[Analytical Perspectives]
[Federal Receipts and Collections]
[19. Tax Expenditures]
[From the U.S. Government Printing Office, www.gpo.gov]
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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. In general, the tax expenditure estimates presented in this
chapter are 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. An alternative approach would be to pattern the tax
expenditure estimates on a comprehensive consumption tax. Which approach
is used is perhaps the most important factor determining what is
included as a tax expenditure. For example, because a consumption tax
does not tax the return to saving or investment, using a comprehensive
consumption tax as the normative baseline for determining tax
expenditures would exclude current tax exemptions related to retirement
and education saving accounts. Similarly, business provisions that
provide accelerated depreciation or expensing of investment would also
be excluded as tax expenditures because investment is generally deducted
immediately under a comprehensive consumption tax.
The choice of the baseline--a comprehensive income or a comprehensive
consumption tax--is arbitrary when viewed from the perspective of the
current so-called income tax system, which includes elements of both
income and consumption taxes. According to Treasury Department analysis,
roughly 35 percent of household financial assets receive consumption tax
treatment because assets are held in tax-preferred accounts such as
individual retirement accounts (IRAs), defined-contribution retirement
plans (401(k) type plans), defined-benefit pension plans, and tax-
preferred annuities and various life insurance products. The balance of
household financial assets reflecting most other saving vehicles receive
income tax treatment.
The ambiguities in the tax expenditure concept are reviewed in greater
detail in Appendix A. This review focuses on defining tax expenditures
relative to a comprehensive income tax baseline and a consumption tax
baseline, and defining negative tax expenditures, i.e., provisions of
current law that over-tax certain items or activities.
The tax expenditure estimates presented below differ from a
comprehensive income tax in a number of other important respects. While
under a comprehensive income tax all income is taxed once, the U.S.
income tax system generally taxes corporate income twice, first at the
corporate level through the corporate income tax and then again when the
income is received by investors as dividends or capital gains. This
``double tax'' is accounted for in some of the tax expenditure
estimates, such as those related to retirement savings, but not in the
corporate tax expenditures. Indeed, the tax expenditure estimates, in
large part, view the individual and corporation income taxes separately,
rather than as an integrated system as appropriate under comprehensive
income tax principles. Other areas of divergence from a comprehensive
income tax are detailed below.
An important assumption underlying each tax expenditure estimate
reported below is that other parts of the tax code remain unchanged. The
estimates would be different if 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.
Tax expenditures relating to the individual and corporate income taxes
are estimated for fiscal years 2006-2012 using two methods of
accounting: current revenue effects and present value effects. The
present value approach provides estimates of the revenue effects for tax
expenditures that generally involve deferrals of tax payments into the
future.
A discussion of performance measures and economic effects related to
the assessment of the effect of tax expenditures on the achievement of
program performance goals is presented in Appendix B. This section is a
complement to the Government-wide performance plan required by the
Government Performance and Results Act of 1993.
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, 2006. Expired or repealed provisions
are not listed if their revenue effects result only from taxpayer
activity occurring before fiscal year 2006. 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
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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 2006-
2012 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.
Two baseline concepts--the normal tax baseline and the reference tax
law baseline--are used to identify and estimate tax expenditures. \1\
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.
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\1\ 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.
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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 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 2008-
2012 revenue effect. The first column provides the number of the
provision in order to cross reference this table to Tables 19-1 and 19-2
as well as to the descriptions below. Outlay Equivalent Estimates of
Income Tax Expenditures, which were included in prior volumes of
Analytical Perspectives, are no longer included in this chapter. \2\
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\2\ The Administration has dropped the estimates of the outlay
equivalents because they were often the same as the normal tax
expenditure estimates, and the criteria for applying the concepts as to
when they should differ were often judgmental and hard to apply with
consistency across time and across tax expenditure items.
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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:
First, 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.
Second, 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.
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Table 19-1. ESTIMATES OF TOTAL INCOME TAX EXPENDITURES
(in millions of dollars)
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Total from corporations and individuals
--------------------------------------------------------------------------------
2006 2007 2008 2009 2010 2011 2012 2008-12
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National Defense
1 Exclusion of benefits and allowances to armed forces 3,100 3,220 3,350 3,480 3,620 3,780 3,930 18,160
personnel..............................................
International affairs:
2 Exclusion of income earned abroad by U.S. citizens...... 2,500 2,630 2,760 2,900 3,050 3,200 3,360 15,270
3 Exclusion of certain allowances for Federal employees 800 840 880 920 970 1,020 1,070 4,860
abroad.................................................
4 Extraterritorial income exclusion....................... 4,400 1,630 ........ ........ ........ ........ ........ .........
5 Inventory property sales source rules exception......... 1,730 1,890 2,120 2,330 2,510 2,704 2,913 12,577
6 Deferral of income from controlled foreign corporations 11,160 11,940 12,770 13,650 14,600 15,620 16,710 73,350
(normal tax method)....................................
7 Deferred taxes for financial firms on certain income 2,260 2,370 2,490 1,060 ........ ........ ........ 3,550
earned overseas........................................
General science, space, and technology:
8 Expensing of research and experimentation expenditures 7,920 5,680 5,280 4,060 5,030 6,230 6,000 26,600
(normal tax method)....................................
9 Credit for increasing research activities............... 2,180 10,320 4,960 2,100 920 360 70 8,410
Energy:
10 Expensing of exploration and development costs, fuels... 680 860 840 710 600 450 310 2,910
11 Excess of percentage over cost depletion, fuels......... 760 790 790 790 780 760 740 3,860
12 Alternative fuel production credit...................... 2,980 2,370 780 10 10 ........ ........ 800
13 Exception from passive loss limitation for working 30 30 30 30 30 30 30 150
interests in oil and gas properties....................
14 Capital gains treatment of royalties on coal............ 160 170 170 170 190 180 130 840
15 Exclusion of interest on energy facility bonds.......... 40 40 50 50 50 50 50 250
16 New technology credit................................... 510 690 960 1,120 1,150 1,150 1,150 5,530
17 Alcohol fuel credits \1\................................ 50 50 60 70 80 30 ........ 240
18 Tax credit and deduction for clean-fuel burning vehicles 110 260 150 130 -20 -50 -60 150
19 Exclusion of utility conservation subsidies............. 110 110 110 110 110 110 100 540
20 Credit for holding clean renewable energy bonds......... 20 60 80 100 100 100 100 480
21 Deferral of gain from dispositions of transmission 620 530 230 -100 -360 -510 -540 -1,280
property to implement FERC restructuring policy........
22 Credit for investment in clean coal facilities.......... ........ 30 50 80 130 180 250 690
23 Temporary 50% expensing for equipment used in the 10 30 120 240 260 180 -50 750
refining of liquid fuels...............................
24 Natural gas distribution pipelines treated as 15-year 20 50 90 120 150 150 120 630
property...............................................
25 Amortize all geological and geophysical expenditures 10 60 90 70 40 10 10 220
over 2 years...........................................
26 Allowance of deduction for certain energy efficient 80 190 170 90 30 -10 -10 270
commercial building property...........................
27 Credit for construction of new energy efficient homes... 10 20 30 20 10 ........ ........ 60
28 Credit for energy efficiency improvements to existing 230 380 150 ........ ........ ........ ........ 150
homes..................................................
29 Credit for energy efficient appliances.................. 120 80 ........ ........ ........ ........ ........ .........
30 30% credit for residential purchases/installations of 10 10 10 ........ ........ ........ ........ 10
solar and fuel cells...................................
31 Credit for business installation of qualified fuel cells 80 90 130 50 -10 -10 -10 150
and stationary microturbine power plants...............
32 Partial expensing for advanced mine safety equipment.... ........ 10 20 ........ ........ ........ ........ 20
Natural resources and environment:
33 Expensing of exploration and development costs, nonfuel 10 10 10 10 10 10 10 50
minerals...............................................
34 Excess of percentage over cost depletion, nonfuel 450 480 490 510 530 550 570 2,650
minerals...............................................
35 Exclusion of interest on bonds for water, sewage, and 510 580 600 630 640 670 680 3,220
hazardous waste facilities.............................
36 Capital gains treatment of certain timber income........ 160 170 170 170 190 180 130 840
37 Expensing of multiperiod timber growing costs........... 290 310 320 330 350 360 370 1,730
38 Tax incentives for preservation of historic structures.. 390 400 430 440 470 490 520 2,350
39 Expensing of capital costs with respect to complying 10 10 30 50 30 ........ ........ 110
with EPA sulfur regulations............................
40 Exclusion of gain or loss on sale or exchange of certain ........ 10 30 40 40 40 30 180
brownfield sites.......................................
Agriculture:
41 Expensing of certain capital outlays.................... 130 130 130 140 140 150 150 710
42 Expensing of certain multiperiod production costs....... 70 70 80 80 80 90 90 420
43 Treatment of loans forgiven for solvent farmers......... 20 20 20 20 20 30 30 120
44 Capital gains treatment of certain income............... 880 940 950 950 1,010 980 700 4,590
45 Income averaging for farmers............................ 60 60 60 60 60 70 70 320
46 Deferral of gain on sale of farm refiners............... 10 20 20 20 20 20 20 100
47 Bio-Diesel and small agri-biodiesel producer tax credits 90 180 200 30 20 10 10 270
Commerce and housing:
Financial institutions and insurance:
48 Exemption of credit union income....................... 1,320 1,400 1,480 1,570 1,660 1,750 1,850 8,310
49 Excess bad debt reserves of financial institutions..... 20 10 10 10 10 ........ ........ 30
50 Exclusion of interest on life insurance savings........ 19,380 20,150 21,925 25,060 27,830 30,090 32,100 137,005
51 Special alternative tax on small property and casualty 50 50 50 50 50 60 60 270
insurance companies...................................
