .......................................................................................................................... 440 2,270 Exclusion of interest on rental housing bonds .................................................................................................................... 410 2,240 Carryover basis of capital gains on gifts ............................................................................................................................. 290 2,170 Assistance for adopted foster children ............................................................................................................................... 350 2,110 Exclusion of railroad retirement system benefits ................................................................................................................ 400 2,000 Expensing of multiperiod timber growing costs ................................................................................................................... 370 1,990 Special Blue Cross/Blue Shield deduction .......................................................................................................................... 360 1,890 Low and moderate income savers credit ............................................................................................................................ 1,170 1,870 Deduction for higher education expenses ........................................................................................................................... 1,840 1,840 Exclusion of interest on student-loan bonds ....................................................................................................................... 340 1,830 Tax incentives for preservation of historic structures ......................................................................................................... 330 1,810 Enhanced oil recovery credit .............................................................................................................................................. 340 1,810 Capital gains exclusion of small corporation stock ............................................................................................................. 250 1,720 Premiums on accident and disability insurance .................................................................................................................. 290 1,550 Education Individual Retirement Accounts .......................................................................................................................... 190 1,540 Expensing of certain small investments (normal tax method) ............................................................................................ 1,650 1,500 Tax credit for orphan drug research ................................................................................................................................... 230 1,470 Deductibility of casualty losses ........................................................................................................................................... 270 1,460 Expensing of exploration and development costs, nonfuel minerals ................................................................................. 250 1,290 Expensing of exploration and development costs, fuels .................................................................................................... 370 1,220 Tax exemption of certain insurance companies owned by tax-exempt organizations ...................................................... 210 1,170 Exclusion of GI bill benefits ................................................................................................................................................ 160 900 Small business retirement plan credit ................................................................................................................................ 120 700 Credit for holders of zone academy bonds ......................................................................................................................... 130 680 Expensing of certain capital outlays ................................................................................................................................... 130 670 Exclusion of veterans pensions .......................................................................................................................................... 120 630 Exclusion of interest on energy facility bonds .................................................................................................................... 110 590 Work opportunity tax credit ................................................................................................................................................. 280 570 Exclusion of military disability pensions .............................................................................................................................. 110 570 Tax credit for corporations receiving income from doing business in U.S. possessions .................................................. 500 550 Tax credit for certain expenditures for maintaining railroad tracks .................................................................................... 140 480 Exclusion of conservation subsidies provided by public utilities ........................................................................................ 100 470 Small life insurance company deduction ............................................................................................................................. 80 400 Capital gains treatment of royalties on coal ....................................................................................................................... 80 390 Capital gains treatment of certain timber income ............................................................................................................... 80 390 Expensing of certain multiperiod production costs .............................................................................................................. 70 380 Exemption of certain mutuals’ and cooperatives’ income .................................................................................................. 60 340 Deferral of interest on U.S. savings bonds ......................................................................................................................... 50 300 Exclusion of interest on veterans housing bonds ............................................................................................................... 50 290 Ordinary income treatment of loss from small business corporation stock sale ............................................................... 50 250 Exceptions from imputed interest rules ............................................................................................................................... 50 250 Tax credit for health insurance purchased by certain displaced and retired individuals .................................................. 40 220 Exclusion of special benefits for disabled coal miners ....................................................................................................... 50 220 Credit for disabled access expenditures ............................................................................................................................. 40 220 Investment credit for rehabilitation of structures (other than historic) ................................................................................ 40 200 Income averaging for farmers ............................................................................................................................................. 40 200 Additional deduction for the blind ....................................................................................................................................... 40 200 Cancellation of indebtedness .............................................................................................................................................. 30 190 Alcohol fuel credits .............................................................................................................................................................. 30 180 Welfare-to-work tax credit ................................................................................................................................................... 80 170 Special deduction for teacher expenses ............................................................................................................................. 150 150 Special rules for certain film and TV production ................................................................................................................ 110 140 Income of trusts to finance supplementary unemployment benefits .................................................................................. 20 100 Exclusion of interest on savings bonds redeemed to finance educational expenses ....................................................... 20 100 Exception from passive loss limitation for working interests in oil and gas properties ..................................................... 20 100 Discharge of student loan indebtedness ............................................................................................................................. 20 100 Deferral of tax on shipping companies ............................................................................................................................... 20 100 Expensing of capital costs with respect to complying with EPA sulfur regulations .......................................................... ............................ 90 Deferral of gain on sale of farm refiners ............................................................................................................................. 10 90 Tax credit for the elderly and disabled ............................................................................................................................... 20 70 Treatment of loans forgiven for solvent farmers ................................................................................................................. 10 50 Special alternative tax on small property and casualty insurance companies .................................................................. 10 50 Employer-provided child care credit ................................................................................................................................... 10 50 Bio-Diesel tax credit ............................................................................................................................................................ 30 40 326 ANALYTICAL PERSPECTIVES Table 19–3. INCOME TAX EXPENDITURES RANKED BY TOTAL 2006–2010 PROJECTED REVENUE EFFECTS— Continued (in millions of dollars) Provision 2006 2006–10 Excess of percentage over cost depletion, nonfuel minerals ............................................................................................. ............................ 10 Expensing of environmental remediation costs ................................................................................................................... 20 –30 Excess bad debt reserves of financial institutions .............................................................................................................. –10 –30 Exclusion of gain or loss on sale or exchange of certain brownfield sites ....................................................................... ............................ –120 Tax credit and deduction for clean-fuel burning vehicles ................................................................................................... 50 –180 Amortization of start-up costs (normal tax method) ............................................................................................................ ............................ –440 Deferral of capital gains with respect of dispositions of transmission property ................................................................ –620 –920 Accelerated depreciation of buildings other than rental housing (normal tax method) ..................................................... –4,786 –58,061 Accelerated depreciation of machinery and equipment (normal tax method) ................................................................... –37,830 –148,650 Table 19–4. PRESENT VALUE OF SELECTED TAX EXPENDITURES FOR ACTIVITY IN CALENDAR YEAR 2004 (in millions of dollars) Provision 2004 Present Value of Revenue Loss 1 Deferral of income from controlled foreign corporations (normal tax method) ................................................... 6,360 2 Deferred taxes for financial firms on income earned overseas .......................................................................... 2,160 3 Expensing of research and experimentation expenditures (normal tax method) ............................................... 2,220 4 Expensing of exploration and development costs—fuels .................................................................................... 160 5 Expensing of exploration and development costs—nonfuels .............................................................................. ........................ 6 Expensing of multiperiod timber growing costs ................................................................................................... 200 7 Expensing of certain multiperiod production costs—agriculture .......................................................................... 140 8 Expensing of certain capital outlays—agriculture ................................................................................................ 180 9 Deferral of income on life insurance and annuity contracts ................................................................................ 25,020 10 Accelerated depreciation on rental housing ......................................................................................................... 5,210 11 Accelerated depreciation of buildings other than rental ...................................................................................... 543 12 Accelerated depreciation of machinery and equipment ....................................................................................... 39,380 13 Expensing of certain small investments (normal tax method) ............................................................................ 670 14 Amortization of start-up costs (normal tax method) ............................................................................................. 50 15 Deferral of tax on shipping companies ................................................................................................................ 20 16 Credit for holders of zone academy bonds ......................................................................................................... 200 17 Credit for low-income housing investments ......................................................................................................... 3,870 18 Deferral for State prepaid tuition plans ................................................................................................................ 1,310 19 Exclusion of pension contributions—employer plans ........................................................................................... 85,040 20 Exclusion of 401(k) contributions .......................................................................................................................... 82,400 21 Exclusion of IRA contributions and earnings ....................................................................................................... 3,460 22 Exclusion of contributions and earnings for Keogh plans ................................................................................... 3,000 23 Exclusion of interest on public-purpose bonds .................................................................................................... 14,650 24 Exclusion of interest on non-public purpose bonds ............................................................................................. 5,680 25 Deferral of interest on U.S. savings bonds .......................................................................................................... 230 26 Expensing of capital costs with respect to complying with EPA sulfur regulations ........................................... ........................ 327 19. TAX EXPENDITURES Table 19–5. OUTLAY EQUIVALENT ESTIMATES OF INCOME TAX EXPENDITURES (in millions of dollars) Corporations Individuals 2004 2005 2006 2007 2008 2009 2010 2006–10 2004 2005 2006 2007 2008 2009 2010 2006–10 National Defense 1 Exclusion of benefits and allowances to armed forces personnel ........................ ............ ............ ................ ................ ................ ................ ................ ................ 2,860 2,880 2,920 2,950 2,980 3,010 3,040 14,900 International affairs 2 Exclusion of income earned abroad by U.S. citizens .......................................... ............ ............ ................ ................ ................ ................ ................ ................ 3,530 3,640 3,700 3,880 4,100 4,320 4,560 20,560 3 Exclusion of certain allowances for Federal employees abroad ......................... ............ ............ ................ ................ ................ ................ ................ ................ 1,100 1,150 1,210 1,280 1,350 1,410 1,490 6,740 4 Extraterritorial income exclusion ............... 8,470 7,950 6,570 2,800 330 50 30 9,780 ................ ................ ................ ................ ................ ................ ................ ................ 5 Inventory property sales solurce rules exception ................................................... 2,310 2,490 2,720 3,000 3,390 3,740 4,050 16,900 ................ ................ ................ ................ ................ ................ ................ ................ 6 Deferral of income from controlled foreign corporations (normal tax method) ........ 7,240 7,000 7,440 7,960 8,510 9,100 9,730 42,740 ................ ................ ................ ................ ................ ................ ................ ................ 7 Deferred taxes for financial firms on certain income earned overseas ............... 2,130 2,190 2,260 960 ................ ................ ................ 3,220 ................ ................ ................ ................ ................ ................ ................ ................ General science, space, and technology 8 Expensing of research and experimentation expenditures (normal tax method) .......................................................... –2,280 4,010 7,770 6,850 6,140 5,250 4,700 30,710 –50 100 150 140 120 110 100 620 9 Credit for increasing research activities ... 7,120 7,820 3,230 1,400 590 270 70 5,560 80 80 60 ................ ................ ................ ................ 60 Energy 10 Expensing of exploration and development costs, fuels ................................... 230 350 330 250 210 180 140 1,110 40 70 60 50 40 30 30 210 11 Excess of percentage over cost depletion, fuels ....................................................... 1,570 1,570 1,690 1,760 1,820 1,880 1,910 9,060 140 140 150 150 170 170 180 820 12 Alternative fuel production credit .............. 1,330 1,330 1,330 1,330 530 ................ ................ 3,190 70 70 70 70 30 ................ ................ 170 13 Exception from passive loss limitation for working interests in oil and gas properties ...................................................... ............ ............ ................ ................ ................ ................ ................ ................ 20 20 20 20 20 20 20 100 14 Capital gains treatment of royalties on coal ........................................................ ............ ............ ................ ................ ................ ................ ................ ................ 100 100 110 110 140 100 90 550 15 Exclusion of interest on energy facility bonds ..................................................... 30 30 30 30 30 30 30 150 120 120 130 130 140 140 160 700 16 Enhanced oil recovery credit .................... 400 410 420 430 440 450 460 2,200 10 10 10 10 10 10 10 50 17 New technology credit ............................... 470 680 880 1,000 1,130 1,160 970 5,140 ................ ................ ................ ................ ................ ................ ................ ................ 18 Alcohol fuel credits 1 .................................. 20 20 20 20 30 30 30 130 10 10 10 10 10 10 10 50 19 Tax credit and deduction for clean-fuel burning vehicles .................................... 30 40 50 30 –10 –30 –10 30 70 50 10 –50 –80 –80 –70 –270 20 Exclusion of utility conservation subsidies ............ ............ ................ ................ ................ ................ ................ ................ 130 130 130 130 130 120 120 630 Natural resources and environment 21 Expensing of exploration and development costs, nonfuel minerals ................ 10 10 10 10 10 10 10 50 ................ ................ ................ ................ ................ ................ ................ ................ 22 Excess of percentage over cost depletion, nonfuel minerals .................................... 280 280 300 300 320 320 340 1,580 20 20 30 30 30 30 30 150 23 Exclusion of interest on bonds for water, sewage, and hazardous waste facilities 150 150 150 170 170 170 180 840 560 610 670 700 740 770 800 3,680 24 Capital gains treatment of certain timber income ................................................... ............ ............ ................ ................ ................ ................ ................ ................ 100 100 110 110 140 100 90 550 25 Expensing of multiperiod timber growing costs ...................................................... 310 320 330 350 370 380 400 1,830 140 140 140 150 150 150 150 740 26 Tax incentives for preservation of historic structures ............................................... 230 240 250 260 270 290 300 1,370 70 80 80 80 90 90 100 440 27 Expensing of capital costs with respect to complying with EPA sulfur regulations ............ 20 ................ 10 30 70 10 120 ................ ................ ................ ................ ................ ................ ................ ................ 28 Exclusion of gain or loss on sale or exchange of certain brownfield sites ....... ............ ............ ................ –10 –20 –30 –50 –110 ................ ................ ................ ................ –10 –10 –20 –40 Agriculture 29 Expensing of certain capital outlays ......... 20 30 30 30 30 30 30 150 100 110 130 130 130 140 140 670 30 Expensing of certain multiperiod production costs ............................................... 10 10 20 20 20 20 20 100 50 60 70 70 80 80 80 380 31 Treatment of loans forgiven for solvent farmers ................................................... ............ ............ ................ ................ ................ ................ ................ ................ 10 10 10 10 10 10 10 50 32 Capital gains treatment of certain income ............ ............ ................ ................ ................ ................ ................ ................ 960 1,040 1,090 1,170 1,410 1,030 830 5,530 33 Income averaging for farmers ................... ............ ............ ................ ................ ................ ................ ................ ................ 40 40 40 40 50 50 50 230 34 Deferral of gain on sale of farm refiners 20 20 20 20 20 20 20 100 ................ ................ ................ ................ ................ ................ ................ ................ 35 Bio-Diesel tax credit .................................. ............ ............ ................ ................ ................ ................ ................ ................ ................ 40 40 10 ................ ................ ................ 50 Commerce and housing Financial institutions and insurance: 36 Exemption of credit union income ........ 1,620 1,690 1,760 1,840 1,920 2,000 2,080 9,600 ................ ................ ................ ................ ................ ................ ................ ................ 37 Bad debt reserves of financial institutions ................................................... –30 –30 –10 –10 –10 ................ ................ –30 ................ ................ ................ ................ ................ ................ ................ ................ 38 Exclusion of interest on life insurance savings .............................................. 2,280 2,450 2,520 2,840 3,180 3,380 3,660 15,580 21,380 23,090 24,260 26,130 28,560 30,690 33,310 142,950 39 Special alternative tax on small property and casualty insurance companies .................................................... 10 10 10 10 10 10 10 50 ................ ................ ................ ................ ................ ................ ................ ................ 40 Tax exemption of certain insurance companies owned by tax-exempt organizations ........................................ 270 290 320 330 350 380 400 1,780 ................ ................ ................ ................ ................ ................ ................ ................ 41 Small life insurance company deduction ..................................................... 120 120 120 120 120 120 120 600 ................ ................ ................ ................ ................ ................ ................ ................ Housing: 42 Exclusion of interest on owner-occupied mortgage subsidy bonds .......... 310 320 320 330 350 350 360 1,710 1,160 1,270 1,380 1,430 1,550 1,590 1,640 7,590 328 ANALYTICAL PERSPECTIVES Table 19–5. OUTLAY EQUIVALENT ESTIMATES OF INCOME TAX EXPENDITURES—Continued (in millions of dollars) Corporations Individuals 2004 2005 2006 2007 2008 2009 2010 2006–10 2004 2005 2006 2007 2008 2009 2010 2006–10 43 Exclusion of interest on rental housing bonds ................................................. 110 110 110 110 120 120 120 580 410 450 480 490 540 550 560 2,620 44 Deductibility of mortgage interest on owner-occupied homes ..................... ............ ............ ................ ................ ................ ................ ................ ................ 61,450 68,870 76,030 81,990 88,990 95,770 102,760 445,540 45 Deductibility of State and local property tax on owner-occupied homes ......... ............ ............ ................ ................ ................ ................ ................ ................ 19,930 16,590 14,830 14,110 13,400 13,000 12,800 68,140 46 Deferral of income from post 1987 installment sales .................................. 290 290 300 300 310 310 320 1,540 810 830 840 860 880 890 890 4,360 47 Capital gains exclusion on home sales ............ ............ ................ ................ ................ ................ ................ ................ 34,980 38,630 42,670 47,120 52,050 68,320 89,950 300,110 48 Exclusion of net imputed rental income ............ ............ ................ ................ ................ ................ ................ ................ 32,790 38,130 39,630 44,280 49,150 54,170 59,710 246,940 49 Exception from passive loss rules for $25,000 of rental loss ....................... ............ ............ ................ ................ ................ ................ ................ ................ 5,030 4,900 4,750 4,580 4,410 4,240 4,240 22,220 50 Credit for low-income housing investments ................................................. 3,910 4,110 4,290 4,470 4,680 4,920 5,170 23,530 1,050 1,100 1,150 1,200 1,250 1,320 1,380 6,300 51 Accelerated depreciation on rental housing (normal tax method) ........... –8 –46 –98 –143 –197 –275 –389 –1,102 758 –110 –895 –1,703 –2,500 –3,686 –5,512 –14,296 Commerce: 52 Cancellation of indebtedness ................ ............ ............ ................ ................ ................ ................ ................ ................ 30 30 30 40 40 40 40 190 53 Exceptions from imputed interest rules ............ ............ ................ ................ ................ ................ ................ ................ 50 50 50 50 50 50 50 250 54 Capital gains (except agriculture, timber, iron ore, and coal) .................... ............ ............ ................ ................ ................ ................ ................ ................ 35,930 38,860 40,530 43,500 52,620 38,430 30,900 205,980 55 Capital gains exclusion of small corporation stock ................................... ............ ............ ................ ................ ................ ................ ................ ................ 220 270 340 400 460 530 610 2,340 56 Step-up basis of capital gains at death ............ ............ ................ ................ ................ ................ ................ ................ 32,260 34,860 38,340 42,180 46,390 47,410 44,910 219,230 57 Carryover basis of capital gains on gifts .................................................... ............ ............ ................ ................ ................ ................ ................ ................ 250 280 340 350 370 530 1,060 2,650 58 Ordinary income treatment of loss from small business corporation stock sale .................................................... ............ ............ ................ ................ ................ ................ ................ ................ 60 60 60 60 60 60 60 300 59 Accelerated depreciation of buildings other than rental housing (normal tax method) ....................................... –2,980 –3,850 –4,340 –6,170 –9,220 –12,620 –17,320 –49,670 –280 –330 –450 –760 –1,140 –2,110 –3,930 –8,390 60 Accelerated depreciation of machinery and equipment (normal tax method) 37,080 –8,780 –32,880 –26,480 –23,310 –21,260 –20,290 –124,230 7,610 –2,220 –4,950 –4,440 –4,640 –4,930 –5,470 –24,430 61 Expensing of certain small investments (normal tax method) ......................... 680 1,780 680 –390 –140 –30 –10 120 840 3,040 970 –100 110 170 240 1,400 62 Amortization of start-up costs (normal tax method) ....................................... 70 40 ................ –40 –80 –120 –150 –390 10 10 ................ ................ –10 –20 –20 –50 63 Graduated corporation income tax rate (normal tax method) ......................... 3,760 4,910 5,730 5,880 6,030 6,180 6,360 30,180 ................ ................ ................ ................ ................ ................ ................ ................ 64 Exclusion of interest on small issue bonds ................................................. 140 140 140 140 150 150 150 730 510 560 590 640 680 700 720 3,330 65 Deduction for U.S. production activities ............ 3,420 5,780 9,480 12,170 12,620 17,150 57,200 ................ 950 1,460 2,180 2,800 2,940 4,000 13,380 66 Special rules for certain film and TV production .......................................... ............ 70 90 70 60 –30 –70 120 ................ 20 20 20 10 –10 –20 20 Transportation 67 Deferral of tax on shipping companies .... 20 20 20 20 20 20 20 100 ................ ................ ................ ................ ................ ................ ................ ................ 68 Exclusion of reimbursed employee parking expenses ......................................... ............ ............ ................ ................ ................ ................ ................ ................ 3,190 3,350 3,530 3,710 3,900 4,100 4,300 19,540 69 Exclusion for employer-provided transit passes ................................................... ............ ............ ................ ................ ................ ................ ................ ................ 510 600 690 790 890 980 1,100 4,450 70 Tax credit for certain expenditures for maintaining railroad tracks .................... ............ 100 190 200 140 70 30 630 ................ ................ ................ ................ ................ ................ ................ ................ Community and regional development 71 Investment credit for rehabilitation of structures (other than historic) .............. 20 20 20 20 20 20 20 100 20 20 20 20 20 20 20 100 72 Exclusion of interest for airport, dock, and similar bonds ......................................... 250 260 260 280 290 290 310 1,430 970 1,070 1,140 1,200 1,290 1,330 1,380 6,340 73 Exemption of certain mutuals’ and cooperatives’ income ................................ 70 70 70 80 80 80 80 390 ................ ................ ................ ................ ................ ................ ................ ................ 74 Empowerment zones, Enterprise communities and Renewal communities .......... 280 290 310 340 370 420 190 1,630 800 830 900 1,000 1,110 1,320 940 5,270 75 New markets tax credit ............................. 70 110 150 210 220 200 170 950 220 320 460 620 650 590 500 2,820 76 Expensing of environmental remediation costs ...................................................... 90 80 20 –20 –20 –20 –20 –60 20 20 ................ ................ ................ ................ ................ ................ 77 Deferral of capital gains with respect of dispositions of transmission property ... ............ –490 –620 –530 –230 100 360 –920 ................ ................ ................ ................ ................ ................ ................ ................ Education, training, employment, and social services Education: 78 Exclusion of scholarship and fellowship income (normal tax method) ............ ............ ............ ................ ................ ................ ................ ................ ................ 1,450 1,540 1,610 1,680 1,760 1,840 1,930 8,820 79 HOPE tax credit .................................... ............ ............ ................ ................ ................ ................ ................ ................ 4,260 4,380 4,130 4,260 4,300 4,380 4,590 21,660 80 Lifetime Learning tax credit .................. ............ ............ ................ ................ ................ ................ ................ ................ 2,800 2,730 2,660 2,960 3,000 3,050 3,150 14,820 81 Education Individual Retirement Accounts ................................................ ............ ............ ................ ................ ................ ................ ................ ................ 130 180 240 310 390 470 570 1,980 82 Deductibility of student-loan interest .... ............ ............ ................ ................ ................ ................ ................ ................ 900 930 960 970 980 990 1,000 4,900 83 Deduction for higher education expenses ............................................... ............ ............ ................ ................ ................ ................ ................ ................ 1,640 2,340 2,360 ................ ................ ................ ................ 2,360 84 State prepaid tuition plans .................... ............ ............ ................ ................ ................ ................ ................ ................ 270 620 830 950 1,070 1,180 1,300 5,330 85 Exclusion of interest on student-loan bonds ................................................. 80 80 100 100 100 100 100 500 330 360 390 410 430 450 460 2,140 86 Exclusion of interest on bonds for private nonprofit educational facilities .. 290 290 310 320 320 330 350 1,630 1,100 1,220 1,300 1,380 1,480 1,520 1,560 7,240 87 Credit for holders of zone academy bonds ................................................. 130 160 180 190 200 200 190 960 ................ ................ ................ ................ ................ ................ ................ ................ 329 19. TAX EXPENDITURES Table 19–5. OUTLAY EQUIVALENT ESTIMATES OF INCOME TAX EXPENDITURES—Continued (in millions of dollars) Corporations Individuals 2004 2005 2006 2007 2008 2009 2010 2006–10 2004 2005 2006 2007 2008 2009 2010 2006–10 88 Exclusion of interest on savings bonds redeemed to finance educational expenses ............................................... ............ ............ ................ ................ ................ ................ ................ ................ 20 20 20 20 20 20 20 100 89 Parental personal exemption for students age 19 or over ....................... ............ ............ ................ ................ ................ ................ ................ ................ 3,550 2,960 2,340 2,040 1,800 1,600 1,480 9,260 90 Deductibility of charitable contributions (education) ........................................ 510 540 560 590 620 660 700 3,130 3,180 2,880 3,120 3,440 3,640 3,890 3,890 17,980 91 Exclusion of employer-provided educational assistance ........................... ............ ............ ................ ................ ................ ................ ................ ................ 650 690 730 770 810 850 890 4,050 92 Special deduction for teacher expenses ............................................... ............ ............ ................ ................ ................ ................ ................ ................ 190 200 180 ................ ................ ................ ................ 180 93 Discharge of student loan indebtedness ................................................... ............ ............ ................ ................ ................ ................ ................ ................ ................ 20 20 20 20 20 20 100 Training, employment, and social services: 94 Work opportunity tax credit ................... 240 210 240 160 50 30 10 490 40 40 40 30 10 ................ ................ 80 95 Welfare-to-work tax credit ..................... 50 50 70 50 20 10 ................ 150 10 10 10 10 ................ ................ ................ 20 96 Exclusion of employer provided child care ................................................... ............ ............ ................ ................ ................ ................ ................ ................ 800 830 1,080 1,240 1,290 1,350 1,410 6,370 97 Employer-provided child care ............... 6 11 13 15 17 18 20 83 ................ ................ ................ ................ ................ ................ ................ ................ 98 Assistance for adopted foster children ............ ............ ................ ................ ................ ................ ................ ................ 330 350 390 430 470 520 570 2,380 99 Adoption credit and exclusion .............. ............ ............ ................ ................ ................ ................ ................ ................ 570 640 690 710 730 750 760 3,640 100 Exclusion of employee meals and lodging (other than military) ............. ............ ............ ................ ................ ................ ................ ................ ................ 990 1,030 1,080 1,130 1,180 1,230 1,290 5,910 101 Child credit 2 .......................................... ............ ............ ................ ................ ................ ................ ................ ................ 25,950 39,010 32,280 31,960 31,450 31,450 31,450 158,590 102 Credit for child and dependent care expenses ........................................... ............ ............ ................ ................ ................ ................ ................ ................ 3,990 4,190 3,750 2,530 2,400 2,280 2,170 13,130 103 Credit for disabled access expenditures .................................................. 20 20 20 20 20 20 20 100 30 30 40 40 40 40 40 200 104 Deductibility of charitable contributions, other than education and health ...... 1,170 1,230 1,290 1,360 1,430 1,500 1,570 7,150 26,200 28,440 31,260 33,140 35,360 37,910 37,910 175,580 105 Exclusion of certain foster care payments ................................................. ............ ............ ................ ................ ................ ................ ................ ................ 510 510 510 510 520 530 540 2,610 106 Exclusion of parsonage allowances ..... ............ ............ ................ ................ ................ ................ ................ ................ 520 550 590 630 660 710 750 3,340 Health 107 Exclusion of employer contributions for medical insurance premiums and medical care ................................................. ............ ............ ................ ................ ................ ................ ................ ................ 126,660 139,650 158,980 177,050 195,850 214,730 228,090 974,700 108 Self-employed medical insurance premiums .................................................... ............ ............ ................ ................ ................ ................ ................ ................ 4,140 4,730 5,480 6,110 6,700 7,360 7,990 33,640 109 Medical Savings Accounts Health Savings Accounts ................................................ ............ ............ ................ ................ ................ ................ ................ ................ 520 1,040 1,670 2,450 3,150 3,540 3,520 14,330 110 Deductibility of medical expenses ............. ............ ............ ................ ................ ................ ................ ................ ................ 7,930 9,280 9,880 10,780 12,050 12,910 13,750 59,370 111 Exclusion of interest on hospital construction bonds .............................................. 560 570 600 610 620 640 670 3,140 2,130 2,330 2,510 2,640 2,820 2,910 3,000 13,880 112 Deductibility of charitable contributions (health) ................................................... 150 160 160 170 180 190 200 900 2,940 3,190 3,510 3,720 3,970 4,260 4,260 19,720 113 Tax credit for orphan drug research ........ 280 310 350 390 430 480 540 2,190 ................ ................ ................ ................ ................ ................ ................ ................ 114 Special Blue Cross/Blue Shield deduction 570 560 510 560 490 530 610 2,700 ................ ................ ................ ................ ................ ................ ................ ................ 115 Tax credit for health insurance purchased by certain displaced and retired individuals 3 ...................................................... ............ ............ ................ ................ ................ ................ ................ ................ 50 60 40 40 50 50 50 230 Income security 116 Exclusion of railroad retirement system benefits .................................................. ............ ............ ................ ................ ................ ................ ................ ................ 400 400 400 400 400 400 400 2,000 117 Exclusion of workers’ compensation benefits ........................................................ ............ ............ ................ ................ ................ ................ ................ ................ 5,490 5,730 5,940 6,100 6,300 6,520 6,730 31,590 118 Exclusion of public assistance benefits (normal tax method) .............................. ............ ............ ................ ................ ................ ................ ................ ................ 410 430 450 470 490 510 480 2,400 119 Exclusion of special benefits for disabled coal miners ............................................ ............ ............ ................ ................ ................ ................ ................ ................ 60 50 50 50 40 40 40 220 120 Exclusion of military disability pensions ... ............ ............ ................ ................ ................ ................ ................ ................ 100 100 110 110 110 120 120 570 Net exclusion of pension contributions and earnings: 121 Employer plans ..................................... ............ ............ ................ ................ ................ ................ ................ ................ 57,280 61,380 62,260 64,110 57,960 55,260 54,350 293,940 122 401(k) plans .......................................... ............ ............ ................ ................ ................ ................ ................ ................ 58,210 55,940 58,710 63,170 68,460 74,300 80,980 345,620 123 Individual Retirement Accounts ............ ............ ............ ................ ................ ................ ................ ................ ................ 8,470 9,300 9,140 9,120 8,730 8,340 7,790 43,120 124 Low and moderate income savers credit .................................................. ............ ............ ................ ................ ................ ................ ................ ................ 1,150 1,310 1,380 830 ................ ................ ................ 2,210 125 Keogh plans .......................................... ............ ............ ................ ................ ................ ................ ................ ................ 11,170 11,800 12,500 13,290 14,490 15,780 17,200 73,260 Exclusion of other employee benefits: 126 Premiums on group term life insurance ............ ............ ................ ................ ................ ................ ................ ................ 2,660 2,690 2,700 2,700 2,750 2,790 2,830 13,770 127 Premiums on accident and disability insurance .............................................. ............ ............ ................ ................ ................ ................ ................ ................ 350 370 390 400 410 430 440 2,070 128 Small business retirement plan credit ...... 60 70 90 100 110 110 100 510 50 70 80 100 100 100 100 480 129 Income of trusts to finance supplementary unemployment benefits ......................... ............ ............ ................ ................ ................ ................ ................ ................ 20 20 20 20 20 20 20 100 130 Special ESOP rules ................................... 2,550 2,740 2,970 3,210 3,460 3,750 4,070 17,460 510 540 550 590 620 610 610 2,980 131 Additional deduction for the blind ............. ............ ............ ................ ................ ................ ................ ................ ................ 40 40 50 40 50 50 50 240 132 Additional deduction for the elderly .......... ............ ............ ................ ................ ................ ................ ................ ................ 2,060 2,190 2,370 2,350 2,290 2,330 2,360 11,700 133 Tax credit for the elderly and disabled .... ............ ............ ................ ................ ................ ................ ................ ................ 20 20 20 20 20 10 10 80 134 Deductibility of casualty losses ................. ............ ............ ................ ................ ................ ................ ................ ................ 610 270 290 280 290 300 320 1,480 135 Earned income tax credit 4 ........................ ............ ............ ................ ................ ................ ................ ................ ................ 5,437 5,536 6,026 5,742 5,874 6,089 5,868 29,599 Social Security Exclusion of social security benefits: 330 ANALYTICAL PERSPECTIVES Table 19–5. OUTLAY EQUIVALENT ESTIMATES OF INCOME TAX EXPENDITURES—Continued (in millions of dollars) Corporations Individuals 2004 2005 2006 2007 2008 2009 2010 2006–10 2004 2005 2006 2007 2008 2009 2010 2006–10 136 Social Security benefits for retired workers .............................................. ............ ............ ................ ................ ................ ................ ................ ................ 19,200 19,480 19,770 20,470 20,900 21,260 23,720 106,120 137 Social Security benefits for disabled .... ............ ............ ................ ................ ................ ................ ................ ................ 3,580 3,740 3,870 4,110 4,290 4,500 4,910 21,680 138 Social Security benefits for dependents and survivors .................................... ............ ............ ................ ................ ................ ................ ................ ................ 4,140 4,120 3,990 4,030 3,880 3,920 4,060 19,880 Veterans benefits and services 139 Exclusion of veterans death benefits and disability compensation ......................... ............ ............ ................ ................ ................ ................ ................ ................ 3,300 3,560 3,750 4,030 4,190 4,360 4,520 20,850 140 Exclusion of veterans pensions ................ ............ ............ ................ ................ ................ ................ ................ ................ 110 120 120 120 120 130 140 630 141 Exclusion of GI bill benefits ...................... ............ ............ ................ ................ ................ ................ ................ ................ 130 150 160 170 180 190 200 900 142 Exclusion of interest on veterans housing bonds ..................................................... 10 10 10 10 10 10 10 50 60 60 60 70 70 70 70 340 General purpose fiscal assistance 143 Exclusion of interest on public purpose State and local bonds ........................... 8,620 8,870 9,130 9,410 9,700 9,980 10,280 48,500 28,880 29,170 29,010 28,340 29,180 30,070 30,970 147,570 144 Deductibility of nonbusiness state and local taxes other than on owner-occupied homes ............................................ ............ ............ ................ ................ ................ ................ ................ ................ 45,290 39,090 34,620 32,890 31,850 31,760 32,120 163,240 145 Tax credit for corporations receiving income from doing business in U.S. possessions ................................................. 1,430 1,290 720 70 ................ ................ ................ 790 ................ ................ ................ ................ ................ ................ ................ ................ Interest 146 Deferral of interest on U.S. savings bonds ..................................................... ............ ............ ................ ................ ................ ................ ................ ................ 50 50 50 50 60 70 70 300 Addendum: Aid to State and local governments: Deductibility of: Property taxes on owner-occupied homes ................................................ ............ ............ ................ ................ ................ ................ ................ ................ 19,930 16,590 14,830 14,110 13,400 13,000 12,800 68,140 Nonbusiness State and local taxes other than on owner-occupied homes ................................................ ............ ............ ................ ................ ................ ................ ................ ................ 45,290 39,090 34,620 32,890 31,850 31,760 32,120 163,240 Exclusion of interest on State and local bonds for: Public purposes ..................................... 8,620 8,870 9,130 9,410 9,700 9,980 10,280 48,500 28,880 29,170 29,010 28,340 29,180 30,070 30,970 147,570 Energy facilities ..................................... 30 30 30 30 30 30 30 150 120 120 130 130 140 140 160 700 Water, sewage, and hazardous waste disposal facilities ............................... 150 150 150 170 170 170 180 840 560 610 670 700 740 770 800 3,680 Small-issues .......................................... 140 140 140 140 150 150 150 730 510 560 590 640 680 700 720 3,330 Owner-occupied mortgage subsidies ... 310 320 320 330 350 350 360 1,710 1,160 1,270 1,380 1,430 1,550 1,590 1,640 7,590 Rental housing ...................................... 110 110 110 110 120 120 120 580 410 450 480 490 540 550 560 2,620 Airports, docks, and similar facilities .... 250 260 260 280 290 290 310 1,430 970 1,070 1,140 1,200 1,290 1,330 1,380 6,340 Student loans ........................................ 80 80 100 100 100 100 100 500 330 360 390 410 430 450 460 2,140 Private nonprofit educational facilities .. 290 290 310 320 320 330 350 1,630 1,100 1,220 1,300 1,380 1,480 1,520 1,560 7,240 Hospital construction ............................. 560 570 600 610 620 640 670 3,140 2,130 2,330 2,510 2,640 2,820 2,910 3,000 13,880 Veterans’ housing ................................. 10 10 10 10 10 10 10 50 60 60 60 70 70 70 70 340 Credit for holders of zone academy bonds ..................................................... 130 160 180 190 200 200 190 960 ................ ................ ................ ................ ................ ................ ................ ................ 1 In addition, the partial exemption from the excise tax and excise credits for alcohol fuels results in a reduction in excise tax receipts (in millions of dollars) as follows: 2004 $1,450; 2005 $1,490; 2006 $1,550; 2007 $1,590; 2008 $1,620; 2009 $1,650; and 2010 $1,680. 2 The figures in the table indicate the effect of the child tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2004 $8,857; 2005 $13,516; 2006 $13,180; 2007 $12,549; 2008 $12,040; 2009 $11,693 and 2010 $11,364 3 In addition to the receipts shown, there are outlays of $70 million in 2004, $90 million in 2005, $100 million in 2006, $120 million in 2007, $130 million in 2008, and $140 million in 2009 and $150 million projected. 4 The figures in the table indicate the effect of the earned income tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2004 $33,134;2005 $33,790; 2006 $34,132; 2007 $34,481; 2008 $34,723; 2009 $35,517; and 2010 $36,099. Tax Expenditure Baselines A tax expenditure is an exception to baseline provisions of the tax structure. The 1974 Congressional Budget Act, which mandated the tax expenditure budget, did not specify the baseline provisions of the tax law. As noted previously, deciding whether provisions are exceptions, therefore, is a matter of judgment. As in prior years, most of this year’s tax expenditure estimates are presented using two baselines: the normal tax baseline and the reference tax law baseline. An exception is provided for the lower tax rate on dividends and capital gains on corporate shares as discussed below. The normal tax baseline is patterned on a comprehensive income tax, which defines income as the sum of consumption and the change in net wealth in a given period of time. The normal tax baseline allows personal exemptions, a standard deduction, and deductions of the expenses incurred in earning income. It is not limited to a particular structure of tax rates, or by a specific definition of the taxpaying unit. In the case of income taxes, the reference tax law baseline is also patterned on a comprehensive income tax, but it is closer to existing law. Tax expenditures under the reference law baseline are generally tax expenditures under the normal tax baseline, but the reverse is not always true. Both the normal and reference tax baselines allow several major departures from a pure comprehensive income tax. For example, under the normal and reference tax baselines: 331 19. TAX EXPENDITURES 1 Gross income does, however, include transfer payments associated with past employment, such as Social Security benefits. 