52 Tax exemption of certain insurance companies owned by 220 230 240 250 260 270 280 1,300
tax-exempt organizations..............................
53 Small life insurance company deduction................. 60 60 60 60 60 50 50 280
54 Exclusion of interest spread of financial institutions. 1,350 1,330 1,400 1,480 1,550 1,950 2,050 8,430
Housing:
55 Exclusion of interest on owner-occupied mortgage 1,170 1,300 1,390 1,430 1,470 1,510 1,560 7,360
subsidy bonds.........................................
56 Exclusion of interest on rental housing bonds.......... 970 1,090 1,150 1,180 1,220 1,260 1,300 6,110
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57 Deductibility of mortgage interest on owner-occupied 68,330 79,940 89,430 96,250 103,540 111,440 119,600 520,260
homes.................................................
58 Deductibility of State and local property tax on owner- 21,260 15,540 12,620 12,590 12,580 22,440 27,770 88,000
occupied homes........................................
59 Deferral of income from installment sales.............. 1,190 1,210 1,230 1,250 1,370 1,500 1,650 7,000
60 Capital gains exclusion on home sales.................. 35,270 37,030 38,890 40,830 42,870 45,010 47,270 214,870
61 Exclusion of net imputed rental income................. 28,780 32,110 35,680 39,440 43,596 48,190 53,269 220,176
62 Exception from passive loss rules for $25,000 of rental 6,590 7,150 7,520 7,790 7,990 8,150 8,300 39,750
loss..................................................
63 Credit for low-income housing investments.............. 4,420 4,660 4,940 5,250 5,570 5,870 6,170 27,800
64 Accelerated depreciation on rental housing (normal tax 10,340 11,240 12,300 13,480 14,560 15,790 17,190 73,320
method)...............................................
Commerce:
65 Cancellation of indebtedness........................... 90 100 90 60 30 30 30 240
66 Exceptions from imputed interest rules................. 50 50 50 50 50 50 50 250
67 Capital gains (except agriculture, timber, iron ore, 48,610 51,770 51,960 52,230 55,400 53,870 38,420 251,880
and coal).............................................
68 Capital gains exclusion of small corporation stock..... 240 270 320 340 370 490 540 2,060
69 Step-up basis of capital gains at death................ 29,600 32,600 35,900 36,750 37,950 39,450 41,010 191,060
70 Carryover basis of capital gains on gifts.............. 590 650 760 800 1,270 6,340 1,500 10,670
71 Ordinary income treatment of loss from small business 50 50 50 50 60 60 60 280
corporation stock sale................................
72 Accelerated depreciation of buildings other than rental -970 -740 -310 260 870 1,550 2,280 4,650
housing (normal tax method)...........................
73 Accelerated depreciation of machinery and equipment 36,470 51,030 64,670 78,390 85,250 92,630 100,850 421,790
(normal tax method)...................................
74 Expensing of certain small investments (normal tax 5,000 5,330 5,330 4,740 -1,090 80 850 9,910
method)...............................................
75 Graduated corporation income tax rate (normal tax 4,050 4,270 4,240 4,320 4,420 4,530 4,690 22,200
method)...............................................
76 Exclusion of interest on small issue bonds............. 510 580 600 630 640 670 680 3,220
77 Deduction for US production activities................. 9,950 10,700 13,810 14,500 19,550 23,890 25,360 97,110
78 Special rules for certain film and TV production....... 110 90 70 -40 -90 -60 -50 -170
Transportation:
79 Deferral of tax on shipping companies................... 20 20 20 20 20 20 20 100
80 Exclusion of reimbursed employee parking expenses....... 2,740 2,890 3,040 3,190 3,350 3,430 3,540 16,550
81 Exclusion for employer-provided transit passes.......... 560 630 710 790 880 960 1,030 4,370
82 Tax credit for certain expenditures for maintaining 140 160 130 60 30 10 10 240
railroad tracks........................................
83 Exclusion of interest on bonds for Financing of Highway 25 50 75 95 95 100 100 465
Projects and rail-truck transfer facilities............
Community and regional development:
84 Investment credit for rehabilitation of structures 40 40 40 40 40 40 40 200
(other than historic)..................................
85 Exclusion of interest for airport, dock, and similar 1,130 1,250 1,320 1,360 1,400 1,440 1,480 7,000
bonds..................................................
86 Exemption of certain mutuals' and cooperatives' income.. 80 80 80 80 80 90 90 420
87 Empowerment zones and renewal communities............... 1,210 1,340 1,480 1,740 1,130 420 570 5,340
88 New markets tax credit.................................. 590 810 990 970 860 730 590 4,140
89 Expensing of environmental remediation costs............ 150 300 130 -40 -20 -20 -30 20
90 Credit to holders of Gulf Tax Credit Bonds.............. 10 10 10 10 10 10 10 50
Education, training, employment, and social services:
Education:
91 Exclusion of scholarship and fellowship income (normal 1,780 1,870 1,960 2,050 2,150 2,250 2,360 10,770
tax method)...........................................
92 HOPE tax credit........................................ 3,900 3,330 3,350 3,600 3,710 4,350 4,730 19,740
93 Lifetime Learning tax credit........................... 2,490 2,190 2,200 2,310 2,390 2,780 3,020 12,700
94 Education Individual Retirement Accounts............... 10 10 10 20 20 20 30 100
95 Deductibility of student-loan interest................. 800 810 820 830 840 780 530 3,800
96 Deduction for higher education expenses................ 1,420 1,450 1,180 ........ ........ ........ ........ 1,180
97 State prepaid tuition plans............................ 690 830 1,000 1,210 1,470 1,820 2,000 7,500
98 Exclusion of interest on student-loan bonds............ 500 550 590 600 630 640 670 3,130
99 Exclusion of interest on bonds for private nonprofit 2,140 2,380 2,530 2,610 2,690 2,770 2,850 13,450
educational facilities................................
100 Credit for holders of zone academy bonds............... 130 140 160 170 170 170 160 830
101 Exclusion of interest on savings bonds redeemed to ........ 20 20 20 20 20 20 100
finance educational expenses..........................
102 Parental personal exemption for students age 19 or over 4,030 2,500 1,590 1,480 1,410 2,620 3,040 10,140
103 Deductibility of charitable contributions (education).. 4,200 4,550 5,120 5,520 5,900 6,320 6,770 29,630
104 Exclusion of employer-provided educational assistance.. 590 620 660 690 720 40 ........ 2,110
105 Special deduction for teacher expenses................. 160 170 160 ........ ........ ........ ........ 160
106 Discharge of student loan indebtedness................. 20 20 20 20 20 20 20 100
Training, employment, and social services: ........ ........ ........ ........ ........ ........ ........ .........
107 Work opportunity tax credit............................ 210 360 370 250 140 70 40 870
108 Welfare-to-work tax credit............................. 80 80 80 50 20 10 10 170
109 Employer provided child care exclusion................. 660 890 1,030 1,080 1,140 1,160 1,210 5,620
110 Employer-provided child care credit.................... 10 10 10 20 20 10 ........ 60
111 Assistance for adopted foster children................. 320 350 400 440 480 530 570 2,420
112 Adoption credit and exclusion.......................... 540 560 570 580 600 540 170 2,460
113 Exclusion of employee meals and lodging (other than 890 930 970 1,010 1,060 1,110 1,170 5,320
military).............................................
114 Child credit \2\....................................... 30,377 32,556 32,341 32,096 31,909 24,719 13,598 134,666
115 Credit for child and dependent care expenses........... 3,190 2,810 1,740 1,650 1,570 1,500 1,430 7,890
116 Credit for disabled access expenditures................ 20 30 30 30 30 30 30 150
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117 Deductibility of charitable contributions, other than 37,120 40,400 45,760 49,360 52,840 56,610 60,740 265,310
education and health..................................
118 Exclusion of certain foster care payments.............. 440 450 460 470 480 490 500 2,400
119 Exclusion of parsonage allowances...................... 480 510 550 580 610 640 670 3,050
120 Employee retention credit for employers affected by ........ 40 ........ ........ ........ ........ ........ .........
Hurricane Katrina, Rita, and Wilma....................
Health:
121 Exclusion of employer contributions for medical 125,000 141,270 160,190 179,580 200,510 221,880 243,820 1,005,980
insurance premiums and medical care....................
122 Self-employed medical insurance premiums................ 3,970 4,370 3,730 4,180 4,670 5,230 5,810 23,620
123 Medical Savings Accounts/Health Savings Accounts........ 280 990 1,980 2,600 2,830 2,910 2,850 13,170
124 Deductibility of medical expenses....................... 3,770 4,240 4,920 5,820 6,840 9,250 10,780 37,610
125 Exclusion of interest on hospital construction bonds.... 3,420 3,770 4,010 4,130 4,260 4,380 4,510 21,290
126 Deductibility of charitable contributions (health)...... 4,190 4,560 5,160 5,570 5,960 6,380 6,850 29,920
127 Tax credit for orphan drug research..................... 230 260 290 320 360 410 460 1,840
128 Special Blue Cross/Blue Shield deduction................ 620 680 740 610 660 690 740 3,440
129 Tax credit for health insurance purchased by certain ........ 10 10 10 10 10 10 50
displaced and retired individuals \3\..................
130 Distributions from retirement plans for premiums for ........ 250 240 280 310 340 380 1,550
health and long-term care insurance....................
Income security:
131 Exclusion of railroad retirement system benefits........ 390 380 380 380 370 360 350 1,840
132 Exclusion of workers' compensation benefits............. 5,660 5,740 5,830 5,920 6,010 6,110 6,200 30,070
133 Exclusion of public assistance benefits (normal tax 450 470 490 510 530 550 580 2,660
method)................................................
134 Exclusion of special benefits for disabled coal miners.. 50 50 40 40 40 40 40 200
135 Exclusion of military disability pensions............... 110 110 120 130 130 140 150 670
Net exclusion of pension contributions and earnings:
136 Employer plans......................................... 49,040 49,510 48,480 48,030 46,350 43,700 42,790 229,350
137 401(k) plans........................................... 40,760 42,410 43,970 45,980 48,550 54,230 57,690 250,420
138 Individual Retirement Accounts......................... 3,970 5,700 6,650 7,130 7,200 7,460 7,840 36,280
139 Low and moderate income savers credit.................. 700 690 670 630 610 590 580 3,080
140 Keogh plans............................................ 10,130 10,860 11,890 13,010 14,230 15,550 16,970 71,650
Exclusion of other employee benefits:
141 Premiums on group term life insurance.................. 2,280 2,310 2,350 2,380 2,420 2,450 2,490 12,090
142 Premiums on accident and disability insurance.......... 290 300 310 320 330 340 350 1,650
143 Income of trusts to finance supplementary unemployment 20 30 30 30 40 40 50 190
benefits...............................................
144 Special ESOP rules...................................... 1,760 1,890 2,030 2,170 2,330 2,490 2,670 11,690
145 Additional deduction for the blind...................... 40 40 40 40 40 50 60 230
146 Additional deduction for the elderly.................... 1,920 1,830 1,830 1,910 2,010 2,890 3,480 12,120
147 Tax credit for the elderly and disabled................. 20 10 10 10 10 10 10 50
148 Deductibility of casualty losses........................ 260 280 300 310 320 350 370 1,650
149 Earned income tax credit \4\............................ 5,050 5,360 5,340 5,490 5,660 5,890 7,900 30,280
150 Additional exemption for housing Hurricane Katrina 110 20 ........ ........ ........ ........ ........ .........
displaced individuals..................................
Social Security:
Exclusion of social security benefits:
151 Social Security benefits for retired workers........... 17,890 18,100 18,930 19,110 20,230 21,320 23,260 102,850
152 Social Security benefits for disabled.................. 4,730 5,120 5,620 5,890 6,240 6,690 7,220 31,660
153 Social Security benefits for dependents and survivors.. 3,360 3,340 3,400 3,330 3,420 3,490 3,700 17,340
Veterans benefits and services:
154 Exclusion of veterans death benefits and disability 3,580 3,770 3,890 4,030 4,200 4,590 5,030 21,740
compensation...........................................
155 Exclusion of veterans pensions.......................... 150 180 180 180 190 200 230 980
156 DExclusion of GI bill benefits.......................... 210 260 280 300 320 360 420 1,680
157 Exclusion of interest on veterans housing bonds......... 40 40 40 50 50 50 50 240
General purpose fiscal assistance:
158 Exclusion of interest on public purpose State and local 22,980 25,430 27,150 27,960 28,800 29,670 30,560 144,140
bonds..................................................
159 Deductibility of nonbusiness state and local taxes other 43,120 33,680 27,900 27,790 28,570 48,560 59,850 192,670
than on owner-occupied homes...........................
160 Tax credit for corporations receiving income from doing 200 20 ........ ........ ........ ........ ........ .........
business in U.S. possessions...........................
Interest:
161 Deferral of interest on U.S. savings bonds.............. 1,260 1,330 1,340 1,360 1,370 1,420 1,520 7,010
Addendum: Aid to State and local governments:
Deductibility of:
Property taxes on owner-occupied homes................. 21,260 15,540 12,620 12,590 12,580 22,440 27,770 88,000
Nonbusiness State and local taxes other than on owner- 43,120 33,680 27,900 27,790 28,570 48,560 59,850 192,670
occupied homes........................................
Exclusion of interest on State and local bonds for:
Public purposes........................................ 22,980 25,430 27,150 27,960 28,800 29,670 30,560 144,140
Energy facilities...................................... 40 40 50 50 50 50 50 250
Water, sewage, and hazardous waste disposal facilities. 510 580 600 630 640 670 680 3,220
Small-issues........................................... 510 580 600 630 640 670 680 3,220
Owner-occupied mortgage subsidies...................... 1,170 1,300 1,390 1,430 1,470 1,510 1,560 7,360
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Rental housing......................................... 970 1,090 1,150 1,180 1,220 1,260 1,300 6,110
Airports, docks, and similar facilities................ 1,130 1,250 1,320 1,360 1,400 1,440 1,480 7,000
Student loans.......................................... 500 550 590 600 630 640 670 3,130
Private nonprofit educational facilities............... 2,140 2,380 2,530 2,610 2,690 2,770 2,850 13,450
Hospital construction.................................. 3,420 3,770 4,010 4,130 4,260 4,380 4,510 21,290
Veterans' housing...................................... 40 40 40 50 50 50 50 240
Credit for holders of zone academy bonds................ 130 140 160 170 170 170 160 830
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\1\ In addition, the alcohol fuel credit results in a reduction in excise tax receipts (in millions of dollars) as follows: 2006 $2,570; 2007 $2,990;
2008 $3,460; 2009 $4,280; 2010 $4,990; 2011 $1,440; 0 in 2012.
\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: 2006 $15,473; 2007 $14,931; 2008 $14,367; 2009 $14,019; 2010 $13,651; 2011 $13,410; and 2012 $1,275.
\3\ The figures in the table indicate the effect of the health insurance tax credit on receipts. The effect of the credit on outlays (in millions of
dollars) is as follows: 2006 $90; 2007 $100; 2008 $110; 2009 $120; 2010 $130; 2011 $140; and 2012 $150.
\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: 2006 $36,166;2007 $36,461; 2008 $37,573; 2009 $38,237; 2010 $38,994; 2011 $40,289; and 2012 $36,982.
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.
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 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 2006 which cause the deferrals or other long-term revenue
effects. For instance, a pension contribution in 2006 would cause a
deferral of tax payments on wages in 2006 and on pension earnings on
this contribution (e.g., interest) in later years. In some future year,
however, the 2006 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.
[[Page 291]]
Table 19-2. ESTIMATES OF TAX EXPENDITURES FOR THE CORPORATE AND INDIVIDUAL INCOME TAXES
(in millions of dollars)
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Corporations Individuals
---------------------------------------------------------------------------------------------------------------------------------------------------------------------------
2006 2007 2008 2009 2010 2011 2012 2008-12 2006 2007 2008 2009 2010 2011 2012 2008-12
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
National Defense
1 Exclusion of benefits and allowances to armed ....... ....... ......... ......... ......... ......... ......... ......... 3,100 3,220 3,350 3,480 3,620 3,780 3,930 18,160
forces personnel............................
International affairs:
2 Exclusion of income earned abroad by U.S. ....... ....... ......... ......... ......... ......... ......... ......... 2,500 2,630 2,760 2,900 3,050 3,200 3,360 15,270
citizens....................................
3 Exclusion of certain allowances for Federal ....... ....... ......... ......... ......... ......... ......... ......... 800 840 880 920 970 1020 1070 4,860
employees abroad............................
4 Extraterritorial income exclusion............ 4,400 1,630 ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... .........
5 Inventory property sales source rules 1,730 1,890 2,120 2,330 2,510 2,704 2,913 12,577 ......... ......... ......... ......... ......... ......... ......... .........
exception...................................
6 Deferral of income from controlled foreign 11,160 11,940 12,770 13,650 14,600 15,620 16,710 73,350 ......... ......... ......... ......... ......... ......... ......... .........
corporations (normal tax method)............
7 Deferred taxes for financial firms on certain 2,260 2,370 2,490 1,060 ......... ......... ......... 3,550 ......... ......... ......... ......... ......... ......... ......... .........
income earned overseas......................
General science, space, and technology:
8 Expensing of research and experimentation 7,770 5,570 5,170 3,980 4,920 6,100 5,880 26,050 150 110 110 80 110 130 120 550
expenditures (normal tax method)............
9 Credit for increasing research activities.... 2,120 10,260 4,910 2,100 920 360 70 8,360 60 60 50 ......... ......... ......... ......... 50
Energy:
10 Expensing of exploration and development 590 750 730 620 520 390 270 2,530 90 110 110 90 80 60 40 380
costs, fuels................................
11 Excess of percentage over cost depletion, 680 710 710 710 700 680 670 3,470 80 80 80 80 80 80 70 390
fuels.......................................
12 Alternative fuel production credit........... 2,860 2,270 750 10 10 ......... ......... 770 120 100 30 ......... ......... ......... ......... 30
13 Exception from passive loss limitation for ....... ....... ......... ......... ......... ......... ......... ......... 30 30 30 30 30 30 30 150
working interests in oil and gas properties.
14 Capital gains treatment of royalties on coal. ....... ....... ......... ......... ......... ......... ......... ......... 160 170 170 170 190 180 130 840
15 Exclusion of interest on energy facility 10 10 10 10 10 10 10 50 30 30 40 40 40 40 40 200
bonds.......................................
16 New technology credit........................ 470 640 900 1060 1090 1090 1090 5,230 40 50 60 60 60 60 60 300
17 Alcohol fuel credits \1\..................... 40 40 50 50 60 20 ......... 180 10 10 10 20 20 10 ......... 60
18 Tax credit and deduction for clean-fuel 40 30 ......... -30 -30 -40 -50 -150 70 230 150 160 10 -10 -10 300
burning vehicles............................