2 In the case of individuals who hold ‘‘passive’’ equity interests in businesses, however, the pro-rata shares of sales and expense deductions reportable in a year are limited. A passive business activity is defined to be one in which the holder of the interest, usually a partnership interest, does not actively perform managerial or other participatory functions. The taxpayer may generally report no larger deductions for a year than will reduce taxable income from such activities to zero. Deductions in excess of the limitation may be taken in subsequent years, or when the interest is liquidated. In addition, costs of earning income may be limited under the alternative minimum tax. • Income is taxable only when it is realized in exchange. Thus, neither the deferral of tax on unrealized capital gains nor the tax exclusion of imputed income (such as the rental value of owneroccupied housing or farmers’ consumption of their own produce) is regarded as a tax expenditure. Both accrued and imputed income would be taxed under a comprehensive income tax. • A comprehensive income tax would generally not exclude from the tax base amounts for personal exemptions or a standard deduction, except perhaps to ease tax administration. • There generally is a separate corporate income tax. • Tax rates are allowed to vary with marital status. • Values of assets and debt are not generally adjusted for inflation. A comprehensive income tax would adjust the cost basis of capital assets and debt for changes in the price level during the time the assets or debt are held. Thus, under a comprehensive income tax baseline, the failure to take account of inflation in measuring depreciation, capital gains, and interest income would be regarded as a negative tax expenditure (i.e., a tax penalty), and failure to take account of inflation in measuring interest costs would be regarded as a positive tax expenditure (i.e., a tax subsidy). Although the reference law and normal tax baselines are generally similar, areas of difference include: Tax rates. The separate schedules applying to the various taxpaying units are included in the reference law baseline. Thus, corporate tax rates below the maximum statutory rate do not give rise to a tax expenditure. The normal tax baseline is similar, except that, by convention, it specifies the current maximum rate as the baseline for the corporate income tax. The lower tax rates applied to the first $10 million of corporate income are thus regarded as a tax expenditure. Again by convention, the alternative minimum tax is treated as part of the baseline rate structure under both the reference and normal tax methods. Income subject to the tax. Income subject to tax is defined as gross income less the costs of earning that income. The Federal income tax defines gross income to include: (1) consideration received in the exchange of goods and services, including labor services or property; and (2) the taxpayer’s share of gross or net income earned and/or reported by another entity (such as a partnership). Under the reference tax rules, therefore, gross income does not include gifts defined as receipts of money or property that are not consideration in an exchange or most transfer payments, which can be thought of as gifts from the Government. 1 The normal tax baseline also excludes gifts between individuals from gross income. Under the normal tax baseline, however, all cash transfer payments from the Government to private individuals are counted in gross income, and exemptions of such transfers from tax are identified as tax expenditures. The costs of earning income are generally deductible in determining taxable income under both the reference and normal tax baselines. 2 Capital recovery. Under the reference tax law baseline no tax expenditures arise from accelerated depreciation. Under the normal tax baseline, the depreciation allowance for property is computed using estimates of economic depreciation. The latter represents a change in the calculation of the tax expenditure under normal law first made in the 2004 Budget. The Appendix provides further details on the new methodology and how it differs from the prior methodology. Treatment of foreign income. Both the normal and reference tax baselines allow a tax credit for foreign income taxes paid (up to the amount of U.S. income taxes that would otherwise be due), which prevents double taxation of income earned abroad. Under the normal tax method, however, controlled foreign corporations (CFCs) are not regarded as entities separate from their controlling U.S. shareholders. Thus, the deferral of tax on income received by CFCs is regarded as a tax expenditure under this method. In contrast, except for tax haven activities, the reference law baseline follows current law in treating CFCs as separate taxable entities whose income is not subject to U.S. tax until distributed to U.S. taxpayers. Under this baseline, deferral of tax on CFC income is not a tax expenditure because U.S. taxpayers generally are not taxed on accrued, but unrealized, income. In addition to these areas of difference, the Joint Committee on Taxation considers a somewhat broader set of tax expenditures under its normal tax baseline than is considered here. Double Taxation of Corporate Profits In a gradual transition to a more economically neutral tax system where corporate income is subject to a single layer of tax, the lower tax rates on dividends and capital gains on corporate equity have not been considered tax preferences since the 2005 Budget. Thus, the difference between ordinary tax rates and the lower tax rates on dividends, introduced by the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), does not give rise to a tax expenditure. Similarly, the lower capital gains tax rates applied to gains realized from the disposition of corporate equity do not give rise to a tax expenditure as well. As a 332 ANALYTICAL PERSPECTIVES 3 Committee on Government Affairs, United States Senate, ‘‘Government Performance and Results Act of 1993’’ (Report 103–58, 1993). 4 Although this section focuses upon tax expenditures under the income tax, tax expenditures also arise under the unified transfer, payroll, and excise tax systems. Such provisions can be useful when they relate to the base of those taxes, such as an excise tax exemption for certain types of consumption deemed meritorious. consequence, tax expenditure estimates for the lower tax rates on capital, step-up in basis, and the inside build-up on pension assets, 401k plans, IRAs, among others, are limited to capital gains from sources other than corporate equity. The Appendix provides a greater discussion of alternative baselines. Performance Measures and the Economic Effects of Tax Expenditures The Government Performance and Results Act of 1993 (GPRA) directs Federal agencies to develop annual and strategic plans for their programs and activities. These plans set out performance objectives to be achieved over a specific time period. Most of these objectives will be achieved through direct expenditure programs. Tax expenditures, however, may also contribute to achieving these goals. The report of the Senate Governmental Affairs Committee on GPRA 3 calls on the Executive branch to undertake a series of analyses to assess the effect of specific tax expenditures on the achievement of agencies’ performance objectives. The Executive Branch is continuing to focus on the availability of data needed to assess the effects of the tax expenditures designed to increase savings. Treasury’s Office of Tax Analysis and Statistics of Income Division (IRS) have developed a new sample of individual income tax filers as one part of this effort. This new ‘‘panel’’ sample will follow the same taxpayers over a period of at least ten years. The first year of this panel sample was drawn from tax returns filed in 2000 for tax year 1999. The sample will capture the changing demographic and economic circumstances of individuals and the effects of changes in tax law over an extended period of time. Data from the sample will therefore permit more extensive, and better, analyses of many tax provisions than can be performed using only annual (‘‘cross-section’’) data. In particular, data from this panel sample will enhance our ability to analyze the effect of tax expenditures designed to increase savings. Other efforts by OMB, Treasury, and other agencies to improve data available for the analysis of savings tax expenditures will continue over the next several years. Comparison of tax expenditure, spending, and regulatory policies. Tax expenditures by definition work through the tax system and, particularly, the income tax. Thus, they may be relatively advantageous policy approaches when the benefit or incentive is related to income and is intended to be widely available. 4 Because there is an existing public administrative and private compliance structure for the tax system, the incremental administrative and compliance costs for a tax expenditure may be low in many cases. In addition, some tax expenditures actually simplify the operation of the tax system, (for example, the exclusion for up to $500,000 of capital gains on home sales). Tax expenditures also implicitly subsidize certain activities. Spending, regulatory or tax-disincentive policies can also modify behavior, but may have different economic effects. Finally, a variety of tax expenditure tools can be used e.g., deductions; credits; exemptions; deferrals; floors; ceilings; phase-ins; phase-outs; dependent on income, expenses, or demographic characteristics (age, number of family members, etc.). This wide range means that tax expenditures can be flexible and can have very different economic effects. Tax expenditures also have limitations. In many cases they add to the complexity of the tax system, which raises both administrative and compliance costs. For example, targeting personal exemptions and credits can complicate filing and decision-making. The income tax system may have little or no contact with persons who have no or very low incomes, and does not require information on certain characteristics of individuals used in some spending programs, such as wealth. These features may reduce the effectiveness of tax expenditures for addressing certain income-transfer objectives. Tax expenditures also generally do not enable the same degree of agency discretion as an outlay program. For example, grant or direct Federal service delivery programs can prioritize activities to be addressed with specific resources in a way that is difficult to emulate with tax expenditures. Finally, tax expenditures may not receive the same level of scrutiny afforded to other programs. Outlay programs have advantages where direct Government service provision is particularly warranted such as equipping and providing the armed forces or administering the system of justice. Outlay programs may also be specifically designed to meet the needs of low-income families who would not otherwise be subject to income taxes or need to file a tax return. Outlay programs may also receive more year-to-year oversight and fine tuning, through the legislative and executive budget process. In addition, many different types of spending programs including direct Government provision; credit programs; and payments to State and local governments, the private sector, or individuals in the form of grants or contracts provide flexibility for policy design. On the other hand, certain outlay programs such as direct Government service provision may rely less directly on economic incentives and private-market provision than tax incentives, which may reduce the relative efficiency of spending programs for some goals. Spending programs also require resources to be raised via taxes, user charges, or Government borrowing, which can impose further costs by diverting resources from their most efficient uses. Finally, spending programs, particularly on the discretionary side, may respond less readily to changing activity levels and economic conditions than tax expenditures. Regulations have more direct and immediate effects than outlay and tax-expenditure programs because regulations apply directly and immediately to the regulated party (i.e., the intended actor) generally in the private sector. Regulations can also be fine-tuned more 333 19. TAX EXPENDITURES quickly than tax expenditures, because they can often be changed as needed by the executive branch without legislation. Like tax expenditures, regulations often rely largely upon voluntary compliance, rather than detailed inspections and policing. As such, the public administrative costs tend to be modest relative to the private resource costs associated with modifying activities. Historically, regulations have tended to rely on proscriptive measures, as opposed to economic incentives. This reliance can diminish their economic efficiency, although this feature can also promote full compliance where (as in certain safety-related cases) policymakers believe that trade-offs with economic considerations are not of paramount importance. Also, regulations generally do not directly affect Federal outlays or receipts. Thus, like tax expenditures, they may escape the degree of scrutiny that outlay programs receive. However, major regulations are subjected to a formal regulatory analysis that goes well beyond the analysis required for outlays and tax-expenditures. To some extent, the GPRA requirement for performance evaluation will address this lack of formal analysis. Some policy objectives are achieved using multiple approaches. For example, minimum wage legislation, the earned income tax credit, and the food stamp program are regulatory, tax expenditure, and direct outlay programs, respectively, all having the objective of improving the economic welfare of low-wage workers. Tax expenditures, like spending and regulatory programs, have a variety of objectives and effects. When measured against a comprehensive income tax, for example, these include: encouraging certain types of activities (e.g., saving for retirement or investing in certain sectors); increasing certain types of after-tax income (e.g., favorable tax treatment of Social Security income); reducing private compliance costs and Government administrative costs (e.g., the exclusion for up to $500,000 of capital gains on home sales); and promoting tax neutrality (e.g., accelerated depreciation in the presence of inflation). Some of these objectives are well suited to quantitative measurement, while others are less well suited. Also, many tax expenditures, including those cited above, may have more than one objective. For example, accelerated depreciation may encourage investment. In addition, the economic effects of particular provisions can extend beyond their intended objectives (e.g., a provision intended to promote an activity or raise certain incomes may have positive or negative effects on tax neutrality). Performance measurement is generally concerned with inputs, outputs, and outcomes. In the case of tax expenditures, the principal input is usually the revenue effect. Outputs are quantitative or qualitative measures of goods and services, or changes in income and investment, directly produced by these inputs. Outcomes, in turn, represent the changes in the economy, society, or environment that are the ultimate goals of programs. Thus, for a provision that reduces taxes on certain investment activity, an increase in the amount of investment would likely be a key output. The resulting production from that investment, and, in turn, the associated improvements in national income, welfare, or security, could be the outcomes of interest. For other provisions, such as those designed to address a potential inequity or unintended consequence in the tax code, an important performance measure might be how they change effective tax rates (the discounted present-value of taxes owed on new investments or incremental earnings) or excess burden (an economic measure of the distortions caused by taxes). Effects on the incomes of members of particular groups may be an important measure for certain provisions. An overview of evaluation issues by budget function. The discussion below considers the types of measures that might be useful for some major programmatic groups of tax expenditures. The discussion is intended to be illustrative and not all encompassing. However, it is premised on the assumption that the data needed to perform the analysis are available or can be developed. In practice, data availability is likely to be a major challenge, and data constraints may limit the assessment of the effectiveness of many provisions. In addition, such assessments can raise significant challenges in economic modeling. National defense. Some tax expenditures are intended to assist governmental activities. For example, tax preferences for military benefits reflect, among other things, the view that benefits such as housing, subsistence, and moving expenses are intrinsic aspects of military service, and are provided, in part, for the benefit of the employer, the U.S. Government. Tax benefits for combat service are intended to reduce tax burdens on military personnel undertaking hazardous service for the Nation. A portion of the tax expenditure associated with foreign earnings is targeted to benefit U.S. Government civilian personnel working abroad by offsetting the living costs that can be higher than those in the United States. These tax expenditures should be considered together with direct agency budget costs in making programmatic decisions. International affairs. Tax expenditures are also aimed at goals such as tax neutrality. These include the exclusion for income earned abroad by nongovernmental employees and exclusions for income of U.S.-controlled foreign corporations. Measuring the effectiveness of these provisions raises challenging issues. General science, space and technology; energy; natural resources and the environment; agriculture; and commerce and housing. A series of tax expenditures reduces the cost of investment, both in specific activities such as research and experimentation, extractive industries, and certain financial activities and more generally, through accelerated depreciation for plant and equipment. These provisions can be evaluated along a number of dimensions. For example, it could be useful to consider the strength of the incentives by measuring their effects on the cost of capital (the interest rate which investments must yield to cover their costs) and effective tax rates. The impact of these provisions on the amounts of corresponding forms of investment (e.g., 334 ANALYTICAL PERSPECTIVES research spending, exploration activity, equipment) might also be estimated. In some cases, such as research, there is evidence that the investment can provide significant positive externalities that is, economic benefits that are not reflected in the market transactions between private parties. It could be useful to quantify these externalities and compare them with the size of tax expenditures. Measures could also indicate the effects on production from these investments such as numbers or values of patents, energy production and reserves, and industrial production. Issues to be considered include the extent to which the preferences increase production (as opposed to benefitting existing output) and their cost-effectiveness relative to other policies. Analysis could also consider objectives that are more difficult to measure but still are ultimate goals, such as promoting the Nation’s technological base, energy security, environmental quality, or economic growth. Such an assessment is likely to involve tax analysis as well as consideration of non-tax matters such as market structure, scientific, and other information (such as the effects of increased domestic fuel production on imports from various regions, or the effects of various energy sources on the environment). Housing investment also benefits from tax expenditures. The imputed net rental income from owner-occupied housing is excluded from the tax base. The mortgage interest deduction and property tax deduction on personal residences also are reported as tax expenditures because the value of owner-occupied housing services is not included in a taxpayer’s taxable income. Taxpayers also may exclude up to $500,000 of the capital gains from the sale of personal residences. Measures of the effectiveness of these provisions could include their effects on increasing the extent of home ownership and the quality of housing. Similarly, analysis of the extent of accumulated inflationary gains is likely to be relevant to evaluation of the capital gains for home sales. Deductibility of State and local property taxes assists with making housing more affordable as well as easing the cost of providing community services through these taxes. Provisions intended to promote investment in rental housing could be evaluated for their effects on making such housing more available and affordable. These provisions should then be compared with alternative programs that address housing supply and demand. Transportation. Employer-provided parking is a fringe benefit that, for the most part, is excluded from taxation. The tax expenditure estimates reflect the cost of parking that is leased by employers for employees; an estimate is not currently available for the value of parking owned by employers and provided to their employees. The exclusion for employer-provided transit passes is intended to promote use of this mode of transportation, which has environmental and congestion benefits. The tax treatments of these different benefits could be compared with alternative transportation policies. Community and regional development. A series of tax expenditures is intended to promote community and regional development by reducing the costs of financing specialized infrastructure, such as airports, docks, and stadiums. Empowerment zone and enterprise community provisions are designed to promote activity in disadvantaged areas. These provisions can be compared with grants and other policies designed to spur economic development. Education, training, employment, and social services. Major provisions in this function are intended to promote post-secondary education, to offset costs of raising children, and to promote a variety of charitable activities. The education incentives can be compared with loans, grants, and other programs designed to promote higher education and training. The child credits are intended to adjust the tax system for the costs of raising children; as such, they could be compared to other Federal tax and spending policies, including related features of the tax system, such as personal exemptions (which are not defined as a tax expenditure). Evaluation of charitable activities requires consideration of the beneficiaries of these activities, who are generally not the parties receiving the tax reduction. Health. Individuals also benefit from favorable treatment of employer-provided health insurance. Measures of these benefits could include increased coverage and pooling of risks. The effects of insurance coverage on final outcome measures of actual health (e.g., infant mortality, days of work lost due to illness, or life expectancy) or intermediate outcomes (e.g., use of preventive health care or health care costs) could also be investigated. Income security, Social Security, and veterans benefits and services. Major tax expenditures in the income security function benefit retirement savings, through employer- provided pensions, individual retirement accounts, and Keogh plans. These provisions might be evaluated in terms of their effects on boosting retirement incomes, private savings, and national savings (which would include the effect on private savings as well as public savings or deficits). Interactions with other programs, including Social Security, also may merit analysis. As in the case of employer-provided health insurance, analysis of employer-provided pension programs requires imputing the value of benefits funded at the firm level to individuals. Other provisions principally affect the incomes of members of certain groups, rather than affecting incentives. For example, tax-favored treatment of Social Security benefits, certain veterans’ benefits, and deductions for the blind and elderly provide increased incomes to eligible parties. The earned-income tax credit, in contrast, should be evaluated for its effects on labor force participation as well as the income it provides lower-income workers. General purpose fiscal assistance and interest. The tax-exemption for public purpose State and local bonds reduces the costs of borrowing for a variety of purposes (borrowing for non-public purposes is reflected under 335 19. TAX EXPENDITURES 5 The determination of whether a provision is a tax expenditure is made on the basis of a broad concept of ‘‘income’’ that is larger in scope than is ‘‘income’’ as defined under general U.S. income tax principles. For that reason, the tax expenditure estimates include, for example, estimates related to the exclusion of extraterritorial income, as well as other exclusions, notwithstanding that such exclusions define income under the general rule of U.S. income taxation. other budget functions). The deductibility of certain State and local taxes reflected under this function primarily relates to personal income taxes (property tax deductibility is reflected under the commerce and housing function). Tax preferences for Puerto Rico and other U.S. possessions are also included here. These provisions can be compared with other tax and spending policies as means of benefitting fiscal and economic conditions in the States, localities, and possessions. Finally, the tax deferral for interest on U.S. savings bonds benefits savers who invest in these instruments. The extent of these benefits and any effects on Federal borrowing costs could be evaluated. The above illustrative discussion, although broad, is nevertheless incomplete, omitting important details both for the provisions mentioned and the many that are not explicitly cited. Developing a framework that is sufficiently comprehensive, accurate, and flexible to reflect the objectives and effects of the wide range of tax expenditures will be a significant challenge. OMB, Treasury, and other agencies will work together, as appropriate, to address this challenge. As indicated above, over the next few years the Executive Branch’s focus will be on the availability of the data needed to assess the effects of the tax expenditures designed to increase savings. Descriptions of Income Tax Provisions Descriptions of the individual and corporate income tax expenditures reported upon in this chapter follow. These descriptions relate to current law as of December 31, 2004, and do not reflect proposals made elsewhere in the Budget. Nine additional provisions are considered when compared to the 2005 Budget. These are: (1) Expensing of capital costs with respect to complying with EPA sulfur regulations, (2) Exclusion of gain or loss on sale or exchange of certain brownfield sites, (3) Bio-Diesel tax credit, (4) Imputed net rental income on owner occupied housing, (5) Deduction for US production activities, (6) Special rules for certain film and TV production, (7) Tax credit for certain expenditures for maintaining railroad tracks, (8) Deferral of capital gains with respect of dispositions of transmission property, and (9) Discharge of student loan indebtedness. National Defense 1. Benefits and allowances to armed forces personnel.— The housing and meals provided military personnel, either in cash or in kind, as well as certain amounts of pay related to combat service, are excluded from income subject to tax. International Affairs 2. Income earned abroad.—U.S. citizens who lived abroad, worked in the private sector, and satisfied a foreign residency requirement may exclude up to $80,000 in foreign earned income from U.S. taxes. In addition, if these taxpayers receive a specific allowance for foreign housing from their employers, they may also exclude the value of that allowance. If they do not receive a specific allowance for housing expenses, they may deduct against their U.S. taxes that portion of such expenses that exceeds one-sixth the salary of a civil servant at grade GS-14, step 1 ($74,335 in 2004). 3. Exclusion of certain allowances for Federal employees abroad.—U.S. Federal civilian employees and Peace Corps members who work outside the continental United States are allowed to exclude from U.S. taxable income certain special allowances they receive to compensate them for the relatively high costs associated with living overseas. The allowances supplement wage income and cover expenses like rent, education, and the cost of travel to and from the United States. 4. Extraterritorial income exclusion. 5—For purposes of calculating U.S. tax liability, a taxpayer may exclude from gross income the qualifying foreign trade income attributable to foreign trading gross receipts. The exclusion generally applies to income from the sale or lease of qualifying foreign trade property and certain types of services income. The FSC Repeal and Extraterritorial Income Exclusion Act of 2000 created the extraterritorial income exclusion to replace the foreign sales corporation provisions, which the Act repealed. The exclusion is generally available for transactions entered into after September 30, 2000. 5. Sales source rule exceptions.—The worldwide income of U.S. persons is taxable by the United States and a credit for foreign taxes paid is allowed. The amount of foreign taxes that can be credited is limited to the pre-credit U.S. tax on the foreign source income. The sales source rules for inventory property allow U.S. exporters to use more foreign tax credits by allowing the exporters to attribute a larger portion of their earnings abroad than would be the case if the allocation of earnings was based on actual economic activity. 6. Income of U.S.-controlled foreign corporations.— The income of foreign corporations controlled by U.S. shareholders is not subject to U.S. taxation. The income becomes taxable only when the controlling U.S. shareholders receive dividends or other distributions from their foreign stockholding. Under the normal tax method, the currently attributable foreign source pre-tax income from such a controlling interest is considered to be subject to U.S. taxation, whether or not distributed. Thus, the normal tax method considers the amount of controlled foreign corporation income not yet distributed to a U.S. shareholder as tax-deferred income. 7. Exceptions under subpart F for active financing income.—Financial firms can defer taxes on income earned overseas in an active business. Taxes on income earned through December 31, 2006 can be deferred. 336 ANALYTICAL PERSPECTIVES General Science, Space, and Technology 8. Expensing R&E expenditures.—Research and experimentation (R&E) projects can be viewed as investments because, if successful, their benefits accrue for several years. It is often difficult, however, to identify whether a specific R&E project is successful and, if successful, what its expected life will be. Under the normal tax method, the expensing of R&E expenditures is viewed as a tax expenditure. The baseline assumed for the normal tax method is that all R&E expenditures are successful and have an expected life of five years. 9. R&E credit.—The research and experimentation (R&E) credit is 20 percent of qualified research expenditures in excess of a base amount. The base amount is generally determined by multiplying a ‘‘fixed-base percentage’’ by the average amount of the company’s gross receipts for the prior four years. The taxpayer’s fixed base percentage generally is the ratio of its research expenses to gross receipts for 1984 through 1988. Taxpayers may also elect an alternative credit regime. Under the alternative credit regime the taxpayer is assigned a three-tiered fixed-base percentage that is lower than the fixed-base percentage that would otherwise apply, and the credit rate is reduced (the rates range from 2.65 percent to 3.75 percent). A 20- percent credit with a separate threshold is provided for a taxpayer’s payments to universities for basic research. The credit applies to research conducted before January 1, 2006 and extends to research conducted in Puerto Rico and the U.S. possessions. Energy 10. Exploration and development costs.—For successful investments in domestic oil and gas wells, intangible drilling costs (e.g., wages, the costs of using machinery for grading and drilling, the cost of unsalvageable materials used in constructing wells) may be expensed rather than amortized over the productive life of the property. Integrated oil companies may deduct only 70 percent of such costs and must amortize the remaining 30 percent over five years. The same rule applies to the exploration and development costs of surface stripping and the construction of shafts and tunnels for other fuel minerals. 11. Percentage depletion.—Independent fuel mineral producers and royalty owners are generally allowed to take percentage depletion deductions rather than cost depletion on limited quantities of output. Under cost depletion, outlays are deducted over the productive life of the property based on the fraction of the resource extracted. Under percentage depletion, taxpayers deduct a percentage of gross income from mineral production at rates of 22 percent for uranium; 15 percent for oil, gas and oil shale; and 10 percent for coal. The deduction is limited to 50 percent of net income from the property, except for oil and gas where the deduction can be 100 percent of net property income. Production from geothermal deposits is eligible for percentage depletion at 65 percent of net income, but with no limit on output and no limitation with respect to qualified producers. Unlike depreciation or cost depletion, percentage depletion deductions can exceed the cost of the investment. 12. Alternative fuel production credit.—A nontaxable credit of $3 per oil-equivalent barrel of production (in 1979 dollars) is provided for several forms of alternative fuels. The credit is generally available if the price of oil stays below $29.50 (in 1979 dollars). The credit generally expires on December 31, 2002. 13. Oil and gas exception to passive loss limitation.— Owners of working interests in oil and gas properties are exempt from the ‘‘passive income’’ limitations. As a result, the working interest-holder, who manages on behalf of himself and all other owners the development of wells and incurs all the costs of their operation, may aggregate negative taxable income from such interests with his income from all other sources. 14. Capital gains treatment of royalties on coal.—Sales of certain coal under royalty contracts can be treated as capital gains rather than ordinary income. 15. Energy facility bonds.—Interest earned on State and local bonds used to finance construction of certain energy facilities is tax-exempt. These bonds are generally subject to the State private-activity bond annual volume cap. 16. Enhanced oil recovery credit.—A credit is provided equal to 15 percent of the taxpayer’s costs for tertiary oil recovery on U.S. projects. Qualifying costs include tertiary injectant expenses, intangible drilling and development costs on a qualified enhanced oil recovery project, and amounts incurred for tangible depreciable property. 17. New technology credits.—A credit of 10 percent is available for investment in solar and geothermal energy facilities. In addition, a credit of 1.5 cents (indexed for inflation) is provided per kilowatt hour of electricity produced from certain renewable resources. Generally, qualifying sources include wind, closed-loop biomass, open-loop biomass including agricultural livestock waste nutrients, geothermal energy, solar energy, small irrigation, landfill gas, and trash combustion used to produce electricity at a facility placed in service before January 1, 2006. For facilities using open-loop biomass, small irrigation, landfill gas, or trash combustion, the credit rate is reduced by half. In addition, refined coal produced at a facility placed in service before January 1, 2009 cn claim a credit at a rate of $4.375 per ton (indexed for inflation). 18. Alcohol fuel credits.—An income tax credit is provided for ethanol that is derived from renewable sources and used as fuel. The credit equals 53 cents per gallon in 2001 and 2002; 52 cents per gallon in 2003 and 2004; and 51 cents per gallon through 2010. To the extent that ethanol is mixed with taxable motor fuel to create gasohol, taxpayers may claim an exemption of the Federal excise tax rather than the income tax credit. In addition, small ethanol producers are eligible for a separate 10 cents per gallon credit. 19. Credit and deduction for clean-fuel vehicles and property.—A tax credit of 10 percent (not to ex337 19. TAX EXPENDITURES ceed $4,000) is provided for purchasers of electric vehicles. Purchasers of other clean-fuel burning vehicles and owners of clean-fuel refueling property may deduct part of their expenditures. The deduction and credit are reduced by 75 percent for vehicles placed in service in 2006 and are not available for vehicles placed in service after December 31, 2006. 20. Exclusion of utility conservation subsidies.— Non-business customers can exclude from gross income subsidies received from public utilities for expenditures on energy conservation measures. Natural Resources and Environment 21. Exploration and development costs.—Certain capital outlays associated with exploration and development of nonfuel minerals may be expensed rather than depreciated over the life of the asset. 22. Percentage depletion.—Most nonfuel mineral extractors may use percentage depletion rather than cost depletion, with percentage depletion rates ranging from 22 percent for sulfur to 5 percent for sand and gravel. 23. Sewage, water, solid and hazardous waste facility bonds.—Interest earned on State and local bonds used to finance the construction of sewage, water, or hazardous waste facilities is tax-exempt. These bonds are generally subject to the State private-activity bond annual volume cap. 24. Capital gains treatment of certain timber.— Certain timber sales can be treated as a capital gain rather than ordinary income. 25. Expensing multiperiod timber growing costs.—Most of the production costs of growing timber may be expensed rather than capitalized and deducted when the timber is sold. In most other industries, these costs are capitalized under the uniform capitalization rules. 26. Historic preservation.—Expenditures to preserve and restore historic structures qualify for a 20- percent investment credit, but the depreciable basis must be reduced by the full amount of the credit taken. 27. Expensing of capital costs with respect to complying with EPA sulfur regulations.—Small refiners are allowed to deduct 75 percent of qualified capital costs incurred by the taxpayer during the taxable year. This provision was introduced by the American Jobs Creation Act (AJCA) enacted in 2004. 28. Exclusion of gain or loss on sale or exchange of certain brownfield sites.—This provision was introduced by the AJCA enacted in 2004. This exclusion applies to taxpayers who have incurred remediation expenditures in an amount which exceeds the greater of $550,000 or 12 percent of the fair market value of the property at the time such property was acquired by the eligible taxpayer, determined as if there were not a presence of a hazardous substance, pollutant, or contaminant on the property which is complicating the expansion, redevelopment, or reuse of the property. Agriculture 29. Expensing certain capital outlays.—Farmers, except for certain agricultural corporations and partnerships, are allowed to expense certain expenditures for feed and fertilizer, as well as for soil and water conservation measures. Expensing is allowed, even though these expenditures are for inventories held beyond the end of the year, or for capital improvements that would otherwise be capitalized. 30. Expensing multiperiod livestock and crop production costs.—The production of livestock and crops with a production period of less than two years is exempt from the uniform cost capitalization rules. Farmers establishing orchards, constructing farm facilities for their own use, or producing any goods for sale with a production period of two years or more may elect not to capitalize costs. If they do, they must apply straight-line depreciation to all depreciable property they use in farming. 31. Loans forgiven solvent farmers.—Farmers are forgiven the tax liability on certain forgiven debt. Normally, debtors must include the amount of loan forgiveness as income or reduce their recoverable basis in the property to which the loan relates. If the debtor elects to reduce basis and the amount of forgiveness exceeds the basis in the property, the excess forgiveness is taxable. For insolvent (bankrupt) debtors, however, the amount of loan forgiveness reduces carryover losses, then unused credits, and then basis; any remainder of the forgiven debt is excluded from tax. Farmers with forgiven debt are considered insolvent for tax purposes, and thus qualify for income tax forgiveness. 32. Capital gains treatment of certain income.— Certain agricultural income, such as unharvested crops, can be treated as capital gains rather than ordinary income. 33. Income averaging for farmers.—Taxpayers can lower their tax liability by averaging, over the prior three-year period, their taxable income from farming and fishing. 34. Deferral of gain on sales of farm refiners.— A taxpayer who sells stock in a farm refiner to a farmers’ cooperative can defer recognition of gain if the taxpayer reinvests the proceeds in qualified replacement property. 35. Bio-Diesel tax credit.—An income tax credit of $0.50, similar to Ethanol benefits, is available for each gallon of biodiesel used or sold. Biodiesel derived from virgin sources (agri-biodiesel) receives an increased credit of $1.00 per gallon. The provision was introduced by the AJCA in 2004, and is set to expire on after December 31, 2006. Commerce and Housing This category includes a number of tax expenditure provisions that also affect economic activity in other functional categories. For example, provisions related to investment, such as accelerated depreciation, could be classified under the energy, natural resources and environment, agriculture, or transportation categories. 338 ANALYTICAL PERSPECTIVES 36. Credit union income.—The earnings of credit unions not distributed to members as interest or dividends are exempt from income tax. 37. Bad debt reserves.—Small (less than $500 million in assets) commercial banks, mutual savings banks, and savings and loan associations may deduct additions to bad debt reserves in excess of actually experienced losses. 38. Deferral of income on life insurance and annuity contracts.—Favorable tax treatment is provided for investment income within qualified life insurance and annuity contracts. Investment income earned on qualified life insurance contracts held until death is permanently exempt from income tax. Investment income distributed prior to the death of the insured is tax-deferred, if not tax-exempt. Investment income earned on annuities is treated less favorably than income earned on life insurance contracts, but it benefits from tax deferral without annual contribution or income limits generally applicable to other tax-favored retirement income plans. 39. Small property and casualty insurance companies.— For taxable years beginning before January 1, 2004, insurance companies that were not life insurance companies and which had annual net premiums of less than $350,000 were exempt from tax; those with $350,000 to $1.2 million of annual net premiums could elect to pay tax only on the income earned by their taxable investment portfolio. For taxable years beginning after December 31, 2003, stock non-life insurance companies are generally exempt from tax if their gross receipts for the taxable year do not exceed $600,00 and more than 50 percent of such gross receipts consists of premiums. Mutual non-life insurance companies are generally tax-exempt if their annual gross receipts do not exceed $150,000 and more than 35 percent of gross receipts consist of premiums. Also, for taxable years beginning after December 31, 2003, non-life insurance companies with no more than $1.2 million of annual net premiums may elect to pay tax only on their taxable investment income. 40. Insurance companies owned by exempt organizations.— Generally, the income generated by life and property and casualty insurance companies is subject to tax, albeit by special rules. Insurance operations conducted by such exempt organizations as fraternal societies and voluntary employee benefit associations, however, are exempt from tax. 41. Small life insurance company deduction.— Small life insurance companies (gross assets of less than $500 million) can deduct 60 percent of the first $3 million of otherwise taxable income. The deduction phases out for otherwise taxable income between $3 million and $15 million. 42. Mortgage housing bonds.—Interest earned on State and local bonds used to finance homes purchased by first-time, low-to-moderate-income buyers is tax-exempt. The amount of State and local tax-exempt bonds that can be issued to finance these and other private activity is limited. The combined volume cap for private activity bonds, including mortgage housing bonds, rental housing bonds, student loan bonds, and industrial development bonds was $62.50 per capita ($187.5 million minimum) per State in 2001, and $75 per capita ($225 million minimum) in 2002. The Community Renewal Tax Relief Act of 2000 accelerated the scheduled increase in the state volume cap and indexed the cap for inflation, beginning in 2003. States may issue mortgage credit certificates (MCCs) in lieu of mortgage revenue bonds. MCCs entitle home buyers to income tax credits for a specified percentage of interest on qualified mortgages. The total amount of MCCs issued by a State cannot exceed 25 percent of its annual ceiling for mortgage- revenue bonds. 43. Rental housing bonds.—Interest earned on State and local government bonds used to finance multifamily rental housing projects is tax-exempt. At least 20 percent (15 percent in targeted areas) of the units must be reserved for families whose income does not exceed 50 percent of the area’s median income; or 40 percent for families with incomes of no more than 60 percent of the area median income. Other tax-exempt bonds for multifamily rental projects are generally issued with the requirement that all tenants must be low or moderate income families. Rental housing bonds are subject to the volume cap discussed in the mortgage housing bond section above. 44. Interest on owner-occupied homes.—Owner-occupants of homes may deduct mortgage interest on their primary and secondary residences as itemized nonbusiness deductions. The mortgage interest deduction is limited to interest on debt no greater than the owner’s basis in the residence and, for debt incurred after October 13, 1987; it is limited to no more than $1 million. Interest on up to $100,000 of other debt secured by a lien on a principal or second residence is also deductible, irrespective of the purpose of borrowing, provided the debt does not exceed the fair market value of the residence. Mortgage interest deductions on personal residences are tax expenditures because the value of owner-occupied housing services is not included in a taxpayer’s taxable income. 45. Taxes on owner-occupied homes.—Owner-occupants of homes may deduct property taxes on their primary and secondary residences even though they are not required to report the value of owner-occupied housing services as gross income. 46. Installment sales.—Dealers in real and personal property (i.e., sellers who regularly hold property for sale or resale) cannot defer taxable income from installment sales until the receipt of the loan repayment. Nondealers (i.e., sellers of real property used in their business) are required to pay interest on deferred taxes attributable to their total installment obligations in excess of $5 million. Only properties with sales prices exceeding $150,000 are includable in the total. The payment of a market rate of interest eliminates the benefit of the tax deferral. The tax exemption for nondealers with total installment obligations of less than $5 million is, therefore, a tax expenditure. 339 19. TAX EXPENDITURES 47. Capital gains exclusion on home sales.—A homeowner can exclude from tax up to $500,000 ($250,000 for singles) of the capital gains from the sale of a principal residence. The exclusion may not be used more than once every two years. 48. Imputed net rental income on owner occupied housing.—The implicit rental value of home ownership, net of expenses such as mortgage interest and depreciation, is excluded from income. The appendix provides a greater explanation of this new addition to the tax expenditure budget. 49. Passive loss real estate exemption.—In general, passive losses may not offset income from other sources. Losses up to $25,000 attributable to certain rental real estate activity, however, are exempt from this rule. 50. Low-income housing credit.—Taxpayers who invest in certain low-income housing are eligible for a tax credit. The credit rate is set so that the present value of the credit is equal to 70 percent for new construction and 30 percent for (1) housing receiving other Federal benefits (such as tax-exempt bond financing), or (2) substantially rehabilitated existing housing. The credit is allowed in equal amounts over 10 years. State agencies determine who receives the credit; States are limited in the amount of credit they may authorize annually. The Community Renewal Tax Relief Act of 2000 increased the per-resident limit to $1.50 in 2001 and to $1.75 in 2002 and indexed the limit for inflation, beginning in 2003. The Act also created a $2 million minimum annual cap for small States beginning in 2002; the cap is indexed for inflation, beginning in 2003. 51. Accelerated depreciation of rental property.— The tax depreciation allowance provisions are part of the reference law rules, and thus do not give rise to tax expenditures under the reference method. Under the normal tax method, however, economic depreciation is assumed. This calculation is described in more detail in the Appendix. 52. Cancellation of indebtedness.—Individuals are not required to report the cancellation of certain indebtedness as current income. If the canceled debt is not reported as current income, however, the basis of the underlying property must be reduced by the amount canceled. 53. Imputed interest rules.—Holders (issuers) of debt instruments are generally required to report interest earned (paid) in the period it accrues, not when paid. In addition, the amount of interest accrued is determined by the actual price paid, not by the stated principal and interest stipulated in the instrument. In general, any debt associated with the sale of property worth less than $250,000 is excepted from the general interest accounting rules. This general $250,000 exception is not a tax expenditure under reference law but is under normal law. Exceptions above $250,000 are a tax expenditure under reference law; these exceptions include the following: (1) sales of personal residences worth more than $250,000, and (2) sales of farms and small businesses worth between $250,000 and $1 million. 54. Capital gains (other than agriculture, timber, iron ore, and coal).—Capital gains on assets held for more than 1 year are taxed at a lower rate than ordinary income. Under the revised reference law baseline used for the 2005 Budget, the lower rate on capital gains is considered a tax expenditure under the reference law method, but only for capital gains that have not been previously taxed under the corporate income tax. As discussed above, this treatment partially adjusts for the double tax on corporate income and is more consistent with a comprehensive income tax base. Prior to passage of the Jobs Growth Tax Relief Reconciliation Act (JGTRRA), the top capital gains tax rate for most assets held for more than 1 year was 20 percent. For assets acquired after December 31, 2000, the top capital gains tax rate for assets held for more than 5 years was 18 percent. Since January 1, 2001, taxpayers may mark-to-market existing assets to start the 5-year holding period. Losses from the mark-to-market are not recognized. For assets held for more than 1 year by taxpayers in the 15-percent ordinary tax bracket, the top capital gains tax rate was 10 percent. After December 31, 2000, the top capital gains tax rate for assets held by these taxpayers for more than 5 years was 8 percent. JGTRRA reduced the previous 20 percent and 18 percent rates on net capital gains to 15 percent and the previous 10 percent and 8 percent rates to 5 percent (0 percent, in 2008). The lower rates apply to assets held for more than one year. The lower rates apply to assets sold after May 6, 2003 through 2008. 55. Capital gains exclusion for small business stock.—An exclusion of 50 percent is provided for capital gains from qualified small business stock held by individuals for more than 5 years. A qualified small business is a corporation whose gross assets do not exceed $50 million as of the date of issuance of the stock. 56. Step-up in basis of capital gains at death.— Capital gains on assets held at the owner’s death are not subject to capital gains taxes. The cost basis of the appreciated assets is adjusted upward to the market value at the owner’s date of death. After repeal of the estate tax for 2010 under the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001, the basis for property acquired from a decedent will be the lesser of fair market value or the decedent’s basis. Certain types of additions to basis will be allowed so that assets in most estates that are not currently subject to estate tax will not be subject to capital gains tax in the hands of the heirs. 57. Carryover basis of capital gains on gifts.— When a gift is made, the donor’s basis in the transferred property (the cost that was incurred when the transferred property was first acquired) carries-over to the donee. The carryover of the donor’s basis allows a continued deferral of unrealized capital gains. Even though the estate tax is repealed for 2010 under 340 ANALYTICAL PERSPECTIVES EGTRRA, the gift tax is retained with a lifetime exemption of $1 million. 58. Ordinary income treatment of losses from sale of small business corporate stock shares.— Up to $100,000 in losses from the sale of small business corporate stock (capitalization less than $1 million) may be treated as ordinary losses. Such losses would, thus, not be subject to the $3,000 annual capital loss writeoff limit. 59. Accelerated depreciation of non-rental-housing buildings.—The tax depreciation allowance provisions are part of the reference law rules, and thus do not give rise to tax expenditures under reference law. Under normal law, however, economic depreciation is assumed. This calculation is described in more detail in the Appendix. 60. Accelerated depreciation of machinery and equipment.—The tax depreciation allowance provisions are part of the reference law rules, and thus do not give rise to tax expenditures under reference law. Under the normal tax baseline, this tax depreciation allowance is measured relative to economic depreciation. This calculation is described in more detail in the Appendix. 61. Expensing of certain small investments.—As of 2003, under prior law, qualifying investments in tangible property up to $25,000 could have been expensed rather than depreciated over time. The amount eligible for expensing was decreased to the extend the taxpayer’s qualifying investment during the year exceeded $200,000. For 2003, however, the expensing limit was temporarily increased to $100,000, the phase-out limit was temporarily increased to $400,000, and computer software became temporarily eligible for expensing treatment. For 2004, through 2007, these higher limits are indexed for inflation, and computer software continues to be an eligible investment. In all years, the amount expensed cannot exceed the taxpayer’s taxable income for the year. The prior rules will apply for taxable years beginning after 2007. 62. Business start-up costs.