19 Exclusion of utility conservation subsidies.. ....... ....... ......... ......... ......... ......... ......... ......... 110 110 110 110 110 110 100 540
20 Credit for holding clean renewable energy 10 30 40 50 50 50 50 240 10 30 40 50 50 50 50 240
bonds.......................................
21 Deferral of gain from dispositions of 620 530 230 -100 -360 -510 -540 -1,280 ......... ......... ......... ......... ......... ......... ......... .........
transmission property to implement FERC
restructuring policy........................
22 Credit for investment in clean coal ....... 30 50 80 130 180 250 690 ......... ......... ......... ......... ......... ......... ......... .........
facilities..................................
23 Temporary 50% expensing for equipment used in 10 30 120 240 260 180 -50 750 ......... ......... ......... ......... ......... ......... ......... .........
the refining of liquid fuels................
24 Natural gas distribution pipelines treated as 20 50 90 120 150 150 120 630 ......... ......... ......... ......... ......... ......... ......... .........
15-year property............................
25 Amortize all geological and geophysical 10 50 70 60 30 10 10 180 ......... 10 20 10 10 ......... ......... 40
expenditures over 2 years...................
26 Allowance of deduction for certain energy 60 140 130 70 20 -10 -10 200 20 50 40 20 10 ......... ......... 70
efficient commercial building property......
27 Credit for construction of new energy 10 20 20 20 10 ......... ......... 50 ......... ......... 10 ......... ......... ......... ......... 10
efficient homes.............................
28 Credit for energy efficiency improvements to ....... ....... ......... ......... ......... ......... ......... ......... 230 380 150 ......... ......... ......... ......... 150
existing homes..............................
29 Credit for energy efficient appliances....... 120 80 ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... .........
30 30% credit for residential purchases/ ....... ....... ......... ......... ......... ......... ......... ......... 10 10 10 ......... ......... ......... ......... 10
installations of solar and fuel cells.......
31 Credit for business installation of qualified 60 70 100 40 -10 -10 -10 110 20 20 30 10 ......... ......... ......... 40
fuel cells and stationary microturbine power
plants......................................
32 Partial expensing for advanced mine safety ....... 10 20 ......... ......... ......... ......... 20 ......... ......... ......... ......... ......... ......... ......... .........
equipment...................................
Natural resources and environment:
33 Expensing of exploration and development 10 10 10 10 10 10 10 50 ......... ......... ......... ......... ......... ......... ......... .........
costs, nonfuel minerals.....................
34 Excess of percentage over cost depletion, 430 460 470 480 500 520 540 2,510 20 20 20 30 30 30 30 140
nonfuel minerals............................
35 Exclusion of interest on bonds for water, 120 140 140 150 150 160 160 760 390 440 460 480 490 510 520 2,460
sewage, and hazardous waste facilities......
36 Capital gains treatment of certain timber ....... ....... ......... ......... ......... ......... ......... ......... 160 170 170 170 190 180 130 840
income......................................
37 Expensing of multiperiod timber growing costs 200 220 230 240 250 260 270 1,250 90 90 90 90 100 100 100 480
38 Tax incentives for preservation of historic 300 310 330 340 360 380 400 1,810 90 90 100 100 110 110 120 540
structures..................................
39 Expensing of capital costs with respect to 10 10 30 50 30 ......... ......... 110 ......... ......... ......... ......... ......... ......... ......... .........
complying with EPA sulfur regulations.......
40 Exclusion of gain or loss on sale or exchange ....... 10 20 30 30 30 20 130 ......... ......... 10 10 10 10 10 50
of certain brownfield sites.................
Agriculture:
41 Expensing of certain capital outlays......... 20 20 20 20 20 30 30 120 110 110 110 120 120 120 120 590
[[Page 292]]
42 Expensing of certain multiperiod production 10 10 10 10 10 20 20 70 60 60 70 70 70 70 70 350
costs.......................................
43 Treatment of loans forgiven for solvent ....... ....... ......... ......... ......... ......... ......... ......... 20 20 20 20 20 30 30 120
farmers.....................................
44 Capital gains treatment of certain income.... ....... ....... ......... ......... ......... ......... ......... ......... 880 940 950 950 1,010 980 700 4,590
45 Income averaging for farmers................. ....... ....... ......... ......... ......... ......... ......... ......... 60 60 60 60 60 70 70 320
46 Deferral of gain on sale of farm refiners.... 10 20 20 20 20 20 20 100 ......... ......... ......... ......... ......... ......... ......... .........
47 Bio-Diesel and small agri-biodiesel producer ....... ....... ......... ......... ......... ......... ......... ......... 90 180 200 30 20 10 10 270
tax credits.................................
Commerce and housing:
Financial institutions and insurance:
48 Exemption of credit union income............ 1320 1400 1480 1570 1660 1750 1850 8,310 ......... ......... ......... ......... ......... ......... ......... .........
49 Excess bad debt reserves of financial 20 10 10 10 10 ......... ......... 30 ......... ......... ......... ......... ......... ......... ......... .........
institutions...............................
50 Exclusion of interest on life insurance 1780 1850 2020 2310 2560 2770 2950 12,610 17600 18300 19905 22750 25270 27320 29150 124,395
savings....................................
51 Special alternative tax on small property 50 50 50 50 50 60 60 270 ......... ......... ......... ......... ......... ......... ......... .........
and casualty insurance companies...........
52 Tax exemption of certain insurance companies 220 230 240 250 260 270 280 1,300 ......... ......... ......... ......... ......... ......... ......... .........
owned by tax-exempt organizations..........
53 Small life insurance company deduction...... 60 60 60 60 60 50 50 280 ......... ......... ......... ......... ......... ......... ......... .........
54 Exclusion of interest spread of financial ....... ....... ......... ......... ......... ......... ......... ......... 1,350 1,330 1,400 1,480 1,550 1,950 2,050 8,430
institutions...............................
Housing:
55 Exclusion of interest on owner-occupied 280 310 330 340 350 360 370 1,750 890 990 1,060 1,090 1,120 1,150 1,190 5,610
mortgage subsidy bonds.....................
56 Exclusion of interest on rental housing 230 260 270 280 290 300 310 1,450 740 830 880 900 930 960 990 4,660
bonds......................................
57 Deductibility of mortgage interest on owner- ....... ....... ......... ......... ......... ......... ......... ......... 68,330 79,940 89,430 96,250 103,540 111,440 119,600 520,260
occupied homes.............................
58 Deductibility of State and local property ....... ....... ......... ......... ......... ......... ......... ......... 21,260 15,540 12,620 12,590 12,580 22,440 27,770 88,000
tax on owner-occupied homes................
59 Deferral of income from installment sales... 310 310 310 320 320 320 330 1,600 880 900 920 930 1,050 1,180 1,320 5,400
60 Capital gains exclusion on home sales....... ....... ....... ......... ......... ......... ......... ......... ......... 35,270 37,030 38,890 40,830 42,870 45,010 47,270 214,870
61 Exclusion of net imputed rental income...... ....... ....... ......... ......... ......... ......... ......... ......... 28,780 32,110 35,680 39,440 43,596 48,190 53,269 220,176
62 Exception from passive loss rules for ....... ....... ......... ......... ......... ......... ......... ......... 6,590 7,150 7,520 7,790 7,990 8,150 8,300 39,750
$25,000 of rental loss.....................
63 Credit for low-income housing investments... 3,980 4,200 4,440 4,730 5,010 5,280 5,550 25,010 440 460 500 520 560 590 620 2,790
64 Accelerated depreciation on rental housing 640 680 720 770 820 870 930 4,110 9,700 10,560 11,580 12,710 13,740 14,920 16,260 69,210
(normal tax method)........................
Commerce:
65 Cancellation of indebtedness................ ....... ....... ......... ......... ......... ......... ......... ......... 90 100 90 60 30 30 30 240
66 Exceptions from imputed interest rules...... ....... ....... ......... ......... ......... ......... ......... ......... 50 50 50 50 50 50 50 250
67 Capital gains (except agriculture, timber, ....... ....... ......... ......... ......... ......... ......... ......... 48,610 51,770 51,960 52,230 55,400 53,870 38,420 251,880
iron ore, and coal)........................
68 Capital gains exclusion of small corporation ....... ....... ......... ......... ......... ......... ......... ......... 240 270 320 340 370 490 540 2,060
stock......................................
69 Step-up basis of capital gains at death..... ....... ....... ......... ......... ......... ......... ......... ......... 29,600 32,600 35,900 36,750 37,950 39,450 41,010 191,060
70 Carryover basis of capital gains on gifts... ....... ....... ......... ......... ......... ......... ......... ......... 590 650 760 800 1,270 6,340 1,500 10,670
71 Ordinary income treatment of loss from small ....... ....... ......... ......... ......... ......... ......... ......... 50 50 50 50 60 60 60 280
business corporation stock sale............
72 Accelerated depreciation of buildings other 230 290 450 680 910 1,170 1,440 4,650 -1,200 -1,030 -760 -420 -40 380 840 .........
than rental housing (normal tax method)....
73 Accelerated depreciation of machinery and 23,730 34,650 44,780 55,310 62,620 68,490 74,110 305,310 12,740 16,380 19,890 23,080 22,630 24,140 26,740 116,480
equipment (normal tax method)..............
74 Expensing of certain small investments 1,150 1,130 1,070 890 -800 -360 -70 730 3,850 4,200 4,260 3,850 -290 440 920 9,180
(normal tax method)........................
75 Graduated corporation income tax rate 4,050 4,270 4,240 4,320 4,420 4,530 4,690 22,200 ......... ......... ......... ......... ......... ......... ......... .........