—Business start-up costs are costs incurred prior to the creation of an active trade or business that would be deductible if incurred in connection with the operation of an existing trade or business. If the start-up costs were incurred on or before October 22, 2004, a taxpayer could elect to amortize them over 60 months. For costs incurred after that date, a taxpayer may elect to deduct up to $5,000 of start-up costs, but this deductible amount is reduced (but now below zero) by the amount by which the taxpayer’s total start-up costs for the year exceed $50,000. Non-deducted start-up costs incurred after October 22, 2004 are amortized over a 15-year period. The normal-tax method treats the 60-month amortized amounts and the deducted amounts as tax expenditures; the reference tax method does not. 63. Graduated corporation income tax rate schedule.—The corporate income tax schedule is graduated, with rates of 15 percent on the first $50,000 of taxable income, 25 percent on the next $25,000, and 34 percent on the next $9.925 million. Compared with a flat 34-percent rate, the lower rates provide an $11,750 reduction in tax liability for corporations with taxable income of $75,000. This benefit is recaptured for corporations with taxable incomes exceeding $100,000 by a 5-percent additional tax on corporate incomes in excess of $100,000 but less than $335,000. The corporate tax rate is 35 percent on income over $10 million. Compared with a flat 35-percent tax rate, the 34-percent rate provides a $100,000 reduction in tax liability for corporations with taxable incomes of $10 million. This benefit is recaptured for corporations with taxable incomes exceeding $15 million by a 3- percent additional tax on income over $15 million but less than $18.33 million. Because the corporate rate schedule is part of reference tax law, it is not considered a tax expenditure under the reference method. A flat corporation income tax rate is taken as the baseline under the normal tax method; therefore the lower rates is considered a tax expenditure under this concept. 64. Small issue industrial development bonds.— Interest earned on small issue industrial development bonds (IDBs) issued by State and local governments to finance manufacturing facilities is tax-exempt. Depreciable property financed with small issue IDBs must be depreciated, however, using the straight-line method. The annual volume of small issue IDBs is subject to the unified volume cap discussed in the mortgage housing bond section above. 65. Deduction for U.S. production activities.— This provision was introduced by the AJCA in 2004 and allows for a deduction equal to a portion of taxable income attributable to domestic production. For taxable years beginning in 2004, 2005, 2006, 2007, and 2008, the amount of the deduction is 5, 5, 5, 6, and 7 percent, respectively. For taxable years beginning after 2008, the amount of the deduction is 9 percent. 66. Special rules for certain film and TV production.— Taxpayers may deduct up to $15 million ($15 million in certain distressed areas) per production expenditures in the year incurred. Excess expenditures may be deducted over three years using the straight line method. This provision was introduced by the AJCA enacted in 2004. Under prior law, production expenses were depreciated. Transportation 67. Deferral of tax on U.S. shipping companies.— Certain companies that operate U.S. flag vessels can defer income taxes on that portion of their income used for shipping purposes, primarily construction, modernization and major repairs to ships, and repayment of loans to finance these investments. Once indefinite, the deferral has been limited to 25 years since January 1, 1987. 68. Exclusion of employee parking expenses.— Employee parking expenses that are paid for by the employer or that are received in lieu of wages are excludable from the income of the employee. In 2004, 341 19. TAX EXPENDITURES the maximum amount of the parking exclusion is $195 (indexed) per month. The tax expenditure estimate does not include parking at facilities owned by the employer. 69. Exclusion of employee transit pass expenses.— Transit passes, tokens, fare cards, and vanpool expenses paid for by an employer or provided in lieu of wages to defray an employee’s commuting costs are excludable from the employee’s income. In 2005, the maximum amount of the exclusion is $105 (indexed) per month. 70. Tax credit for certain expenditures for maintaining railroad tracks.—Eligible taxpayers may claim a credit equal to the lesser of 50 percent of maintenance expenditures and the product of $3,500 and the number of miles of track owned or leased. This provision was introduced by the AJCA in 2004. Community and Regional Development 71. Rehabilitation of structures.—A 10-percent investment tax credit is available for the rehabilitation of buildings that are used for business or productive activities and that were erected before 1936 for other than residential purposes. The taxpayer’s recoverable basis must be reduced by the amount of the credit. 72. Airport, dock, and similar facility bonds.— Interest earned on State and local bonds issued to finance high-speed rail facilities and government-owned airports, docks, wharves, and sport and convention facilities is tax-exempt. These bonds are not subject to a volume cap. 73. Exemption of income of mutuals and cooperatives.— The incomes of mutual and cooperative telephone and electric companies are exempt from tax if at least 85 percent of their revenues are derived from patron service charges. 74. Empowerment zones, enterprise communities, and renewal communities.—Qualifying businesses in designated economically depressed areas can receive tax benefits such as an employer wage credit, increased expensing of investment in equipment, special tax-exempt financing, accelerated depreciation, and certain capital gains incentives. The Job Creation and Worker Assistance Act of 2002 expanded the existing provisions by adding the ‘‘New York City Liberty Zone.’’ In addition, the Working Families Tax Relief Act of 2004 extended the District of Columbia Enterprise Zone and the District of Columbia first time homebuyer credit by two years through 2005. 75. New markets tax credit.—Taxpayers who invest in a community development entity (CDE) after December 31, 2000 are eligible for a tax credit. The total equity investment available for the credit across all CDEs is $1.0 billion in 2001, $1.5 billion in 2002 and 2003, $2.0 billion in 2004 and 2005, and $3.5 billion in 2006 and 2007. The amount of the credit equals (1) 5 percent in the year of purchase and the following 2 years, and (2) 6 percent in the following 4 years. A CDE is any domestic firm whose primary mission is to serve or provide investment capital for low-income communities/individuals; a CDE must be accountable to residents of low-income communities. The Community Renewal Tax Relief Act of 2000 created the new markets tax credit. 76. Expensing of environmental remediation costs.—Taxpayers who clean up certain hazardous substances at a qualified site may expense the clean-up costs, rather than capitalize the costs, even though the expenses will generally increase the value of the property significantly or appreciably prolong the life of the property. The Working Families Tax Relief Act of 2004 extended this provision for two years, allowing remediation expenditures incurred before December 31, 2005 to be eligible for expensing. 77. Deferral of capital gains with respect of dispositions of transmission property.—This provision, introduced by the AJCA, provides for the deferral of gains from sales or dispositions to implement Federal Energy Regulatory Commission or State electric restructuring policy. Education, Training, Employment, and Social Services 78. Scholarship and fellowship income.—Scholarships and fellowships are excluded from taxable income to the extent they pay for tuition and course-related expenses of the grantee. Similarly, tuition reductions for employees of educational institutions and their families are not included in taxable income. From an economic point of view, scholarships and fellowships are either gifts not conditioned on the performance of services, or they are rebates of educational costs. Thus, under the reference law method, this exclusion is not a tax expenditure because this method does not include either gifts or price reductions in a taxpayer’s gross income. The exclusion, however, is considered a tax expenditure under the normal tax method, which includes gift-like transfers of Government funds in gross income (many scholarships are derived directly or indirectly from Government funding). 79. HOPE tax credit.—The non-refundable HOPE tax credit allows a credit for 100 percent of an eligible student’s first $1,000 of tuition and fees and 50 percent of the next $1,000 of tuition and fees. The credit only covers tuition and fees paid during the first two years of a student’s post-secondary education. In 2004, the credit is phased out ratably for taxpayers with modified AGI between $85,000 and $105,000 ($42,000 and $52,000 for singles), indexed. 80. Lifetime Learning tax credit.—The non-refundable Lifetime Learning tax credit allows a credit for 20 percent of an eligible student’s tuition and fees. For tuition and fees paid after December 31, 2002, the maximum credit per return is $2,000. The credit is phased out ratably for taxpayers with modified AGI between $85,000 and $105,000 ($42,000 and $52,000 for singles) (indexed beginning in 2002). The credit applies to both undergraduate and graduate students. 81. Deduction for Higher Education Expenses.— The maximum annual deduction for qualified higher education expenses is $4,000 in 2004 for taxpayers with 342 ANALYTICAL PERSPECTIVES adjusted gross income up to $130,000 on a joint return ($65,000 for singles). Taxpayers with adjusted gross income up to $160,000 on a joint return ($80,000 for singles) may deduct up to $2,000 beginning in 2004. No deduction is allowed for expenses paid after December 31, 2005. 82. Education Individual Retirement Accounts.— Contributions to an education IRA are not tax-deductible. Investment income earned by education IRAs is not taxed when earned, and investment income from an education IRA is tax-exempt when withdrawn to pay for a student’s tuition and fees. The maximum contribution to an education IRA in 2004 is $2000 per beneficiary. The maximum contribution is phased down ratably for taxpayers with modified AGI between $190,000 and $220,000 ($95,000 and $110,000 for singles). 83. Student-loan interest.—Taxpayers may claim an above-the-line deduction of up to $2,500 on interest paid on an education loan. Interest may only be deducted for the first five years in which interest payments are required. In 2004, the maximum deduction is phased down ratably for taxpayers with modified AGI between $100,000 and $130,000 ($50,000 and $65,000 for singles), indexed. 84. State prepaid tuition plans.—Some States have adopted prepaid tuition plans and prepaid room and board plans, which allow persons to pay in advance for college expenses for designated beneficiaries. In 2001 taxes on the earnings from these plans are paid by the beneficiaries and are deferred until tuition is actually paid. Beginning in 2002, investment income is not taxed when earned, and is tax-exempt when withdrawn to pay for qualified expenses. 85. Student-loan bonds.—Interest earned on State and local bonds issued to finance student loans is taxexempt. The volume of all such private activity bonds that each State may issue annually is limited. 86. Bonds for private nonprofit educational institutions.— Interest earned on State and local Government bonds issued to finance the construction of facilities used by private nonprofit educational institutions is not taxed. 87. Credit for holders of zone academy bonds.— Financial institutions that own zone academy bonds receive a non-refundable tax credit (at a rate set by the Treasury Department) rather than interest. The credit is included in gross income. Proceeds from zone academy bonds may only be used to renovate, but not construct, qualifying schools and for certain other school purposes. The total amount of zone academy bonds that may be issued is limited to $1.6 billion— $400 million in each year from 1998 to 2005. 88. U.S. savings bonds for education.—Interest earned on U.S. savings bonds issued after December 31, 1989 is tax-exempt if the bonds are transferred to an educational institution to pay for educational expenses. The tax exemption is phased out for taxpayers with AGI between $89,750 and $119.750 ($59,850 and $74,850 for singles) in 2004. 89. Dependent students age 19 or older.—Taxpayers may claim personal exemptions for dependent children age 19 or over who (1) receive parental support payments of $1,000 or more per year, (2) are full-time students, and (3) do not claim a personal exemption on their own tax returns. 90. Charitable contributions to educational institutions.— Taxpayers may deduct contributions to nonprofit educational institutions. Taxpayers who donate capital assets to educational institutions can deduct the asset’s current value without being taxed on any appreciation in value. An individual’s total charitable contribution generally may not exceed 50 percent of adjusted gross income; a corporation’s total charitable contributions generally may not exceed 10 percent of pre-tax income. 91. Employer-provided educational assistance.— Employer-provided educational assistance is excluded from an employee’s gross income even though the employer’s costs for this assistance are a deductible business expense. EGTRRA permanently extended this exclusion and extended the exclusion to also include graduate education (beginning in 2002). 92. Special deduction for teacher expenses.—Educators in both public and private elementary and secondary schools, who work at least 900 hours during a school year as a teacher, instructor, counselor, principal or aide, may subtract up to $250 of qualified expenses when figuring their adjusted gross income (AGI). 93. Discharge of student loan indebtedness.—Certain professionals who perform in underserved areas, and as a consequence get their student loans discharged, may not recognize such discharge as income. This provision was expanded by the AJCA to include health professionals. 94. Work opportunity tax credit.—Employers can claim a tax credit for qualified wages paid to individuals who begin work on or before December 31, 2005 and who are certified as members of various targeted groups. The amount of the credit that can be claimed is 25 percent for employment of less than 400 hours and 40 percent for employment of 400 hours or more. The maximum credit per employee is $2,400 and can only be claimed on the first year of wages an individual earns from an employer. Employers must reduce their deduction for wages paid by the amount of the credit claimed. 95. Welfare-to-work tax credit.—An employer is eligible for a tax credit on the first $20,000 of eligible wages paid to qualified long-term family assistance recipients during the first two years of employment. The credit is 35 percent of the first $10,000 of wages in the first year of employment and 50 percent of the first $10,000 of wages in the second year of employment. The maximum credit is $8,500 per employee. The credit applies to wages paid to employees who are hired on or before December 31, 2005. 96. Employer-provided child care exclusion.—Up to $5,000 of employer-provided child care is excluded from an employee’s gross income even though the em343 19. TAX EXPENDITURES ployer’s costs for the child care are a deductible business expense. 97. Employer-provided child care credit.—Employers can deduct expenses for supporting child care or child care resource and referral services. EGTRRA provides a tax credit to employers for qualified expenses beginning in 2002. The credit is equal to 25 percent of qualified expenses for employee child care and 10 percent of qualified expenses for child care resource and referral services. Employer deductions for such expenses are reduced by the amount of the credit. The maximum total credit is limited to $150,000 per taxable year. 98. Assistance for adopted foster children.—Taxpayers who adopt eligible children from the public foster care system can receive monthly payments for the children’s significant and varied needs and a reimbursement of up to $2,000 for nonrecurring adoption expenses. These payments are excluded from gross income. 99. Adoption credit and exclusion.—Taxpayers can receive a nonrefundable tax credit for qualified adoption expenses. The maximum credit is $10,390 per child for 2004, and is phased-out ratably for taxpayers with modified AGI between $155,860 and $195,860. The credit amounts and the phase-out thresholds are indexed for inflation beginning in 2003. Unused credits may be carried forward and used during the five subsequent years. Taxpayers may also exclude qualified adoption expenses from income, subject to the same maximum amounts and phase-out as the credit. The same expenses cannot qualify for tax benefits under both programs; however, a taxpayer may use the benefits of the exclusion and the tax credit for different expenses. Stepchild adoptions are not eligible for either benefit. 100. Employer-provided meals and lodging.—Employer- provided meals and lodging are excluded from an employee’s gross income even though the employer’s costs for these items are a deductible business expense. 101. Child credit.—Taxpayers with children under age 17 can qualify for a $1,000 refundable per child credit. The maximum credit declines to $500 in 2011 and later years. The credit is phased out for taxpayers at the rate of $50 per $1,000 of modified AGI above $110,000 ($75,000 for singles). 102. Child and dependent care expenses.—Married couples with child and dependent care expenses may claim a tax credit when one spouse works full time and the other works at least part time or goes to school. The credit may also be claimed by single parents and by divorced or separated parents who have custody of children. Expenditures up to a maximum $3,000 for one dependent and $6,000 for two or more dependents are eligible for the credit. The credit is equal to 35 percent of qualified expenditures for taxpayers with incomes of $15,000. The credit is reduced to a minimum of 20 percent by one percentage point for each $2,000 of income in excess of $15,000. 103. Disabled access expenditure credit.—Small businesses (less than $1 million in gross receipts or fewer than 31 full-time employees) can claim a 50-percent credit for expenditures in excess of $250 to remove access barriers for disabled persons. The credit is limited to $5,000. 104. Charitable contributions, other than education and health.—Taxpayers may deduct contributions to charitable, religious, and certain other nonprofit organizations. Taxpayers who donate capital assets to charitable organizations can deduct the assets’ current value without being taxed on any appreciation in value. An individual’s total charitable contribution generally may not exceed 50 percent of adjusted gross income; a corporation’s total charitable contributions generally may not exceed 10 percent of pre-tax income. 105. Foster care payments.—Foster parents provide a home and care for children who are wards of the State, under contract with the State. Compensation received for this service is excluded from the gross incomes of foster parents; the expenses they incur are nondeductible. 106. Parsonage allowances.—The value of a minister’s housing allowance and the rental value of parsonages are not included in a minister’s taxable income. Health 107. Employer-paid medical insurance and expenses.— Employer-paid health insurance premiums and other medical expenses (including long-term care) are deducted as a business expense by employers, but they are not included in employee gross income. The self-employed also may deduct part of their family health insurance premiums. 108. Self-employed medical insurance premiums.— Self-employed taxpayers may deduct a percentage of their family health insurance premiums. Taxpayers without self-employment income are not eligible for the special percentage deduction. The deductible percentage is 60 percent in 2001, 70 percent in 2002, and 100 percent in 2003 and thereafter. 109. Medical and health savings accounts.—Some employees may deduct annual contributions to a medical savings account (MSA); employer contributions to MSAs (except those made through cafeteria plans) for qualified employees are also excluded from income. An employee may contribute to an MSA in a given year only if the employer does not contribute to the MSA in that year. MSAs are only available to self-employed individuals or employees covered under an employersponsored high deductible health plan of a small employer. The maximum annual MSA contribution is 75 percent of the deductible under the high deductible plan for family coverage (65 percent for individual coverage). Earnings from MSAs are excluded from taxable income. Distributions from an MSA for medical expenses are not taxable. The number of taxpayers who may benefit annually from MSAs is generally limited to 750,000. No new MSAs may be established after December 31, 2003. The Medicare Prescription Drug, Improvement, 344 ANALYTICAL PERSPECTIVES and Modernization Act of 2003 introduced health savings accounts (HSA) which provides a tax-favored savings for health care expenses. The definition of a highdeductible health plan is less restrictive for HSAs than for MSAs. 110. Medical care expenses.—Personal expenditures for medical care (including the costs of prescription drugs) exceeding 7.5 percent of the taxpayer’s adjusted gross income are deductible. 111. Hospital construction bonds.—Interest earned on State and local government debt issued to finance hospital construction is excluded from income subject to tax. 112. Charitable contributions to health institutions.— Individuals and corporations may deduct contributions to nonprofit health institutions. Tax expenditures resulting from the deductibility of contributions to other charitable institutions are listed under the education, training, employment, and social services function. 113. Orphan drugs.—Drug firms can claim a tax credit of 50 percent of the costs for clinical testing required by the Food and Drug Administration for drugs that treat rare physical conditions or rare diseases. 114. Blue Cross and Blue Shield.—Blue Cross and Blue Shield health insurance providers in existence on August 16, 1986 and certain other nonprofit health insurers are provided exceptions from otherwise applicable insurance company income tax accounting rules that substantially reduce (or even eliminate) their tax liabilities. 115. Tax credit for health insurance purchased by certain displaced and retired individuals.—The Trade Act of 2002 provided a refundable tax credit of 65 percent for the purchase of health insurance coverage by individuals eligible for Trade Adjustment Assistance and certain PBGC pension recipients. Income Security 116. Railroad retirement benefits.—Railroad retirement benefits are not generally subject to the income tax unless the recipient’s gross income reaches a certain threshold. The threshold is discussed more fully under the Social Security function. 117. Workers’ compensation benefits.—Workers compensation provides payments to disabled workers. These benefits, although income to the recipients, are not subject to the income tax. 118. Public assistance benefits.—Public assistance benefits are excluded from tax. The normal tax method considers cash transfers from the Government as taxable and, thus, treats the exclusion for public assistance benefits as a tax expenditure. 119. Special benefits for disabled coal miners.— Disability payments to former coal miners out of the Black Lung Trust Fund, although income to the recipient, are not subject to the income tax. 120. Military disability pensions.—Most of the military pension income received by current disabled retired veterans is excluded from their income subject to tax. 121. Employer-provided pension contributions and earnings.—Certain employer contributions to pension plans are excluded from an employee’s gross income even though the employer can deduct the contributions. In addition, the tax on the investment income earned by the pension plans is deferred until the money is withdrawn. 122. 401(k) plans.—Individual taxpayers can make tax-preferred contributions to certain types of employerprovided 401(k) plans (and 401(k)-type plans like 403(b) plans and the Federal government’s Thrift Savings Plan). In 2004, an employee could exclude up to $14,000 of wages from AGI under a qualified arrangement with an employer’s 401(k) plan. This increases to $14,000 in 2005 and $15,000 in 2006 (indexed thereafter). The tax on the investment income earned by 401(k)-type plans is deferred until withdrawn. Employees are allowed to make after-tax contributions to 401(k) and 401(k)-type plans. These contributions are not excluded from AGI, but the investment income of such after-tax contributions is not taxed when earned or withdrawn. 123. Individual Retirement Accounts.—Individual taxpayers can take advantage of several different Individual Retirement Accounts (IRAs): deductible IRAs, non-deductible IRAs, and Roth IRAs. The annual contributions limit applies to the total of a taxpayer’s deductible, non-deductible, and Roth IRAs contributions. The IRA contribution limit is $3,000 in 2004, $4,000 in 2005, and $5,000 in 2008 (indexed thereafter) and allows taxpayers over age 50 to make additional ‘‘catchup’’ contributions of $1,000 (by 2006). Taxpayers whose AGI is below $75,000 ($55,000 for non-joint filers) in 2004 can claim a deduction for IRA contributions. The IRA deduction is phased out for taxpayers with AGI between $65,000 and $75,000 ($45,000 and $55,000 for non-joint). The phase-out range increases annually until it reaches $80,000 to $100,000 in 2007 ($50,000 to $60,000 in 2005 for non-joint filers). Taxpayers whose AGI is above the phase-out range can also claim a deduction for their IRA contributions depending on whether they (or their spouse) are an active participant in an employer-provided retirement plan. The tax on the investment income earned by 401(k) plans, non-deductible IRAs, and deductible IRAs is deferred until the money is withdrawn. Taxpayers with incomes below $160,000 ($110,000 for nonjoint filers) can make contributions to Roth IRAs. The maximum contribution to a Roth IRA is phased out for taxpayers with AGI between $150,000 and $160,000 ($95,000 and $110,000 for singles). Investment income of a Roth IRA is not taxed when earned nor when withdrawn. Withdrawals from a Roth IRA are penalty free if: (1) the Roth IRA was opened at least 5 years before the withdrawal, and (2) the taxpayer either (a) is at least 591/2, (b) dies, (c) is disabled, or (d) purchases a first-time house. 345 19. TAX EXPENDITURES Taxpayers can contribute to a non-deductible IRA regardless of their income and whether they are an active participant in an employer-provided retirement plan. The tax on investment income earned by non-deductible IRAs is deferred until the money is withdrawn. 124. Low and moderate income savers’ credit.— The Tax Code provides an additional incentive for lower-income taxpayers to save through a nonrefundable credit of up to 50 percent on IRA and other retirement contributions of up to $2,000. This credit is in addition to any deduction or exclusion. The credit is completely phased out by $50,000 for joint filers and $25,000 for single filers. This temporary credit is in effect from 2002 through 2006. 125. Keogh plans.—Self-employed individuals can make deductible contributions to their own retirement (Keogh) plans equal to 25 percent of their income, up to a maximum of $40,000 in 2001. Total plan contributions are limited to 25 percent of a firm’s total wages. The tax on the investment income earned by Keogh plans is deferred until withdrawn. 126. Employer-provided life insurance benefits.— Employer-provided life insurance benefits are excluded from an employee’s gross income even though the employer’s costs for the insurance are a deductible business expense, but only to the extent that the employer’s share of the total costs does not exceed the cost of $50,000 of such insurance. 