(normal tax method)........................
76 Exclusion of interest on small issue bonds.. 120 140 140 150 150 160 160 760 390 440 460 480 490 510 520 2,460
77 Deduction for US production activities...... 8,180 8,690 11,380 12,000 16,220 19,100 19,770 78,470 1,770 2,010 2,430 2,500 3,330 4,790 5,590 18,640
78 Special rules for certain film and TV 90 70 60 -30 -70 -50 -40 -130 20 20 10 -10 -20 -10 -10 -40
production.................................
Transportation:
79 Deferral of tax on shipping companies........ 20 20 20 20 20 20 20 100 ......... ......... ......... ......... ......... ......... ......... .........
80 Exclusion of reimbursed employee parking ....... ....... ......... ......... ......... ......... ......... ......... 2,740 2,890 3,040 3,190 3,350 3,430 3,540 16,550
expenses....................................
81 Exclusion for employer-provided transit ....... ....... ......... ......... ......... ......... ......... ......... 560 630 710 790 880 960 1,030 4,370
passes......................................
82 Tax credit for certain expenditures for 140 160 130 60 30 10 10 240 ......... ......... ......... ......... ......... ......... ......... .........
maintaining railroad tracks.................
83 Exclusion of interest on bonds for Financing 10 15 20 25 25 25 25 120 15 35 55 70 70 75 75 345
of Highway Projects and rail-truck transfer
facilities..................................
Community and regional development:
84 Investment credit for rehabilitation of 20 20 20 20 20 20 20 100 20 20 20 20 20 20 20 100
structures (other than historic)............
[[Page 293]]
85 Exclusion of interest for airport, dock, and 270 300 310 320 330 340 350 1,650 860 950 1,010 1,040 1,070 1,100 1,130 5,350
similar bonds...............................
86 Exemption of certain mutuals' and 80 80 80 80 80 90 90 420 ......... ......... ......... ......... ......... ......... ......... .........
cooperatives' income........................
87 Empowerment zones and renewal communities.... 310 340 370 420 190 60 90 1,130 900 1,000 1,110 1,320 940 360 480 4,210
88 New markets tax credit....................... 150 210 250 240 210 180 140 1,020 440 600 740 730 650 550 450 3,120
89 Expensing of environmental remediation costs. 120 250 110 -30 -20 -20 -30 10 30 50 20 -10 ......... ......... ......... 10
90 Credit to holders of Gulf Tax Credit Bonds... ....... ....... ......... ......... ......... ......... ......... ......... 10 10 10 10 10 10 10 50
Education, training, employment, and social
services:
Education:
91 Exclusion of scholarship and fellowship ....... ....... ......... ......... ......... ......... ......... ......... 1,780 1,870 1,960 2,050 2,150 2,250 2,360 10,770
income (normal tax method).................
92 HOPE tax credit............................. ....... ....... ......... ......... ......... ......... ......... ......... 3,900 3,330 3,350 3,600 3,710 4,350 4,730 19,740
93 Lifetime Learning tax credit................ ....... ....... ......... ......... ......... ......... ......... ......... 2,490 2,190 2,200 2,310 2,390 2,780 3,020 12,700
94 Education Individual Retirement Accounts.... ....... ....... ......... ......... ......... ......... ......... ......... 10 10 10 20 20 20 30 100
95 Deductibility of student-loan interest...... ....... ....... ......... ......... ......... ......... ......... ......... 800 810 820 830 840 780 530 3,800
96 Deduction for higher education expenses..... ....... ....... ......... ......... ......... ......... ......... ......... 1,420 1,450 1,180 ......... ......... ......... ......... 1,180
97 State prepaid tuition plans................. ....... ....... ......... ......... ......... ......... ......... ......... 690 830 1,000 1,210 1,470 1,820 2,000 7,500
98 Exclusion of interest on student-loan bonds. 120 130 140 140 150 150 160 740 380 420 450 460 480 490 510 2,390
99 Exclusion of interest on bonds for private 510 570 600 620 640 660 680 3,200 1630 1810 1930 1990 2050 2110 2170 10,250
nonprofit educational facilities...........
100 Credit for holders of zone academy bonds.... 130 140 160 170 170 170 160 830 ......... ......... ......... ......... ......... ......... ......... .........
101 Exclusion of interest on savings bonds ....... ....... ......... ......... ......... ......... ......... ......... ......... 20 20 20 20 20 20 100
redeemed to finance educational expenses...
102 Parental personal exemption for students age ....... ....... ......... ......... ......... ......... ......... ......... 4,030 2,500 1,590 1,480 1,410 2,620 3,040 10,140
19 or over.................................
103 Deductibility of charitable contributions 570 600 630 670 710 750 790 3,550 3,630 3,950 4,490 4,850 5,190 5,570 5,980 26,080
(education)................................
104 Exclusion of employer-provided educational ....... ....... ......... ......... ......... ......... ......... ......... 590 620 660 690 720 40 ......... 2,110
assistance.................................
105 Special deduction for teacher expenses...... ....... ....... ......... ......... ......... ......... ......... ......... 160 170 160 ......... ......... ......... ......... 160
106 Discharge of student loan indebtedness...... ....... ....... ......... ......... ......... ......... ......... ......... 20 20 20 20 20 20 20 100
Training, employment, and social services:
107 Work opportunity tax credit................. 180 320 340 220 120 60 30 770 30 40 30 30 20 10 10 100
108 Welfare-to-work tax credit.................. 70 70 60 40 20 10 10 140 10 10 20 10 ......... ......... ......... 30
109 Employer provided child care exclusion...... ....... ....... ......... ......... ......... ......... ......... ......... 660 890 1030 1080 1140 1160 1210 5,620
110 Employer-provided child care credit......... 10 10 10 20 20 10 ......... 60 ......... ......... ......... ......... ......... ......... ......... .........
111 Assistance for adopted foster children...... ....... ....... ......... ......... ......... ......... ......... ......... 320 350 400 440 480 530 570 2,420
112 Adoption credit and exclusion............... ....... ....... ......... ......... ......... ......... ......... ......... 540 560 570 580 600 540 170 2,460
113 Exclusion of employee meals and lodging ....... ....... ......... ......... ......... ......... ......... ......... 890 930 970 1,010 1,060 1,110 1,170 5,320
(other than military)......................
114 Child credit \2\............................ ....... ....... ......... ......... ......... ......... ......... ......... 30,377 32,556 32,341 32,096 31,909 24,719 13,601 134,666
115 Credit for child and dependent care expenses ....... ....... ......... ......... ......... ......... ......... ......... 3,190 2,810 1,740 1,650 1,570 1,500 1,430 7,890
116 Credit for disabled access expenditures..... 10 10 10 10 10 10 10 50 10 20 20 20 20 20 20 100
117 Deductibility of charitable contributions, 1,300 1,370 1,440 1,510 1,580 1,650 1720 7,900 35,820 39,030 44,320 47,850 51,260 54,960 59,020 257,410
other than education and health............
118 Exclusion of certain foster care payments... ....... ....... ......... ......... ......... ......... ......... ......... 440 450 460 470 480 490 500 2,400
119 Exclusion of parsonage allowances........... ....... ....... ......... ......... ......... ......... ......... ......... 480 510 550 580 610 640 670 3,050
120 Employee retention credit for employers ....... 40 ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... .........
affected by Hurricane Katrina, Rita, and
Wilma......................................
Health:
121 Exclusion of employer contributions for ....... ....... ......... ......... ......... ......... ......... ......... 125,000 141,270 160,190 179,580 200,510 221,880 243,820 1,005,980
medical insurance premiums and medical care.
122 Self-employed medical insurance premiums..... ....... ....... ......... ......... ......... ......... ......... ......... 3,970 4,370 3,730 4,180 4,670 5,230 5,810 23,620
123 Medical Savings Accounts / Health Savings ....... ....... ......... ......... ......... ......... ......... ......... 280 990 1,980 2,600 2,830 2,910 2,850 13,170
Accounts....................................
124 Deductibility of medical expenses............ ....... ....... ......... ......... ......... ......... ......... ......... 3,770 4,240 4,920 5,820 6,840 9,250 10,780 37,610
125 Exclusion of interest on hospital 820 900 950 980 1,010 1,040 1,070 5,050 2,600 2,870 3,060 3,150 3,250 3,340 3,440 16,240
construction bonds..........................
126 Deductibility of charitable contributions 170 180 190 200 210 220 230 1,050 4,020 4,380 4,970 5,370 5,750 6,160 6,620 28,870
(health)....................................
127 Tax credit for orphan drug research.......... 230 260 290 320 360 410 460 1,840 ......... ......... ......... ......... ......... ......... ......... .........
128 Special Blue Cross/Blue Shield deduction..... 620 680 740 610 660 690 740 3,440 ......... ......... ......... ......... ......... ......... ......... .........
129 Tax credit for health insurance purchased by ....... ....... ......... ......... ......... ......... ......... ......... ......... 10 10 10 10 10 10 50
certain displaced and retired individuals
\3\.........................................
[[Page 294]]
130 Distributions from retirement plans for ....... ....... ......... ......... ......... ......... ......... ......... ......... 250 240 280 310 340 380 1,550
premiums for health and long-term care
insurance...................................
Income security:
131 Exclusion of railroad retirement system ....... ....... ......... ......... ......... ......... ......... ......... 390 380 380 380 370 360 350 1,840
benefits....................................
132 Exclusion of workers' compensation benefits.. ....... ....... ......... ......... ......... ......... ......... ......... 5,660 5,740 5,830 5,920 6,010 6,110 6,200 30,070
133 Exclusion of public assistance benefits ....... ....... ......... ......... ......... ......... ......... ......... 450 470 490 510 530 550 580 2,660
(normal tax method).........................
134 Exclusion of special benefits for disabled ....... ....... ......... ......... ......... ......... ......... ......... 50 50 40 40 40 40 40 200
coal miners.................................
135 Exclusion of military disability pensions.... ....... ....... ......... ......... ......... ......... ......... ......... 110 110 120 130 130 140 150 670
Net exclusion of pension contributions and
earnings:
136 Employer plans.............................. ....... ....... ......... ......... ......... ......... ......... ......... 49,040 49,510 48,480 48,030 46,350 43,700 42,790 229,350
137 401(k) plans................................ ....... ....... ......... ......... ......... ......... ......... ......... 40,760 42,410 43,970 45,980 48,550 54,230 57,690 250,420
138 Individual Retirement Accounts.............. ....... ....... ......... ......... ......... ......... ......... ......... 3,970 5,700 6,650 7,130 7,200 7,460 7,840 36,280
139 Low and moderate income savers credit....... ....... ....... ......... ......... ......... ......... ......... ......... 700 690 670 630 610 590 580 3,080
140 Keogh plans................................. ....... ....... ......... ......... ......... ......... ......... ......... 10,130 10,860 11,890 13,010 14,230 15,550 16,970 71,650
Exclusion of other employee benefits:
141 Premiums on group term life insurance....... ....... ....... ......... ......... ......... ......... ......... ......... 2280 2310 2350 2380 2420 2450 2490 12,090
142 Premiums on accident and disability ....... ....... ......... ......... ......... ......... ......... ......... 290 300 310 320 330 340 350 1,650
insurance..................................
143 Income of trusts to finance supplementary ....... ....... ......... ......... ......... ......... ......... ......... 20 30 30 30 40 40 50 190
unemployment benefits.......................
144 Special ESOP rules........................... 1420 1540 1660 1780 1940 2100 2280 9,760 340 350 370 390 390 390 390 1,930
145 Additional deduction for the blind........... ....... ....... ......... ......... ......... ......... ......... ......... 40 40 40 40 40 50 60 230
146 Additional deduction for the elderly......... ....... ....... ......... ......... ......... ......... ......... ......... 1,920 1,830 1,830 1,910 2,010 2,890 3,480 12,120
147 Tax credit for the elderly and disabled...... ....... ....... ......... ......... ......... ......... ......... ......... 20 10 10 10 10 10 10 50
148 Deductibility of casualty losses............. ....... ....... ......... ......... ......... ......... ......... ......... 260 280 300 310 320 350 370 1,650
149 Earned income tax credit \4\................. ....... ....... ......... ......... ......... ......... ......... ......... 5,050 5,360 5,340 5,490 5,660 5,890 7,900 30,280
150 Additional exemption for housing Hurricane ....... ....... ......... ......... ......... ......... ......... ......... 110 20 ......... ......... ......... ......... ......... .........
Katrina displaced individuals...............
Social Security:
Exclusion of Social Security benefits:
151 Social Security benefits for retired workers ....... ....... ......... ......... ......... ......... ......... ......... 17,890 18,100 18,930 19,110 20,230 21,320 23,260 102,850
152 Social Security benefits for disabled....... ....... ....... ......... ......... ......... ......... ......... ......... 4,730 5,120 5,620 5,890 6,240 6,690 7,220 31,660
153 Social Security benefits for dependents and ....... ....... ......... ......... ......... ......... ......... ......... 3,360 3,340 3,400 3,330 3,420 3,490 3,700 17,340
survivors..................................
Veterans benefits and services:
154 Exclusion of veterans death benefits and ....... ....... ......... ......... ......... ......... ......... ......... 3,580 3,770 3,890 4,030 4,200 4,590 5,030 21,740
disability compensation.....................
155 Exclusion of veterans pensions............... ....... ....... ......... ......... ......... ......... ......... ......... 150 180 180 180 190 200 230 980
156 Exclusion of GI bill benefits................ ....... ....... ......... ......... ......... ......... ......... ......... 210 260 280 300 320 360 420 1,680
157 Exclusion of interest on veterans housing 10 10 10 10 10 10 10 50 30 30 30 40 40 40 40 190
bonds.......................................
General purpose fiscal assistance:
158 Exclusion of interest on public purpose State 7,230 8,000 8,460 8,710 8,970 9,240 9,520 44,900 15,750 17,430 18,690 19,250 19,830 20,430 21,040 99,240
and local bonds.............................
159 Deductibility of nonbusiness State and local ....... ....... ......... ......... ......... ......... ......... ......... 43,120 33,680 27,900 27,790 28,570 48,560 59,850 192,670
taxes other than on owner-occupied homes....
160 Tax credit for corporations receiving income 200 20 ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... ......... .........
from doing business in U.S. possessions.....
Interest:
161 Deferral of interest on U.S. savings bonds... ....... ....... ......... ......... ......... ......... ......... ......... 1,260 1,330 1,340 1,360 1,370 1,420 1,520 7,010
Addendum: Aid to State and local governments:
Deductibility of:
Property taxes on owner-occupied homes...... ....... ....... ......... ......... ......... ......... ......... ......... 21,260 15,540 12,620 12,590 12,580 22,440 27,770 88,000
Nonbusiness State and local taxes other than ....... ....... ......... ......... ......... ......... ......... ......... 43,120 33,680 27,900 27,790 28,570 48,560 59,850 192,670
on owner-occupied homes....................
Exclusion of interest on State and local
bonds for:
Public purposes............................. 7,230 8,000 8,460 8,710 8,970 9,240 9,520 44,900 15,750 17,430 18,690 19,250 19,830 20,430 21,040 99,240
Energy facilities........................... 10 10 10 10 10 10 10 50 30 30 40 40 40 40 40 200
Water, sewage, and hazardous waste disposal 120 140 140 150 150 160 160 760 390 440 460 480 490 510 520 2,460
facilities.................................
Small-issues................................ 120 140 140 150 150 160 160 760 390 440 460 480 490 510 520 2,460
Owner-occupied mortgage subsidies........... 280 310 330 340 350 360 370 1,750 890 990 1,060 1,090 1,120 1,150 1,190 5,610
Rental housing.............................. 230 260 270 280 290 300 310 1,450 740 830 880 900 930 960 990 4,660
Airports, docks, and similar facilities..... 270 300 310 320 330 340 350 1,650 860 950 1,010 1,040 1,070 1,100 1,130 5,350
Student loans............................... 120 130 140 140 150 150 160 740 380 420 450 460 480 490 510 2,390
Private nonprofit educational facilities.... 510 570 600 620 640 660 680 3,200 1,630 1,810 1,930 1,990 2,050 2,110 2,170 10,250
Hospital construction....................... 820 900 950 980 1010 1040 1070 5,050 2,600 2,870 3,060 3,150 3,250 3,340 3,440 16,240
Veterans' housing........................... 10 10 10 10 10 10 10 50 30 30 30 40 40 40 40 190
[[Page 295]]
Credit for holders of zone academy bonds....... 130 140 160 170 170 170 160 830 ......... ......... ......... ......... ......... ......... ......... .........
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\1\ In addition, the alcohol fuel credit results in a reduction in excise tax receipts (in millions of dollars) as follows: 2006 $2,570; 2007 $2,990; 2008 $3,460; 2009 $4,280; 2010 $4,990; 2011 $1,440; 0 in 2012.
\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: 2006 $15,473; 2007 $14,931; 2008 $14,367; 2009 $14,019; 2010 $13,651;
2011 $13,410; and 2012 $1,275.
\3\ The figures in the table indicate the effect of the health insurance tax credit on receipts. The effect of the credit on outlays (in millions of dollars) is as follows: 2006 $90; 2007 $100; 2008 $110; 2009 $120; 2010 $130; 2011
$140; and 2012 $150.
\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: 2006 $36,166;2007 $36,461; 2008 $37,573; 2009 $38,237; 2010
$38,994; 2011 $40,289; and 2012 $36,982.
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.
Tax Expenditure Baselines
A tax expenditure is an exception to baseline provisions of the tax
structure that usually results in a reduction in the amount of tax owed.
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 deduction of 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:
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 owner-occupied housing or farmers' consumption of
their own produce) are regarded as tax expenditures. 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.
A separate corporate income tax is not part of a
comprehensive income tax.
Tax rates vary by level of income. Multiple tax rates exist
as a means to facilitate the redistribution of income.
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
nor does gross income include most transfer payments which can be
thought of as gifts from the
[[Page 296]]
Government. \3\ 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. \4\
---------------------------------------------------------------------------
\3\ Gross income does, however, include transfer payments associated
with past employment, such as Social Security benefits.
\4\ 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.
---------------------------------------------------------------------------
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. Appendix A 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.