127. Small business retirement plan credit.— EGTRRA provides businesses with 100 or fewer employees a credit for 50 percent of the qualified startup costs associated with a new qualified retirement plan. The credit is limited to $500 annually and may only be claimed for expenses incurred during the first three years from the start of the qualified plan. Qualified startup expenses include expenses related to the establishment and administration of the plan, and the retirement- related education of employees. The credit applies to costs incurred beginning in 2002. 128. Employer-provided accident and disability benefits.—Employer-provided accident and disability benefits are excluded from an employee’s gross income even though the employer’s costs for the benefits are a deductible business expense. 129. Employer-provided supplementary unemployment benefits.—Employers may establish trusts to pay supplemental unemployment benefits to employees separated from employment. Interest payments to such trusts are exempt from taxation. 130. Employer Stock Ownership Plan (ESOP) provisions.—ESOPs are a special type of tax-exempt employee benefit plan. Employer-paid contributions (the value of stock issued to the ESOP) are deductible by the employer as part of employee compensation costs. They are not included in the employees’ gross income for tax purposes, however, until they are paid out as benefits. The following special income tax provisions for ESOPs are intended to increase ownership of corporations by their employees: (1) annual employer contributions are subject to less restrictive limitations; (2) ESOPs may borrow to purchase employer stock, guaranteed by their agreement with the employer that the debt will be serviced by his payment (deductible by him) of a portion of wages (excludable by the employees) to service the loan; (3) employees who sell appreciated company stock to the ESOP may defer any taxes due until they withdraw benefits; and (4) dividends paid to ESOP-held stock are deductible by the employer. 131. Additional deduction for the blind.—Taxpayers who are blind may take an additional $1,200 standard deduction if single, or $950 if married in 2004. 132. Additional deduction for the elderly.—Taxpayers who are 65 years or older may take an additional $1,200 standard deduction if single, or $950 if married in 2004. 133. Tax credit for the elderly and disabled.— Individuals who are 65 years of age or older, or who are permanently disabled, can take a tax credit equal to 15 percent of the sum of their earned and retirement income. Income is limited to no more than $5,000 for single individuals or married couples filing a joint return where only one spouse is 65 years of age or older, and up to $7,500 for joint returns where both spouses are 65 years of age or older. These limits are reduced by one-half of the taxpayer’s adjusted gross income over $7,500 for single individuals and $10,000 for married couples filing a joint return. 134. Casualty losses.—Neither the purchase of property nor insurance premiums to protect its value are deductible as costs of earning income; therefore, reimbursement for insured loss of such property is not reportable as a part of gross income. Taxpayers, however, may deduct uninsured casualty and theft losses of more than $100 each, but only to the extent that total losses during the year exceed 10 percent of AGI. 135. Earned income tax credit (EITC).—The EITC may be claimed by low income workers. For a family with one qualifying child, the credit is 34 percent of the first $7,660 of earned income in 2004. The credit is 40 percent of the first $10,750 of income for a family with two or more qualifying children. The credit is phased out beginning when the taxpayer’s income exceeds $14,040 at the rate of 15.98 percent (21.06 percent if two or more qualifying children are present). It is completely phased out when the taxpayer’s modified adjusted gross income reaches $30,338 ($34,458 if two or more qualifying children are present), $31,338 (or $35,458) for those married. The credit may also be claimed by workers who do not have children living with them. Qualifying workers must be at least age 25 and may not be claimed as a dependent on another taxpayer’s return. The credit is not available to workers age 65 or older. In 2004, the credit is 7.65 percent of the first $5,100 of earned income. When the taxpayer’s income exceeds $6,390 (7,390 if married), the credit is phased out at the rate of 7.65 percent. It is completely phased out at $11,490 ($12,490 for married) of modified adjusted gross income. 346 ANALYTICAL PERSPECTIVES For workers with or without children, the income levels at which the credit begins to phase-out and the maximum amounts of income on which the credit can be taken are adjusted for inflation. For married taxpayers filing a joint return, the base amount for the phase-out increases by $2,000 in 2005 through 2007, and $3,000 in 2008 (indexed thereafter). Earned income tax credits in excess of tax liabilities owed through the individual income tax system are refundable to individuals. This portion of the credit is shown as an outlay, while the amount that offsets tax liabilities is shown as a tax expenditure. Social Security 136. Social Security benefits for retired workers.— The non-taxation of Social Security benefits that exceed the beneficiary’s contributions out of taxed income is a tax expenditure. These additional retirement benefits are paid for partly by employers’ contributions that were not included in employees’ taxable compensation. Portions (reaching as much as 85 percent) of recipients’ Social Security and Tier 1 Railroad Retirement benefits are included in the income tax base, however, if the recipient’s provisional income exceeds certain base amounts. Provisional income is equal to adjusted gross income plus foreign or U.S. possession income and tax-exempt interest, and one half of Social Security and tier 1 railroad retirement benefits. The tax expenditure is limited to the portion of the benefits received by taxpayers who are below the base amounts at which 85 percent of the benefits are taxable. 137. Social Security benefits for the disabled.— Benefit payments from the Social Security Trust Fund for disability are partially excluded from a beneficiary’s gross incomes. 138. Social Security benefits for dependents and survivors.—Benefit payments from the Social Security Trust Fund for dependents and survivors are partially excluded from a beneficiary’s gross income. Veterans Benefits and Services 139. Veterans death benefits and disability compensation.— All compensation due to death or disability paid by the Veterans Administration is excluded from taxable income. 140. Veterans pension payments.—Pension payments made by the Veterans Administration are excluded from gross income. 141. G.I. Bill benefits.—G.I. Bill benefits paid by the Veterans Administration are excluded from gross income. 142. Tax-exempt mortgage bonds for veterans.— Interest earned on general obligation bonds issued by State and local governments to finance housing for veterans is excluded from taxable income. The issuance of such bonds is limited, however, to five pre-existing State programs and to amounts based upon previous volume levels for the period January 1, 1979 to June 22, 1984. Furthermore, future issues are limited to veterans who served on active duty before 1977. General Government 143. Public purpose State and local bonds.—Interest earned on State and local government bonds issued to finance public-purpose construction (e.g., schools, roads, sewers), equipment acquisition, and other public purposes is tax-exempt. Interest on bonds issued by Indian tribal governments for essential governmental purposes is also tax-exempt. 144. Deductibility of certain nonbusiness State and local taxes.—Taxpayers may deduct State and local income taxes and property taxes even though these taxes primarily pay for services that, if purchased directly by taxpayers, would not be deductible. 145. Business income earned in U.S. possessions.— U.S. corporations operating in a U.S. possession (e.g., Puerto Rico) can claim a credit against some or all of their U.S. tax liability on possession business income. The credit expires December 31, 2005. Interest 146. U.S. savings bonds.—Taxpayers may defer paying tax on interest earned on U.S. savings bonds until the bonds are redeemed. Appendix: TREASURY REVIEW OF THE TAX EXPENDITURE PRESENTATION This appendix provides a presentation of the Treasury Department’s continuing review of the tax expenditure budget. The review focuses on three issues: (1) using comprehensive income as a baseline tax system, (2) using a consumption tax as a baseline tax system, and (3) defining negative tax expenditures (provisions that cause taxpayers to pay too much tax). The first section of this appendix compares major tax expenditures in the current budget to those implied by a comprehensive income baseline. This comparison includes a discussion of negative tax expenditures. The second section compares the major tax expenditures in the current budget to those implied by a consumption tax baseline, and also discusses negative tax expenditures. The final section addresses concerns that have been raised over the measurement of some current tax expenditures by describing new estimates of the tax expenditure caused by accelerated depreciation and by the tax exemption of the return earned on owner-occupied housing, and an alternative estimate of the tax expenditure for the preferential treatment of capital gains. The final section also provides an estimate of the negative tax expenditure caused by the double tax on corporate profits. 347 19. TAX EXPENDITURES 6 See, e.g., David F. Bradford, Untangling the Income Tax (Cambridge, MA: Harvard University Press, 1986), pp. 15–31, and Richard Goode, ‘‘The Economic Definition of Income’’ in Joseph Pechman, ed., Comprehensive Income Taxation (Washington, D.C.: The Brookings Institution, 1977), pp. 1–29. DIFFERENCES BETWEEN OFFICIAL TAX EXPENDITURES AND THOSE BASED ON COMPREHENSIVE INCOME As discussed in the main body of the tax expenditure chapter, official tax expenditures are measured relative to normal law or reference law baselines that deviate from a uniform tax on a comprehensive concept of income. Consequently, tax expenditures identified in the budget can differ from those that would be identified if a comprehensive income tax were chosen as the baseline tax system. This appendix addresses this issue by comparing major tax expenditures listed in the current tax expenditure budget with those implied by a comprehensive income baseline. Many large tax expenditures would continue to be tax expenditures were the baseline taken to be comprehensive income, although some would be smaller. A comprehensive income baseline would also result in a number of additional tax provisions being counted as tax expenditures. Current budgetary practice excludes from the list of official tax expenditures those provisions that over-tax certain items of income. This exclusion conforms to the view that tax expenditures are substitutes for direct Government spending programs. However, this treatment gives a one-sided picture of how current law deviates from the baseline tax system. Relative to comprehensive income, a number of current tax provisions would be negative tax expenditures. Some of these also might be negative tax expenditures under the reference law or normal law baselines, expanded to admit negative tax expenditures. Treatment of Major Tax Expenditures from the Current Budget under a Comprehensive Income Tax Baseline Comprehensive income, also called Haig-Simons income, is the real, inflation adjusted, accretion to one’s economic power arising between two points in time, e.g., the beginning and ending of the year. It includes all accretions to wealth, whether or not realized, whether or not related to a market transaction, and whether a return to capital or labor. Inflation adjusted capital gains (and losses) would be included in comprehensive income as they accrue. Business, investment, and casualty losses, including losses caused by depreciation, would be deducted. Implicit returns, such as those accruing to homeowners, also would be included in comprehensive income. A comprehensive income tax baseline would tax all sources of income once. Thus, it would not include a separate tax on corporate income that leads to the double taxation of corporate profits. While comprehensive income can be defined on the sources side of the consumer’s balance sheet, it sometimes is instructive to use the identity between the sources of wealth and the uses of wealth to redefine it as the sum of consumption during the period plus the change in net worth between the beginning and the end of the period. Comprehensive income is widely held to be the idealized base for an income tax even though it is not a perfectly defined concept. 6 It suffers from conceptual ambiguities, some of which are discussed below, as well as practical problems in measurement and tax administration, e.g., how to implement a practicable deduction for economic depreciation or include in income the return earned on consumer durable goods, including housing, automobiles, and major appliances. Furthermore, comprehensive income does not necessarily represent an ideal tax base; efficiency or equity might be improved by deviating from comprehensive income as a tax base, e.g., by reducing the tax on capital income in order to further spur economic growth or by subsidizing certain types of activities in order to correct for market failures or to improve the aftertax distribution of income. In addition, some elements of comprehensive income would be difficult or impossible to include in a tax system that is administrable. Classifying individual tax provisions relative to a comprehensive income baseline is difficult, in part because of the ambiguity of the baseline. It also is difficult because of interactions between tax provisions (or their absence). These interactions mean that it may not always be appropriate to consider each provision in isolation. Nonetheless, Appendix Table 1 attempts such a classification for each of the thirty largest tax expenditures from the Budget. We classify fifteen of the thirty items as tax expenditures under a comprehensive tax base (those in panel A). Most of these give preferential tax treatment to the return on certain types of savings or investment. They are a result of the explicitly hybrid nature of the existing tax system, and arise out of policy decisions that reflect discomfort with the high tax rate on capital income that would otherwise arise under the current structure of the income tax. Even these relatively clear cut items, however, can raise ambiguities particularly in light of the absence of integration of the corporate and individual tax systems. Given current law’s corporate income tax, the reduction or elimination of individual level tax on income from investment in corporate equities might not be a tax expenditure relative to a comprehensive income baseline. Rather, an individual income tax preference might undo the corporate tax penalty (i.e., the double tax). This perspective is reflected in adjustments that have been made to the calculation of the tax expenditures for pensions and several other items in the 2006 budget (as discussed above). However, these adjustments have not been made in all tax expenditure calculations, e.g., no adjustment was made in the exclusion of interest on life insurance saving. A similar line of reasoning could be used to argue that in the case of corporations, expens348 ANALYTICAL PERSPECTIVES 7 Expensing means immediate deduction. Proper income tax treatment requires capitalization followed by annual depreciation allowances reflecting the decay in value of the associated R&E spending. 8 Suppose a taxpayer buys a one year term unemployment insurance policy at the beginning of the year. At that time he exchanges one asset, cash, for another, the insurance policy, so there is no change in net worth. But, at the end of the year, the policy expires and so is worthless, hence the taxpayer has a reduction in net worth equal to the premium. If the policy pays off during the year (i.e., the taxpayer has a work related injury), then the taxpayer would include the proceeds in income because they represent an increase in his net worth. 9 The treatment of insurance premiums and benefits is discussed more completely below. 10 If there were no deduction for interest and property taxes, the tax expenditure base (i.e., the proper tax base minus the actual tax base) for owner-occupied housing would equal the homeowner’s net rental income: gross rents—(depreciation+interest+property taxes+other expenses). With the deduction for interest and property taxes, the tax expenditure base rises to gross rents minus (depreciation+other expenses). 11 Fiscal Year 2003 Budget of the United States Government, Analytical Perspectives (Washington, D.C.: U.S. Government Printing Office, 2002) p. 127. 12 Property taxes on owner-occupied housing also might serve as a proxy for the value of untaxed local services provided to homeowners. As such, they would be listed in the tax expenditure budget (as configured, i.e., building on the estimate for the failure to tax net rents) twice, once because current law does not tax rental income and again as a proxy for government services received. Property taxes on other consumer durables such as automobiles also might be included twice, owing to current law’s exclusion from income of the associated service flow. 13 U.S. Treasury, Blueprints for Basic Tax Reform (Washington, D.C.: U.S. Government Printing Office, 1977) p. 92. 14 Under the normal tax method employed by the Joint Committee on Taxation, the value of some public assistance benefits provided by State Governments is included as a tax expenditure, thereby raising a potential double counting issue. ing 7 of R&E is not a tax expenditure because it serves to offset the corporate tax penalty. In contrast to treatment in previous budgets, the 2006 budget includes as a tax expenditure the failure to tax net rental income from owner-occupied housing. Because net rental income (gross rents minus depreciation, interest, taxes, and other expenses) would be in the homeowner’s tax base under a comprehensive income tax baseline, this item would be a tax expenditure relative to a comprehensive income baseline. The exclusion of worker’s compensation benefits also would be a tax expenditure under comprehensive income principles. Under comprehensive income tax principles, if the worker were to buy the insurance himself, he would be able to deduct the premium (since it represents a reduction in net worth) but should include in income the benefit when paid (since it represents an increase in net worth). 8 If the employer pays the premium, the proper treatment would allow the employer a deduction and allow the employee to disregard the premium, but he would take the proceeds, if any, into income. Current law allows the employer to deduct the premium and excludes both the premium and the benefits from the employee’s tax base. Veteran’s death and disability benefits seem likely to represent a tax expenditure. This is clearly the case to the extent they are seen as deferred wages or as transfers. It also is the case to the extent that they are seen as insurance benefits, since the premiums, which come in the form of foregone wages, were not included in taxable income. 9 Panel B deals with items that probably are tax expenditures, but that raise issues. Current law allows deductions for home mortgage interest and for property taxes on owner-occupied housing. The tax expenditure budget includes both of these deductions. From one perspective, these two deductions would not be considered tax expenditures relative to a comprehensive tax base; a comprehensive base would allow both deductions. However, this perspective ignores current law’s failure to impute gross rental income. Conditional on this failure, the deductions for interest and property taxes might be viewed as inappropriate, because they move the tax system away from rather than towards a comprehensive income tax base. 10 Indeed, the sum of the tax expenditure for these two deductions, plus the tax expenditure for the failure to include net rental income, sums to the tax expenditure for owner-occupied housing relative to a comprehensive income tax base. Consequently, there is a strong argument for classifying them as tax expenditures relative to a comprehensive income baseline. The deduction of nonbusiness State and local taxes other than on owner-occupied homes also is included in this section. These taxes include income, sales, and property taxes. The stated justification for this tax expenditure is that ‘‘Taxpayers may deduct State and local income taxes and property taxes even though these taxes primarily pay for services that, if purchased directly by taxpayers, would not be deductible. 11 The idea is that these taxes represent (or serve as proxies for) consumption expenditures for which current law makes no imputations to income. 12 In contrast to the view in the official Budget, however, the deduction for State and local taxes might not be a tax expenditure if the baseline were comprehensive income. Properly measured comprehensive income would include the value of State and local government benefits received, but would allow a deduction for State and local taxes paid. 13 Thus, in this sense the deductibility of State and local taxes is consistent with comprehensive income tax principles; it should not be a tax expenditure. Nonetheless, imputing the value of State and local services is difficult and is not done under current law. Consequently, a deduction for taxes might sensibly be viewed as a tax expenditure relative to a comprehensive income baseline. 14 To the extent that the personal and dependent care exemptions and the standard deduction properly remove from taxable income all expenditures that do not yield suitably discretionary consumption value, or otherwise appropriately adjust for differing taxpaying capacity, then the child care credit and the earned income tax credit would be tax expenditures. In contrast, a competing perspective views these credits as appropriate modifications that account for differing taxpaying capacity. Even accepting this competing perspective, however, one might question why these programs come in the form of credits rather than deductions. The step-up of basis at death lowers the income tax on capital gains for those who inherit assets below what it would be otherwise. From that perspective it would be a tax expenditure under a comprehensive income baseline. Nonetheless, there are ambiguities. Under a comprehensive income baseline, all real inflation adjusted gains would be taxed as accrued, so there would be no deferred unrealized gains on assets held at death. The lack of full taxation of Social Security benefits also is listed in panel B. Consider first Social Security retirement benefits. To the extent that Social Security 349 19. TAX EXPENDITURES 15 As a practical matter, this may be impossible to do. Valuing claims subject to future contingencies is very difficult, as discussed in Bradford, Untangling the Income Tax, pp. 23–24. 16 This includes the tax expenditure for benefits paid to workers, that for benefits paid to survivors and dependents, and that for benefits paid to dependents. 17 The current budget does not include as a tax expenditure the absence of income taxation on the employer’s contributions (payroll taxes) to Social Security retirement at the time these contributions are made. 18 Private pensions allow the employee to defer tax on all inside build-up. They also allow the employee to defer tax on contributions made by the employer, but not on contributions made directly by the employee. Applying these tax rules to Social Security would require the employee to include in his taxable income benefits paid out of inside buildup and out of the employer’s contributions, but would allow the employee to exclude from his taxable income benefits paid out of his own contributions. 19 See, for example, Goode, The Economic Definition of Income, pp. 16–17, and Bradford, Untangling the Income Tax, pp. 19–21, and pp.30–31. 20 The item also includes gifts of appreciated property, at least part of which represents a tax expenditure relative to an ideal income tax, even if one assumes that charitable donations are not consumption. is viewed as a pension, a comprehensive income tax would include in income all contributions to Social Security retirement funds (payroll taxes) and tax accretions to value as they arise (inside build-up). 15 Benefits paid out of prior contributions and the inside buildup, however, would not be included in the tax base because the fall in the value of the individual’s Social Security account would be offset by an increase in cash. In contrast, to the extent that Social Security is viewed as a transfer program, all contributions should be deductible from the income tax base and all benefits received should be included in the income tax base. A similar analysis applies to Social Security benefits paid to dependents and survivors. If these benefits represent transfers from the Government, then they should be included in the tax base. If the taxpaying unit consists of the worker plus dependents and survivors, then to the extent that Social Security benefits represent payments from a pension, the annual pension earnings should be taxed in the same way that earnings accruing to retirees are taxed. However, benefits paid to dependents and survivors might be viewed as a gift or transfer from the decedent, in which case the dependents and survivors should pay tax on the full amount of the benefit received. (In this case the decedent or his estate should pay tax on the pension income as well, to the extent that the gift represents consumption rather than a reduction in net worth). In addition, dependent and survivors benefits might be viewed in part as providing life insurance. In that case, the annual premiums paid each year, or the portion of Social Security taxes attributable to the premiums, should be deducted from income, since they represent a decline in net worth, while benefits should be included in income. Alternatively, taxing premiums and excluding benefits also would represent appropriate income tax policy. In contrast to any of these treatments, current law excludes one-half of Social Security contributions (employer- paid payroll taxes) from the base of the income tax, makes no attempt to tax accretions, and subjects some, but not all, benefits to taxation. The difference between current law’s treatment of Social Security benefits and their treatment under a comprehensive income tax would qualify as a tax expenditure, but such a tax expenditure differs in concept from that included in the official budget. The tax expenditures in the official budget 16 reflect exemptions for lower income beneficiaries from the tax on 85 percent of Social Security benefits. 