Table 19-3. INCOME TAX EXPENDITURES RANKED BY TOTAL 2008-2012 PROJECTED REVENUE EFFECT
(in millions of dollars)
--------------------------------------------------------------------------------------------------------------------------------------------------------
Provision 2008 2008-12
--------------------------------------------------------------------------------------------------------------------------------------------------------
121 Exclusion of employer contributions for medical insurance premiums and medical care...................... 160,190 1,005,980
57 Deductibility of mortgage interest on owner-occupied homes............................................... 89,430 520,260
73 Accelerated depreciation of machinery and equipment (normal tax method).................................. 64,670 421,790
117 Deductibility of charitable contributions, other than education and health............................... 45,760 265,310
67 Capital gains (except agriculture, timber, iron ore, and coal)........................................... 51,960 251,880
137 401(k) plans............................................................................................. 43,970 250,420
136 Employer plans........................................................................................... 48,480 229,350
61 Exclusion of net imputed rental income................................................................... 35,680 220,176
60 Capital gains exclusion on home sales.................................................................... 38,890 214,870
159 Deductibility of nonbusiness State and local taxes other than on owner-occupied homes.................... 27,900 192,670
69 Step-up basis of capital gains at death.................................................................. 35,900 191,060
158 Exclusion of interest on public purpose State and local bonds............................................ 27,150 144,140
50 Exclusion of interest on life insurance savings.......................................................... 21,925 137,005
114 Child tax credit......................................................................................... 32,341 134,666
151 Social Security benefits for retired workers............................................................. 18,930 102,850
77 Deduction for U.S. production activities................................................................. 13,810 97,110
58 Deductibility of State and local property tax on owner-occupied homes.................................... 12,620 88,000
6 Deferral of income from controlled foreign corporations (normal tax method).............................. 12,770 73,350
64 Accelerated depreciation on rental housing (normal tax method)........................................... 12,300 73,320
140 Keogh plans.............................................................................................. 11,890 71,650
62 Exception from passive loss rules for $25,000 of rental loss............................................. 7,520 39,750
124 Deductibility of medical expenses........................................................................ 4,920 37,610
138 Individual Retirement Accounts........................................................................... 6,650 36,280
152 Social Security benefits for disabled.................................................................... 5,620 31,660
149 Earned income tax credit................................................................................. 5,340 30,280
132 Exclusion of workers' compensation benefits.............................................................. 5,830 30,070
126 Deductibility of charitable contributions (health)....................................................... 5,160 29,920
103 Deductibility of charitable contributions (education).................................................... 5,120 29,630
63 Credit for low-income housing investments................................................................ 4,940 27,800
8 Expensing of research and experimentation expenditures (normal tax method)............................... 5,280 26,600
122 Self-employed medical insurance premiums................................................................. 3,730 23,620
75 Graduated corporation income tax rate (normal tax method)................................................ 4,240 22,200
154 Exclusion of veterans death benefits and disability compensation......................................... 3,890 21,740
125 Exclusion of interest on hospital construction bonds..................................................... 4,010 21,290
92 HOPE tax credit.......................................................................................... 3,350 19,740
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1 Exclusion of benefits and allowances to armed forces personnel........................................... 3,350 18,160
153 Social Security benefits for dependents and survivors.................................................... 3,400 17,340
80 Exclusion of reimbursed employee parking expenses........................................................ 3,040 16,550
2 Exclusion of income earned abroad by U.S. citizens....................................................... 2,760 15,270
99 Exclusion of interest on bonds for private nonprofit educational facilities.............................. 2,530 13,450
123 Medical Savings Accounts / Health Savings Accounts....................................................... 1,980 13,170
93 Lifetime Learning tax credit............................................................................. 2,200 12,700
5 Inventory property sales source rules exception.......................................................... 2,120 12,577
146 Additional deduction for the elderly..................................................................... 1,830 12,120
141 Premiums on group term life insurance.................................................................... 2,350 12,090
144 Special ESOP rules....................................................................................... 2,030 11,690
91 Exclusion of scholarship and fellowship income (normal tax method)....................................... 1,960 10,770
70 Carryover basis of capital gains on gifts................................................................ 760 10,670
102 Parental personal exemption for students age 19 or over.................................................. 1,590 10,140
74 Expensing of certain small investments (normal tax method)............................................... 5,330 9,910
54 Exclusion of interest spread of financial institutions................................................... 1,400 8,430
9 Credit for increasing research activities................................................................ 4,960 8,410
48 Exemption of credit union income......................................................................... 1,480 8,310
115 Credit for child and dependent care expenses............................................................. 1,740 7,890
97 State prepaid tuition plans.............................................................................. 1,000 7,500
55 Exclusion of interest on owner-occupied mortgage subsidy bonds........................................... 1,390 7,360
161 Deferral of interest on U.S. savings bonds............................................................... 1,340 7,010
59 Deferral of income from installment sales................................................................ 1,230 7,000
85 Exclusion of interest for airport, dock, and similar bonds............................................... 1,320 7,000
56 Exclusion of interest on rental housing bonds............................................................ 1,150 6,110
109 Employer provided child care exclusion................................................................... 1,030 5,620
16 New technology credit.................................................................................... 960 5,530
87 Empowerment zones, Enterprise communities, and Renewal communities....................................... 1,480 5,340
113 Exclusion of employee meals and lodging (other than military)............................................ 970 5,320
3 Exclusion of certain allowances for Federal employees abroad............................................. 880 4,860
72 Accelerated depreciation of buildings other than rental housing (normal tax method)...................... -310 4,650
44 Capital gains treatment of certain income................................................................ 950 4,590
81 Exclusion for employer-provided transit passes........................................................... 710 4,370
88 New markets tax credit................................................................................... 990 4,140
11 Excess of percentage over cost depletion, fuels.......................................................... 790 3,860
95 Deductibility of student-loan interest................................................................... 820 3,800
7 Deferred taxes for financial firms on certain income earned overseas..................................... 2,490 3,550
128 Special Blue Cross/Blue Shield deduction................................................................. 740 3,440
35 Exclusion of interest on bonds for water, sewage, and hazardous waste facilities......................... 600 3,220
76 Exclusion of interest on small issue bonds............................................................... 600 3,220
98 Exclusion of interest on student-loan bonds.............................................................. 590 3,130
139 Low and moderate income savers credit.................................................................... 670 3,080
119 Exclusion of parsonage allowances........................................................................ 550 3,050
10 Expensing of exploration and development costs, fuels.................................................... 840 2,910
133 Exclusion of public assistance benefits (normal tax method).............................................. 490 2,660
34 Excess of percentage over cost depletion, nonfuel minerals............................................... 490 2,650
112 Adoption credit and exclusion............................................................................ 570 2,460
111 Assistance for adopted foster children................................................................... 400 2,420
118 Exclusion of certain foster care payments................................................................ 460 2,400
38 Tax incentives for preservation of historic structures................................................... 430 2,350
104 Exclusion of employer-provided educational assistance.................................................... 660 2,110
68 Capital gains exclusion of small corporation stock....................................................... 320 2,060
127 Tax credit for orphan drug research...................................................................... 290 1,840
131 Exclusion of railroad retirement system benefits......................................................... 380 1,840
37 Expensing of multiperiod timber growing costs............................................................ 320 1,730
156 Exclusion of GI bill benefits............................................................................ 280 1,680
142 Premiums on accident and disability insurance............................................................ 310 1,650
148 Deductibility of casualty losses......................................................................... 300 1,650
130 Distributions from retirement plans for premiums for health and long-term care insurance................. 240 1,550
52 Tax exemption of certain insurance companies owned by tax-exempt organizations........................... 240 1,300
96 Deduction for higher education expenses.................................................................. 1,180 1,180
155 Exclusion of veterans pensions........................................................................... 180 980
107 Work opportunity tax credit.............................................................................. 370 870
14 Capital gains treatment of royalties on coal............................................................. 170 840
36 Capital gains treatment of certain timber income......................................................... 170 840
100 Credit for holders of zone academy bonds................................................................. 160 830
12 Alternative fuel production credit....................................................................... 780 800
23 Temporary 50% expensing for equipment used in the refining of liquid fuels............................... 120 750
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41 Expensing of certain capital outlays..................................................................... 130 710
22 Credit for investment in clean coal facilities........................................................... 50 690
135 Exclusion of military disability pensions................................................................ 120 670
24 Natural gas distribution pipelines treated as 15-year property........................................... 90 630
19 Exclusion of utility conservation subsidies.............................................................. 110 540
20 Credit for holding clean renewable energy bonds.......................................................... 80 480
83 Exclusion of interest on bonds for Financing of Highway Projects and rail-truck transfer facilities...... 75 465
42 Expensing of certain multiperiod production costs........................................................ 80 420
86 Exemption of certain mutuals' and cooperatives' income................................................... 80 420
45 Income averaging for farmers............................................................................. 60 320
53 Small life insurance company deduction................................................................... 60 280
71 Ordinary income treatment of loss from small business corporation stock sale............................. 50 280
26 Allowance of deduction for certain energy efficient commercial building property......................... 170 270
47 Bio-Diesel tax credit.................................................................................... 200 270
51 Special alternative tax on small property and casualty insurance companies............................... 50 270
15 Exclusion of interest on energy facility bonds........................................................... 50 250
66 Exceptions from imputed interest rules................................................................... 50 250
17 Alcohol fuel credits..................................................................................... 60 240
65 Cancellation of indebtedness............................................................................. 90 240
82 Tax credit for certain expenditures for maintaining railroad tracks...................................... 130 240
157 Exclusion of interest on veterans housing bonds.......................................................... 40 240
145 Additional deduction for the blind....................................................................... 40 230
25 Amortize all geological and geophysical expenditures over 2 years........................................ 90 220
84 Investment credit for rehabilitation of structures (other than historic)................................. 40 200
134 Exclusion of special benefits for disabled coal miners................................................... 40 200
143 Income of trusts to finance supplementary unemployment benefits.......................................... 30 190
40 Exclusion of gain or loss on sale or exchange of certain brownfield sites................................ 30 180
108 Welfare-to-work tax credit............................................................................... 80 170
105 Special deduction for teacher expenses................................................................... 160 160
13 Exception from passive loss limitation for working interests in oil and gas properties................... 30 150
18 Tax credit and deduction for clean-fuel burning vehicles................................................. 150 150
28 Credit for energy efficiency improvements to existing homes.............................................. 150 150
31 Credit for business installation of qualified fuel cells and stationary microturbine power plants........ 130 150
116 Credit for disabled access expenditures.................................................................. 30 150
43 Treatment of loans forgiven for solvent farmers.......................................................... 20 120
39 Expensing of capital costs with respect to complying with EPA sulfur regulations......................... 30 110
46 Deferral of gain on sale of farm refiners................................................................ 20 100
79 Deferral of tax on shipping companies.................................................................... 20 100
94 Education Individual Retirement Accounts................................................................. 10 100
101 Exclusion of interest on savings bonds redeemed to finance educational expenses.......................... 20 100
106 Discharge of student loan indebtedness................................................................... 20 100
27 Credit for construction of new energy efficient homes.................................................... 30 60
110 Employer-provided child care credit...................................................................... 10 60
33 Expensing of exploration and development costs, nonfuel minerals......................................... 10 50
90 Credit to holders of Gulf Tax Credit Bonds............................................................... 10 50
129 Tax credit for health insurance purchased by certain displaced and retired individuals................... 10 50
147 Tax credit for the elderly and disabled.................................................................. 10 50
49 Excess bad debt reserves of financial institutions....................................................... 10 30
32 Partial expensing for advanced mine safety equipment..................................................... 20 20
89 Expensing of environmental remediation costs............................................................. 130 20
30 30% credit for residential purchases/installations of solar and fuel cells............................... 10 10
4 Extraterritorial income exclusion........................................................................ ............... ...............