17 Historically, payroll taxes paid by the employee represented no more than 15 percent of the expected value of the retirement benefits received by a lower-earnings Social Security beneficiary. The 85 percent inclusion rate is intended to tax upon distribution the remaining amount of the retirement benefit payment—the portion arising from the payroll tax contributions made by employers and the implicit return on the employee and employer contributions. Thus, the tax expenditure conceived and measured in the current budget is not intended to capture the deviation from a comprehensive income baseline, which would additionally account for the deferral of tax on the employer’s contributions and on the rate of return (less an inflation adjustment attributable to the employee’s payroll tax contributions). Rather, it is intended to approximate the taxation of private pensions with employee contributions made from after-tax income, 18 on the assumption that Social Security is comparable to such pensions. Hence, the official tax expenditure understates the tax advantage accorded Social Security retirement benefits relative to a comprehensive income baseline. To the extent that the benefits paid to dependents and survivors should be taxed as private pensions, the same conclusion applies: the official tax expenditure understates the tax advantage. The deduction for U.S. production activities also raises some problems. To the extent it is viewed as a tax break for certain qualifying businesses (‘‘manufacturers’’), it would be a tax expenditure. In contrast, the deduction may prove to be so broad that it is available to most U.S. businesses, in which case it might not be seen as a tax expenditure. Rather, it would represent a feature of the baseline tax rate system, because the deduction is equivalent to a lower tax rate. In addition, to the extent that it is viewed as providing relief from the double tax on corporate profits, it might not be a tax expenditure. The next category (panel C) includes items whose treatment is less certain. The proper treatment of some of these items under a comprehensive income tax is ambiguous, while others perhaps serve as proxies for what would be a tax expenditure under a comprehensive income base. 19 Consider, for example, the items relating to charitable contributions. Under existing law, charitable contributions are deductible, and this deduction is considered on its face a tax expenditure in the current budget. 20 The treatment of charitable donations, however, is ambiguous under a comprehensive income tax. If charitable contributions are a consumption item for the giver, then they are properly included in his taxable income; a deduction for contributions would then be a tax expenditure relative to a comprehensive income tax baseline. In contrast, charitable contributions could represent a transfer of purchasing power from the giver 350 ANALYTICAL PERSPECTIVES 21 If recipients tend to be in lower tax brackets, then the tax expenditure is smaller than when measured at the donor’s tax rates. 22 In contrast, the passive loss rules themselves, which restrict the deduction of losses, would be a negative tax expenditure when compared to a comprehensive tax base. 23 To the extent that premiums are deductible. to the receiver. As such, they would represent a reduction in the giver’s net worth, not an item of consumption, and so properly would be deductible, implying that current law’s treatment is not a tax expenditure. At the same time, however, the value of the charitable benefits received is income to the recipient. Under current law, such income generally is not taxed, and so represents a tax expenditure whose size might be approximated by the size of the donor’s contribution. 21 Medical expenditures may or may not be an element of income (or consumption). Some argue that medical expenditures don’t represent discretionary spending, and so aren’t really consumption. Instead, they are a reduction of net worth and should be excluded from the tax base. In contrast, others argue that there is no way to logically distinguish medical care from other consumption items. Those who view medical spending as consumption point out that there is choice in many health care decisions, e.g., whether to go to the best doctor, whether to have voluntary surgical procedures, and whether to exercise and eat nutritiously so as to improve and maintain one’s health and minimize medical expenditures. This element of choice makes it more difficult to argue, at least in many cases, that medical spending is more ‘‘necessary’’ than, or otherwise different from, other consumption spending. The exemption of full taxation of Social Security benefits paid to the disabled also raises some issues. Social Security benefits for the disabled most closely resemble either Government transfers or insurance. A comprehensive income tax would require the worker to include the benefit fully in his income and would allow him to deduct associated Social Security taxes. If viewed as insurance, he also could include the premium (i.e., tax) and exclude the benefit. The deviation between such treatment and current law’s treatment (described above) would be a tax expenditure under a comprehensive income baseline. In contrast, as described above, the official tax expenditure measures the benefit of exemption for low income beneficiaries from the tax on 85 percent of Social Security benefits. This measurement does not correspond closely to that required under a comprehensive income base. If the payment of the benefit is viewed as a transfer and divorced from the treatment of Social Security taxes, then the current tax expenditure understates the tax expenditure measured relative to a comprehensive income baseline. If the payment of the benefit is viewed as a transfer but the inability to deduct the employee’s share of the Social Security tax is simultaneously considered, then it is less likely that the current tax expenditure overstates the tax expenditure relative to a comprehensive income baseline, and in some cases it may generate a negative tax expenditure. If the benefit is viewed as insurance and the tax as a premium, then the current tax expenditure overstates the tax expenditure relative to a comprehensive income baseline. Indeed, in the insurance model, the ability to exclude from tax only 1/2 of the premium might suggest that 1/2 of the payout should be taxed, so that the current tax rules impose a greater tax burden than that implied by a comprehensive income tax, i.e., a negative tax expenditure. 22 The final category (panel D) includes items that would not be tax expenditures under a comprehensive income tax base. A tax based on comprehensive income would allow all losses to be deducted. Hence, the exception from the passive loss rules would not be a tax expenditure. Major Tax Expenditures under a Comprehensive Income Tax That Are Excluded from the Current Budget While most of the major tax expenditures in the current budget also would be tax expenditures under a comprehensive income base, there also are tax expenditures relative to a comprehensive income base that are not found on the existing tax expenditure list. These additional tax expenditures include the imputed return from certain consumer durables (e.g., automobiles), the imputed return to consumption of financial services (e.g., checking account services received in kind and paid for by accepting a below market interest rate on deposits), the difference between capital gains (and losses) as they accrue and capital gains as they are realized, private gifts and inheritances received, in-kind benefits from such Government programs as foodstamps, Medicaid, and public housing, the value of payouts from insurance policies, 23 and benefits received from private charities. Under some ideas of comprehensive income, the value of leisure and of household production of goods and services also would be included as tax expenditures. The personal exemption and standard deduction also might be considered tax expenditures, although they can be viewed differently, e.g., as elements of the basic tax rate schedule. The foreign tax credit also might be a tax expenditure, since a deduction for foreign taxes, rather than a credit, would seem to measure the income of U.S. residents properly. Negative Tax Expenditures Under current budgetary practice, negative tax expenditures, tax provisions that raise rather than lower taxes, are excluded from the official tax expenditure list. This exclusion conforms with the view that tax expenditures are intended to be similar to Government spending programs. If attention is expanded from a focus on spendinglike programs to include any deviation from the baseline tax system, negative tax expenditures would be of interest. Relative to a comprehensive income baseline, there are a number of important negative tax expenditures, some of which also might be viewed as negative tax expenditures under an expanded interpretation of the normal or reference law baseline. Among the more important negative tax expenditures is the corporation income tax, or more generally the double 351 19. TAX EXPENDITURES 24 Current law offers favorable treatment to some education costs, thereby creating (positive) tax expenditures. Current law allows expensing of that part of the cost of education and career training that is related to foregone earnings and this would be a tax expenditure under a comprehensive income baseline. 25 See Bradford, Untangling the Income Tax, p. 41. 26 Accelerated depreciation can be described as the equivalent of an interest free loan from the Government to the taxpayer. Under federal budget accounting principles, such a loan would be treated as an outlay equal to the present value of the foregone interest. tax on corporate profits, which would be eliminated under a comprehensive income tax. The Jobs and Growth Tax Relief and Reconciliation Act of 2003 (JGTRRA) reduced the tax rate on dividends and capital gains to 15 percent, thus reducing the double tax compared to prior law. Nonetheless, as discussed later in the Appendix, current law still imposes a substantial double tax on corporate profits. The passive loss rules, restrictions on the deductibility of capital losses, and NOL carry-forward requirements each would generate a negative tax expenditure, since a comprehensive income tax would allow full deductibility of losses. If human capital were considered an asset, then its cost (e.g., certain education and training expenses, including perhaps the cost of college and professional school) should be amortizable, but it is not under current law. 24 Some restricted deductions under the individual AMT might be negative tax expenditures as might the phase-out of personal exemptions and of itemized deductions. The inability to deduct consumer interest also might be a negative tax expenditure, as an interest deduction may be required to properly measure income, as seen by the equivalence between borrowing and reduced lending. 25 As discussed above, the current treatment of Social Security payments to the disabled also might represent a negative tax expenditure, if viewed as payments on an insurance policy. Current tax law also fails to index for inflation interest receipts, capital gains, depreciation, and inventories. This failure leads to negative tax expenditures because comprehensive income would be indexed for inflation. Current law, however, also fails to index for inflation the deduction for interest payments; this represents a (positive) tax expenditure. The issue of indexing also highlights that even if one wished to focus only on tax policies that are similar to spending programs, accounting for some negative tax expenditures may be required. For example, the net subsidy created by accelerated depreciation is properly measured by the difference between depreciation allowances specified under existing tax law and economic depreciation, which is indexed for inflation. 26 DIFFERENCES BETWEEN OFFICIAL TAX EXPENDITURES AND TAX EXPENDITURES RELATIVE TO A CONSUMPTION BASE This section compares tax expenditures listed in the official tax expenditure budget with those implied by a comprehensive consumption tax baseline. It first discusses some of the difficulties encountered in trying to compare current tax provisions to those that would be observed under a comprehensive consumption tax. Next, it discusses which of the thirty largest official tax expenditures would be tax expenditures under the consumption tax baseline, concluding that about onehalf of the top thirty official tax expenditures would remain tax expenditures under a consumption tax baseline. Most of those that fall off the list are tax incentives for saving and investment. The section next discusses some major differences between current law and a comprehensive consumption tax baseline that are excluded from the current list of tax expenditures. These differences include the consumption value of owner-occupied housing and other consumer durables, benefits from in-kind Government transfers, and gifts. It concludes with a discussion of negative tax expenditures relative to a consumption tax baseline Ambiguities in Determining Tax Expenditures Relative to a Consumption Baseline A broad-based consumption tax is a combination of an income tax plus a deduction for net saving. This follows from the definition of comprehensive income as consumption plus the change in net worth. It therefore seems straightforward to say that current law’s deviations from a consumption base are the sum of (a) tax expenditures on an income base associated with exemptions and deductions for certain types of income, plus (b) overpayments of tax, or negative tax expenditures, to the extent net saving is not deductible from the tax base. In reality, however, the situation is more complicated. A number of issues arise, some of which also are problems in defining a comprehensive income tax, but seem more severe, or at least only more obvious, for the consumption tax baseline. It is not always clear how to treat certain items under a consumption tax. One problem is determining whether a particular expenditure is an item of consumption. Spending on medical care and charitable donations are two examples. The classification below suggests that medical spending and charitable contributions might be included in the definition of consumption, but also considers an alternative view. There may be more than one way to treat various items under a consumption tax. For example, a consumption tax might ignore borrowing and lending by excluding from the borrower’s tax base the proceeds from loans, denying the borrower a deduction for payments of interest and principal, and excluding interest and principal payments received from the lender’s tax base. On the other hand, a consumption tax might include borrowing and lending in the tax base by requiring the borrower to add the proceeds from loans in his tax base, allowing the lender to deduct loans from his tax base, allowing the borrower to deduct payments of principal and interest, and requiring the lender to include receipt of principal and interest payments. In 352 ANALYTICAL PERSPECTIVES present value terms, the two approaches are equivalent for both the borrower and the lender; in particular both allow the tax base to measure consumption and both impose a zero effective tax rate on interest income. But which approach is taken obviously has different implications (at least on an annual flow basis) for the treatment of many important items of income and expense, such as the home mortgage interest deduction. The classification below suggests that the deduction for home mortgage interest could well be a tax expenditure, but takes note of alternative views. Some exclusions of income are equivalent in many respects to consumption tax treatment that immediately deducts the cost of an investment while taxing the future cash-flow. For example, exempting investment income is equivalent to consumption tax treatment as far as the normal rate of return on new investment is concerned. This is because expensing generates a tax reduction that offsets in present value terms the tax paid on the investment’s future normal returns. Expensing gives the income from a marginal investment a zero effective tax rate. However, a yield exemption approach differs from a consumption tax as far as the distribution of income and Government revenue is concerned. Pure profits in excess of the normal rate of return would be taxed under a consumption tax, because they are an element of cash-flow, but would not be taxed under a yield exemption tax system. Should exemption of certain kinds of investment income, and certain investment tax credits, be regarded as the equivalent of consumption tax treatment? The classification that follows takes a fairly broad view of this equivalence and considers many tax provisions that reduce or eliminate the tax on capital income to be roughly consistent with a broad-based consumption tax. Looking at provisions one at a time can be misleading. The hybrid character of the existing tax system leads to many provisions that might make good sense in the context of a consumption tax, but that generate inefficiencies because of the problem of the ‘‘uneven playing field’’ when evaluated within the context of the existing tax rules. It is not clear how these should be classified. For example, many saving incentives are targeted to specific tax favored sources of capital income. The inability to save on a similar tax-favored basis irrespective of the ultimate purpose to which the saving is applied potentially distorts economic choices in ways that would not occur under a broad-based consumption tax. As another example, under a consumption VAT based on the destination principle, there would be a rebate of the VAT on exports and a tax on imports. Does this mean that the extraterritorial income exclusion (the successor of the Foreign Sales Corporation provision) is not a tax expenditure? Resolution comes down to judgments about how broad is broad enough to be considered general, or whether it even matters at all that a provision is targeted in some way. The classification that follows views many savings incentives, even if targeted, as roughly consistent with a broad based consumption tax. In addition, provisions can interact even once an appropriate treatment is determined. For example, suppose that it is determined that financial flows are out of the tax base. Then the deduction for home mortgage interest would seem to be a tax expenditure. However, this conclusion is cast into doubt because current law generally taxes interest income. When combined with the homeowners’ deduction, this results in a zero tax rate on the interest flow, consistent with consumption tax treatment. Capital gains would not be a part of a comprehensive consumption tax base. Proceeds from asset sales and sometimes borrowing would be part of the cash-flow tax base, but, for transactions between domestic investors at a flat tax rate, would cancel out in the economy as a whole. How should existing tax expenditures related to capital gains be classified? The classification below generally views available capital gains tax breaks as consistent with a broad-based consumption tax because they lower the tax rate on capital income toward the zero rate that is consistent with a consumptionbased tax. Such considerations suggest that trying to compute the current tax’s deviations from ‘‘the’’ base of a consumption tax is impossible because deviations cannot be uniquely determined, making it very difficult to do a consistent accounting of the differences between the current tax base and a consumption tax base. Nonetheless, Appendix Table 2 attempts a classification based on the judgments outlined above. Treatment of Major Tax Expenditures under a Comprehensive Consumption Baseline As noted above, the major difference between a comprehensive consumption tax and a comprehensive income tax is in the treatment of saving, or in the taxation of capital income. Consequently, many current tax expenditures related to preferential taxation of capital income would not be tax expenditures under a consumption tax. However, preferential treatment of items of income that is unrelated to moderately broad-based saving or investment incentives would remain tax expenditures under a consumption baseline. In addition, several official tax expenditures relating to items of income and expense are difficult to classify properly, while others may serve as proxies for properly measured tax expenditures. Appendix Table 2 shows thirty large official tax expenditures from the Budget classified according to whether they would be considered a tax expenditure under a consumption tax. Two of the thirty items clearly would be a tax expenditure (shown in panel A) under a consumption tax, while an additional seven (those in panel B) probably would be tax expenditures. A consumption tax would include in the homeowners’ tax base the value of the implicit (gross) rental income from owner-occupied housing. Net rental income is a 353 19. TAX EXPENDITURES 27 Suppose that the rental value of a house is $100 per year, and that depreciation is $20, interest is $15, property taxes are $10, and other expenses are $5. Net rental income is $50 (gross rents less all items of expense). Hence, net rental income is a component of the gross rent, which is the consumption value of the housing services. Under a real based cash flow tax, in which financial flows are outside the tax base, the homeowner’s net tax base would be $85: gross rents—(property taxes + other expenses), assuming that property taxes are viewed as a reduction in net worth and that he makes no new investment (which would be deductible). 28 Using the figures from the example in the previous footnote, the homeowner would pay tax on gross rents minus property taxes minus other expenses, or on $85. If property taxes and mortgage interest were not deducted, then this would be the size of the tax expenditure. However, current law allows these deductions, which raises the tax expenditure base to $110. 29 One must guard against double counting here, however, to the extent that current law’s general taxation of capital income is calculated elsewhere in the tax expenditure budget as a negative tax expenditure. component of this, and so would be included as a tax expenditure, relative to a consumption tax baseline. 27 Exclusion of workers’ compensation benefits allows an exclusion from income that is unrelated to investment, and so should be included in the base of a comprehensive consumption tax. Consider next the deductibility of home mortgage interest and of property taxes on owner-occupied housing. Both items would seem to be strong candidates for inclusion as a tax expenditure, given current law’s failure to impute the consumption value of housing. That is, focusing on the homeowner’s tax base, these deductions move the tax system away from rather than towards the proper treatment of housing services. 28 However, with respect to the home mortgage interest deduction, some ambiguity is introduced by the taxation of interest income to lenders. In a sense, the homeowner’s deduction offsets the lenders inclusion, leaving (for equal tax rates) no net tax due on the interest flow, as would be appropriate under a consumption tax. Hence, from the perspective of the entire tax system, it is less clear that the home mortgage interest deduction represents a tax expenditure. 29 Some ambiguity also is introduced by the variable treatment of financial flows possible under a consumption tax. That is, the proper treatment of interest under a consumption tax depends on whether financial flows are in or out of the consumption tax base. If the loans are taken into income (as they would be under some types of consumption taxes), then the associated interest and principal payments should be deductible, otherwise not. With respect to property taxes on housing as well as other State and local taxes, some ambiguity arises because the tax might not represent consumption—it might be considered a reduction in net worth. Considered alone, this argument perhaps has some merit. However, there are two problems with this argument when viewed from the context of the entire tax system. First, the deduction for property taxes would seem to be inappropriate when there is no imputation for the associated consumption value, as discussed above. Second, the current tax system does not impute the consumption value of State and local services, and tax payments might serve as a proxy for that value, making their deduction unnecessary for the proper measurement of consumption. The official tax expenditures for Social Security benefits reflects exceptions for low income taxpayers from the general rule that 85 percent of Social Security benefits are included in the recipient’s tax base. The 85 percent inclusion is intended as a simplified mechanism for taxing Social Security benefits as if the Social Security program were a private pension with employee contributions made from after-tax income. Under these tax rules, income earned on contributions made by both employers and employees benefits from tax deferral, but employer contributions also benefit because the employee may exclude them from his taxable income, while the employee’s own contributions are included in his taxable income. These tax rules give the equivalent of consumption tax treatment, a zero effective tax rate on the return, to the extent that the original pension contributions are made by the employer, but give less generous treatment to the extent that the original contributions are made by the employee. Income earned on employee contributions is taxed at a low, but positive, effective tax rate. Based on historical calculations, the 85 percent inclusion reflects roughly the outcome of applying these tax rules to a lower-income earner when one-half of the contributions are from the employer and one-half from the employee. The current tax expenditure measures a tax benefit relative to a baseline that is somewhere between a comprehensive income tax and a consumption tax. The properly measured tax expenditure relative to a consumption tax baseline would include only those Social Security benefits that are accorded treatment more favorable than that implied by a consumption tax, which would correspond to including 50 percent of Social Security benefits in the recipient’s tax base. A similar analysis would apply to exclusion of Social Security benefits of dependents and retirees. There is a strong case for viewing the child credit and the earned income tax credit as social welfare programs (transfers). As such, they would be tax expenditures relative to a consumption baseline. Nonetheless, these credits could alternatively be viewed as relieving tax on ‘‘nondiscretionary’’ consumption, and so not properly considered a tax expenditure. The treatment of the items in panels C is less uncertain. Several of these items relate to the costs of medical care or to charitable contributions. As discussed in the previous section of the appendix, there is disagreement within the tax policy community over the extent to which medical care and charitable giving represent consumption items. Medical care is widely held to be consumption, except perhaps the medical care that actually raises, rather than simply sustains the individual’s ability to work. Charitable giving, on the other hand, may be considered to be a reduction in net worth that should be excluded from the tax base because it does not yield direct satisfaction to taxpayer who makes the expenditure. In this case, the tax expenditure lies not with the individual making the charitable deduction, but with the exclusion from taxation of the amounts received by the recipient. There also is the issue of how to tax medical insurance premiums. Under current law, employees do not 354 ANALYTICAL PERSPECTIVES have to include insurance premiums paid for by employers in their income. The self-employed also may exclude (via a deduction) medical insurance premiums from their taxable income. From some perspectives, these premiums should be in the tax base because they appear to represent consumption. Yet an alternative perspective would support excluding the premium from tax as long as the consumption tax base included the value of any medical services paid for by the insurance policy, because the premium equals the expected value of insurance benefits received. But even from this alternative perspective, the official tax expenditure might continue to be a tax expenditure under a consumption tax baseline because current law excludes the value of medical services paid with insurance benefits from the employee’s taxable income. If medical spending is not consumption, one approach to measuring the consumption base would ignore insurance, but allow the consumer to deduct the value of all medical services obtained. An alternative approach would allow a deduction for the premium but include the value of any insurance benefits received, while continuing to allow a deduction for a value of all medical services obtained. In either case, the official tax expenditure for the exclusion of employer provided medical insurance and expenses would not be a tax expenditure relative to a consumption tax baseline. The extraterritorial income exclusion replaces the previous Foreign Sales Corporation program. It provides an exclusion from income for certain exports. To the extent that the program is viewed as a component of a destination based VAT it might not be a tax expenditure. In addition, to the extent that the exclusion reduces the income tax bias against investment it might be consistent with consumption tax principles (i.e., a low tax rate on capital income). The taxation of Social Security benefits for the disabled also is difficult to classify. As discussed in this appendix above, these benefits generally ought to be taxed because they represent purchasing power. However, the associated Social Security taxes ought to be fully deductible, but they are not. Hence the proper treatment is unclear. Moreover, if the insurance model is applied, the taxation of Social Security benefits might be a negative tax expenditure. The credit for low income housing acts to lower the tax burden on qualified investment, and so from one perspective would not be a tax expenditure under a consumption tax baseline. However, in some cases the credit is too generous; it can give a negative tax on income from qualified investment rather than the zero tax called for under consumption tax principles. In addition, the credit is very narrowly targeted. Consequently, it could be considered a tax expenditure relative to a consumption tax baseline. The final panel (D) shows items that are not likely to be tax expenditures under a consumption base. Most of these relate to tax provisions that eliminate or reduce the tax on various types of capital income because a zero tax on capital income is consistent with consumption tax principles. The deduction for U.S. production activities is not classified as a tax expenditure. This reflects the view that it represents a widespread reduction in taxes on capital income or an offset to the corporate income tax. In contrast to this classification, however, it would be a tax expenditure to the extent that it is viewed as a targeted tax incentive. The exception from the passive loss rules probably would not be a tax expenditure because proper measurement of income, and hence of consumption, requires full deduction of losses. Major Tax Expenditures under a Consumption Tax That Are Excluded from the Current Budget Several differences between current law and a consumption tax are left off the official tax expenditure list. Additional tax expenditures include the imputed consumption value from consumer durables and financial services received in kind, private gifts and inheritances received, possibly benefits paid by insurance policies, in-kind benefits from such Government programs as food-stamps, Medicaid, and public housing, and benefits received from charities. Under some ideas of a comprehensive consumption tax, the value of leisure and of household production of goods and services would be included as a tax expenditure. A consumption tax implemented as a tax on cash flows would tax all proceeds from sales of capital assets when consumed, rather than just capital gains; because of expensing, taxpayers effectively would have a zero basis. The proceeds from borrowing would be in the base of a consumption tax that also allowed a deduction for repayment of principal and interest, but are excluded from the current tax base. The deduction of business interest expense might be a tax expenditure, since under some forms of consumption taxation interest is neither deducted from the borrower’s tax base nor included in the lender’s tax base. The personal exemption and standard deduction also might be considered tax expenditures, although they can be viewed differently, e.g., as elements of the basic tax rate schedule. Negative Tax Expenditures Importantly, current law also deviates from a consumption tax norm in ways that increase, rather than decrease, tax liability. These could be called negative tax expenditures. The official budget excludes negative tax expenditures on the theory that tax expenditures are intended to substitute for Government spending programs. Yet excluding negative tax expenditures gives a very one-sided look at the differences between the existing tax system and a consumption tax. A large item on this list would be the inclusion of capital income in the current individual income tax base, including the income earned on inside-build up in Social Security accounts. The revenue from the corporation income tax, or more generally a measure of the double tax on corporate profits, also would be a negative tax expenditure. Depreciation allowances, even 355 19. TAX EXPENDITURES 30 See Barbara Fraumeni, ‘‘The Measurement of Depreciation in the U.S. National Income and Product Accounts,’’ in Survey of Current Business 77 No. 7 (Washington, D.C.: Department of Commerce, Bureau of Economic Analysis, July, 1997), pp. 7–42, and the National Income and Product Accounts of the United States, Table 7.6, ‘‘Chain-type Quantity and Price Indexes for Private Fixed Investment by Type,’’ U.S. Department of Commerce, Bureau of Economic Analysis. 31 The temporary provision allows 30 percent of the cost of a qualifying investment to be deducted immediately rather than capitalized and depreciated over time. It is generally effective for qualifying investments made after September 10, 2001 and before September 11, 2004. The Jobs and Growth Tax Relief Reconciliation Act of 2003 raised the deduction to 50 percent depreciation (up from 30 percent) of the cost new equipment purchased after May 5, 2003 and placed into service before January 1, 2005. Qualifying investments generally are limited to tangible property with depreciation recovery periods of 20 years or less, certain software, and leasehold improvements, but this set of assets corresponds closely to machinery and equipment. 32 Estimates under the old methodology are no longer shown in the tables. 33 U.S. Department of the Treasury, Report to the Congress on Depreciation Recovery Periods and Methods (Washington, D.C.: U.S. Government Printing Office, July, 2000), p. 32. if accelerated, would be a negative tax expenditure since consumption tax treatment generally would require expensing. Depending on the treatment of loans, the borrower’s inability to deduct payments of principal and the lender’s inability to deduct loans might be a negative tax expenditure. The passive loss rules and NOL carry-forward provisions also might generate negative tax expenditures, because the change in net worth requires a deduction for losses (consumption = income— the change in net worth). If human capital were considered an asset, then its cost (e.g., certain education and training expenses, including perhaps costs of college and professional school) should be expensed, but it is not under current law. Certain restrictions under the individual AMT as well as the phase-out of personal exemptions and of itemized deductions also might be considered negative tax expenditures. Under some views, the current tax treatment of Social Security benefits paid to the disabled would be a negative tax expenditure. REVISED ESTIMATES OF SELECTED TAX EXPENDITURES Accelerated Depreciation Under the reference tax law baseline no tax expenditures arise from accelerated depreciation. In the past, official tax expenditure estimates of accelerated depreciation under the normal tax law baseline compared tax allowances based on the historic cost of an asset with allowances calculated using the straight-line method over relatively long recovery periods. Normal law allowances also were determined by the historical cost of the asset and so did not adjust for inflation, although such an adjustment is required when measuring economic depreciation, the age related fall in the real value of the asset. Beginning with the 2004 Budget, the tax expenditures for accelerated depreciation under the normal law concept have been recalculated using as a baseline depreciation rates and replacement cost indexes from the National Income and Product Accounts. 30 The revised estimates are intended to approximate the degree of acceleration provided by current law over a baseline determined by real, inflation adjusted, and economic depreciation. Current law depreciation allowances for machinery and equipment include the benefits of a temporary expensing provision. 31 The estimates are shown in tables in the body of the main text, e.g., Table 19–1. The revised tax expenditure estimates differ substantially from estimates calculated under the old methodology. In general, the new tax expenditure estimates are smaller than the old estimates. 32 In part, this is because the new baseline uses depreciation allowances that are faster than those in the old baseline. In addition, the new baseline calculates depreciation on a replacement cost basis rather on the historic cost basis previously used; this translates into larger depreciation allowances to the extent that asset prices rise over time. In many years the new tax expenditures are negative, indicating that current law’s tax depreciation allowances are smaller than those implied by economic depreciation. Because these estimates are on a cash flow, rather than a present value, basis, the negative value does not necessarily indicate that tax depreciation is decelerated relative to economic depreciation over the life of an investment. Even when tax depreciation is accelerated over the life of an investment, negative annual cash flow estimates could obtain in the later years of an investment’s economic life. This type of vintage effect contributes importantly to the negative tax expenditures calculated for equipment in 2006–2010 because the temporary expensing provision expires at the end of 2004. Calculations that compare the present value of tax depreciation (without the temporary expensing) with the present value of inflation indexed economic depreciation over each investment’s economic life show that for many types of assets tax depreciation is accelerated, but only slightly, assuming a moderate rate of inflation. 33 Owner-Occupied Housing A homeowner receives a flow of housing services equal in gross value to the rent that could have been earned had the owner chosen to rent the house to others. Comprehensive income would include in the homeowner’s tax base this gross rental flow, and would allow the homeowner a deduction for expenses such as interest, depreciation, property taxes, and other costs associated with earning the rental income. Thus, a comprehensive tax base would include in its base the homeowner’s implicit net rental income (gross income minus deductions) earned on investment in owner-occupied housing. In contrast to a comprehensive income tax, current law makes no imputation for gross rental income and allows no deduction for depreciation or for other expenses, such as utilities and maintenance. Current law does, however, allow a deduction for home mortgage interest and for property taxes. Consequently, relative to a comprehensive income baseline, the total tax expenditure for owner-occupied housing is the sum of tax on net rental income plus the tax saving from the de356 ANALYTICAL PERSPECTIVES 34 The homeowner’s tax base under a comprehensive income tax is net rents. Under current law, the homeowner’s tax base is–(interest + property taxes). The tax expenditure base is the difference between the comprehensive income base and current law’s tax base, which for homeowners is the sum of net rents plus interest plus property taxes. 35 This estimate combines the positive tax expenditure for the failure to impute rental income with the negative tax expenditure for the failure to allow a deduction for depreciation and other costs. 36 National Income and Production Accounts, Table 2.4. duction for property taxes and for home mortgage interest. 34 Prior to 2006, the official list of tax expenditures did not include the exclusion of net implicit rental income on owner-occupied housing. Instead, it included as a tax expenditure deductions for home mortgage interest and for property taxes. While these deductions are legitimately considered tax expenditures, given current law’s failure to impute rental income, they are highly flawed as estimates of the total tax advantage to housing; they overlook the additional exclusion of implicit net rental income. To the extent that a homeowner owns his house outright, unencumbered by a mortgage, he would have no home mortgage interest deduction, yet he still would enjoy the benefits of receiving tax free the implicit rental income earned on his house. The treatment of owner-occupied housing has been revised in the 2006 budget, which now includes an item for the exclusion of net rental income of homeowners. 35 Appendix Table 3 as well as the Tables in the body of the main text, e.g., Table 19–1 show estimates of the tax expenditure caused by the exclusion of implicit net rental income from investment in owner-occupied housing. This estimate starts with the NIPA calculated value of gross rent on owner-occupied housing, and subtracts interest, taxes, economic depreciation, and other costs in arriving at an estimate of net-rental income from owner-occupied housing. 36 Accrued Capital Gains Under a comprehensive income baseline, all real gains would be taxed as accrued. These gains would be taxed as ordinary income rather than at preferential rates. There would be no deferred unrealized gains on assets held at death, nor gains carried over on gifts, or other preferential treatments. Indeed, all of the provisions related to capitals gains listed in the tax expenditure budget would be dropped. Instead, in their place the difference between the ordinary tax on real gains accrued and the actual tax paid would be calculated. For 1999, for instance, the tax on real accrued gains on corporate equity is estimated at $594 billion. This compares to an estimated tax on realized gains of $62 billion, for forgone revenues of $562 billion. However, this forgone revenue may easily turn into a revenue gain given the limits on capital losses. For 2000, for instance, real accrued losses in corporate equity amounted to $1.4 trillion. Yet, taxpayers paid an estimated $70 billion in capital gains taxes. This roughly translates into an overpayment of taxes to the tune of $464 billion. Double Tax on Corporate Profits A comprehensive income tax would tax all sources of income once. Taxes would not vary by type or source of income. In contrast to this benchmark, current law taxes income that shareholders earn on investment in corporate stocks at least twice, and at combined rates that generally are higher than those imposed on other sources of income. Corporate profits are taxed once at the company level under the corporation income tax. They are taxed again at the shareholder level when received as a dividend or recognized as a capital gain. Corporate profits can be taxed more then twice when they pass through multiple corporations before being distributed to noncorporate shareholders. Corporate level taxes cascade because corporations are taxed on capital gains they realize on the sale of stock shares and on some dividend income received. Compared to a comprehensive income tax current law’s double (or more) tax on corporate profits is an example of a negative tax expenditure because it subjects income to a larger tax burden than implied by a comprehensive income baseline. Appendix Table 3 provides an estimate of the negative tax expenditure caused by the multiple levels of tax on corporate profits. This negative tax expenditure is measured as the shareholder level tax on dividends paid and capital gains realized out of earnings that have been fully taxed at the corporate level. It also includes the corporate tax paid on inter-corporate dividends and on corporate capital gains attributable to the sale of stock shares. The estimate includes the reduction in the dividends and capital gains tax rates enacted in JGTRRA. The negative tax expenditure is large in magnitude; it exceeds $33 billion in the years 2006 through in 2010. It is comparable in size (but opposite in sign) to all but the largest official tax expenditures. JGTRRA reduced but did not eliminate the double tax on corporate profits. 357 19. TAX EXPENDITURES Appendix Table 1. COMPARISON OF CURRENT TAX EXPENDITURES WITH THOSE IMPLIED BY A COMPREHENSIVE INCOME TAX 1 Description Revenue Effect 2006 A. Tax Expenditure Under a Comprehensive Income Tax Net exclusion of pension contributions and earnings: Employer plans ............................................................................. 51,050 Net exclusion of pension contributions and earnings: 401(k) plans .................................................................................. 48,140 Capital gains exclusion on home sales ............................................................................................................................... 36,270 Exclusion of net imputed rental income on owner-occupied housing ................................................................................ 29,720 Capital gains (except agriculture, timber, iron ore, and coal) ............................................................................................ 28,370 Exclusion of interest on public purpose State and local bonds ......................................................................................... 26,610 Exclusion of interest on life insurance savings ................................................................................................................... 24,070 Net exclusion of pension contributions and earnings: Keogh plans .................................................................................. 9,980 Expensing of research and experimentation expenditures (normal tax method) .............................................................. 7,920 Deferral of income from controlled foreign corporations (normal tax method) .................................................................. 7,440 Net exclusion of pension contributions and earnings: Individual Retirement Accounts .................................................... 7,310 Exclusion of workers’ compensation benefits ...................................................................................................................... 5,940 Extraterritorial income exclusion ......................................................................................................................................... 4,260 Credit for low-income housing investments ......................................................................................................................... 4,010 Exclusion of veterans death beenfits and disability compensation .................................................................................... 3,750 B. Possibly a Tax Expenditure Under a Comprehensive Income Tax, But With Some Qualifications Deductibility of mortgage interest on owner-occupied homes ............................................................................................ 76,030 Deductibility of nonbusiness state and local taxes other than on owner-occupied homes .............................................. 34,620 Child credit ........................................................................................................................................................................... 32,810 Step-up basis of capital gains at death .............................................................................................................................. 28,760 Exclusion of Social Security benefits for retired workers ................................................................................................... 19,770 Deductibility of State and local property tax on owner-occupied homes ........................................................................... 14,830 Earned income tax credit .................................................................................................................................................... 5,423 Deduction for U.S. production activities .............................................................................................................................. 5,420 Exclusion of Social security benefits of dependents and survivors ................................................................................... 3,990 C. Uncertain Exclusion of employer contributions for medical insurance premiums and medical care ................................................. 125,690 Deductibility of charitable contributions, other than education and health ......................................................................... 32,550 Deductibility of medical expenses ....................................................................................................................................... 9,140 Deductibility of self-employed medical insurance premiums .............................................................................................. 4,330 Social Security benefits for disabled .................................................................................................................................. 3,870 D. Probably Not a Tax Expenditure Under a Comprehensive Income Tax Exception from passive loss rules for $25,000 of rental loss ............................................................................................ 4,750 1 The measurement of certain tax expenditures under a comprehensive income tax baseline may differ from the official budget estimate even when the provision would be a tax expenditure under both baselines. Source: Table 19–2, Tax Expenditure Budget. 358 ANALYTICAL PERSPECTIVES Appendix Table 2. COMPARISON OF CURRENT TAX EXPENDITURES WITH THOSE IMPLIED BY A COMPREHENSIVE CONSUMPTION TAX 1 Description Revenue Effect 2006 A. Tax Expenditure Under a Consumption Base Exclusion of net imputed rental income on owner-occupied housing ................................................................................ 29,720 Exclusion of workers’ compensation benefits ...................................................................................................................... 5,940 B. Probably a Tax Expenditure Under a Consumption Base Deductibility of mortgage interest on owner-occupied homes ............................................................................................ 76,030 Deductibility of nonbusiness state and local taxes other than on owner-occupied homes .............................................. 34,620 Child credit ........................................................................................................................................................................... 32,810 Exclusion of Social Security benefits for retired workers ................................................................................................... 19,770 Earned income tax credit .................................................................................................................................................... 5,423 Exclusion of Social Security benefits of dependents and survivors ................................................................................... 3,990 Exclusion of veterans death beenfits and disability compensation .................................................................................... 3,750 C. Uncertain Exclusion of employer contributions for medical insurance premiums and medical care ................................................. 125,690 Deductibility of charitable contributions, other than education and health ......................................................................... 32,550 Deductibility of State and local property tax on owner-occupied homes ........................................................................... 14,830 Deductibility of medical expenses ....................................................................................................................................... 9,140 Deductibility of self-employed medical insurance premiums .............................................................................................. 4,330 Extraterritorial income exclusion ......................................................................................................................................... 4,260 Credit for low-income housing investments ......................................................................................................................... 4,010 Social Security benefits for disabled .................................................................................................................................. 3,870 D. Not a Tax Expenditure Under a Consumption Base Net exclusion of pension contributions and earnings: Employer plans ............................................................................. 51,050 Net exclusion of pension contributions and earnings: 401(k) plans .................................................................................. 48,140 Capital gains exclusion on home sales ............................................................................................................................... 36,270 Step-up basis of capital gains at death .............................................................................................................................. 28,760 Capital gains (except agriculture, timber, iron ore, and coal) ............................................................................................ 28,370 Exclusion of interest on public purpose State and local bonds ......................................................................................... 26,610 Exclusion of interest on life insurance savings ................................................................................................................... 24,070 Net exclusion of pension contributions and earnings: Keogh plans .................................................................................. 9,980 Expensing of research and experimentation expenditures (normal tax method) .............................................................. 7,920 Deferral of income from controlled foreign corporations (normal tax method) .................................................................. 7,440 Net exclusion of pension contributions and earnings: Individual Retirement Accounts .................................................... 7,310 Deduction for U.S. production activities .............................................................................................................................. 5,420 Exception from passive loss rules for $25,000 of rental loss ............................................................................................ 4,750 1 The measurement of certain tax expenditures under a consumption tax baseline may differ from the official budget estimate even when the provision would be a tax expenditure under both baselines. Source: Table 19–2, Tax Expenditure Budget. Appendix Table 3. REVISED TAX EXPENDITURE ESTIMATES 1 Provision Revenue Loss 2004 2005 2006 2007 2008 2009 2010 Imputed Rent On Owner-Occupied Housing ..................................... 24,590 28,600 29,720 33,210 36,860 40,630 44,786 Double Tax on corporate profit 2 ....................................................... –23,730 –30,170 –29,600 –30,330 –31,540 –33,260 –35,074 1 Calculations described in the appendix text. 2 This is a negative tax expenditure, a tax provision that overtaxes income relative to the treatment specified by the baseline tax system.

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