29 Credit for energy efficient appliances................................................................... ............... ...............
120 Employee retention credit for employers affected by Hurricane Katrina, Rita, and Wilma................... ............... ...............
150 Additional exemption for housing Hurricane Katrina displaced individuals................................. ............... ...............
160 Tax credit for corporations receiving income from doing business in U.S. possessions..................... ............... ...............
78 Special rules for certain film and TV production......................................................... 70 -170
21 Deferral of gain from dispositions of transmission property to implement FERC restructuring policy....... 230 -1,280
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[[Page 299]]
Table 19-4. PRESENT VALUE OF SELECTED TAX EXPENDITURES FOR ACTIVITY IN CALENDAR YEAR 2006
(in millions of dollars)
----------------------------------------------------------------------------------------------------------------
2006 Present
Provision Value of
Revenue Loss
----------------------------------------------------------------------------------------------------------------
1 Deferral of income from controlled foreign corporations (normal tax method)......... 10,520
2 Deferred taxes for financial firms on income earned overseas........................ 2,380
3 Expensing of research and experimentation expenditures (normal tax method).......... 2,690
4 Expensing of exploration and development costs--fuels............................... 260
5 Expensing of exploration and development costs--nonfuels............................ 10
6 Expensing of multiperiod timber growing costs....................................... 160
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.......................... 19,750
10 Accelerated depreciation on rental housing.......................................... 16,240
11 Accelerated depreciation of buildings other than rental............................. 10,510
12 Accelerated depreciation of machinery and equipment................................. 68,430
13 Expensing of certain small investments (normal tax method).......................... 860
14 Deferral of tax on shipping companies............................................... 20
15 Credit for holders of zone academy bonds............................................ 210
16 Credit for low-income housing investments........................................... 4,530
17 Deferral for state prepaid tuition plans............................................ 4,730
18 Exclusion of pension contributions--employer plans.................................. 75,660
19 Exclusion of 401(k) contributions................................................... 110,000
20 Exclusion of IRA contributions and earnings......................................... 4,100
21 Exclusion of contributions and earnings for Keogh plans............................. 7,640
22 Exclusion of interest on public-purpose bonds....................................... 20,420
23 Exclusion of interest on non-public purpose bonds................................... 6,900
24 Deferral of interest on U.S. savings bonds.......................................... 420
25 Exclusion of Roth earnings and distributions........................................ 8,380
26 Exclusion of non-deductible IRA earnings............................................ 400
----------------------------------------------------------------------------------------------------------------
Double Taxation of Corporate Profits
In a gradual transition to a more economically neutral tax system
under which all income is taxed no more than once, the lower tax rates
on dividends and capital gains on corporate equity under current law
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 a 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. Appendix A provides a
greater discussion of alternative baselines.
Descriptions of Income Tax Provisions
Descriptions of the individual and corporate income tax expenditures
reported on in this chapter follow. These descriptions relate to current
law as of December 31, 2006, and do not reflect proposals made elsewhere
in the Budget. Legislation enacted in 2006, such as the Tax Increase
Prevention and Reconciliation Act of 2005 (TIPRA), the Pension
Protection Act of 2006 (PPA), and the Tax Relief and Health Care Act of
2006 (TRHCA) extended and expanded the scope of many existing
provisions.
TIPRA extended the 15 percent tax rate for dividends and capital gains
through December 31, 2010, and the higher limit for certain investment
that can be expensed through December 31, 2009.
Provisions extended or expanded by the PPA include:
the low-income saver's credit (made permanent)
Section 529 education savings provisions (made permanent)
the maximum contribution and benefit limits under qualified
pension plans (made permanent)
the enhanced charitable deduction for food and book
inventories
the indexation of the IRA contribution limits (and higher
limits made permanent)
allowing for tax-free distributions from retirement plans
for premiums for health and long-term care insurance for
public safety officers
tax-free distributions from IRAs to public charities
Provisions extended or expanded by the TRHCA include:
the deduction for tuition and teaching related expenses
the new markets tax credit
the deduction for State and local sales taxes
the research and experimentation tax credit
the work opportunity and welfare to work tax credits
qualified zone academy bonds
[[Page 300]]
expensing of remediation costs
charitable contributions of computers and scientific
property
credit for clean renewable energy bonds
credits for construction of new energy efficient homes and
commercial buildings
credits for alternative technologies
select empowerment zone incentives
Chapter 17 on Federal Receipts has more detailed descriptions of the
provisions of these three bills.
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, then 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 ($77,793 in 2006).
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\.--The exclusion for
extraterritorial income was repealed by the American Jobs Creation Act
of 2004. Under the transition rules, taxpayers retain 80 percent of ETI
benefits for 2005, 60 percent of ETI benefits for 2006, and no ETI
benefits thereafter. The exclusion for extraterritorial income remains
in effect for certain transactions which occur pursuant to a binding
contract entered into on or before September 17, 2003.
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\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.
---------------------------------------------------------------------------
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.
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 incremental credit regime.
Under the alternative incremental 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). Beginning in 2007,
the rates for the alternative incremental credit increases to a range of
3 percent to 5 percent. An alternative simplified credit is also allowed
which is equal to 12 percent of qualified research expenses that exceed
50 percent of the average qualified research expenses for the three
preceding taxable years. A 20-percent credit with a separate threshold
is provided for a taxpayer's payments to universities for basic
research. A 20-percent ``flat'' credit with no threshold base amount is
available for energy research expenditures paid to certain research
consortia. The credit applies to research conducted before January 1,
2008 and extends to research conducted in Puerto Rico and the U.S.
possessions.
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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 credit of $3 per oil-
equivalent barrel of production (in 1979 dollars) is provided for gas
produced from biomass and liquid, gaseous, or solid synthetic fuels
produced from coal. The credit is generally available if the price of
oil stays below $29.50 (in 1979 dollars). The credit applies only to
fuel (1) produced at a facility placed in service before July 1, 1998,
and (2) sold before January 1, 2008. A credit is also available for the
production of coke or coke gas from a qualified facility. Qualified
facilities must have been placed in service before January 1, 1993, or
after June 30, 1998, and before January 1, 2010.
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 taxexempt.
These bonds are generally subject to the State private-activity bond
annual volume cap.
16. New technology, refined coal, Indian coal and coke and coke gas
credits.--A credit is provided equal to 10 percent of the basis of solar
property (30 percent for purchases beginning in 2006 through 2008) and
10 percent of the basis of geothermal property placed in service during
the taxable year. A credit is also available for certain electricity
produced from wind energy, biomass, geothermal energy, solar energy,
small irrigation power, municipal solid waste, or qualified hydropower
and sold to an unrelated party. The credit rate in 2006 is 1.9 cents per
kilowatt hour (0.9 cents per kilowatt hour for open-loop biomass, small
irrigation power, municipal solid waste and qualified hydropower) and
the rate is indexed in subsequent years. Another credit is available for
refined coal. The credit rate in 2006 is $5.679 per ton and the rate is
indexed in subsequent years. An additional credit is available for the
production of Indian coal. The value of the credit is $1.50 per ton in
2006 and indexed for inflation in subsequent years.
17. Alcohol fuel credits.--An income tax credit is provided for
ethanol that is derived from renewable sources and used as fuel. The
credit equals 51 cents per gallon through 2010. In lieu of the alcohol
mixture credit, the taxpayer may claim a refundable excise tax credit.
In addition, small ethanol producers are eligible for a separate 10
cents per gallon credit.
18. Credit and deduction for clean-fuel vehicles and property and
alternative motor vehicle credits.--A tax credit of 10 percent (not to
exceed $4,000) is provided for purchasers of electric vehicles. The
credit is reduced by 75 percent for vehicles placed in service in 2006
and is not available for vehicles placed in service after December 31,
2006. No deduction is available to taxpayers for vehicles placed in
service after December 31, 2005. The deduction for clean-fuel property
is available for costs incurred before January 1, 2007. A taxpayer may
claim a 30 percent credit for the cost of installing clean-fuel vehicle
refueling property for property placed in service after December 31,
2005 and before January 1, 2008. The taxpayer may not claim deductions
with respect to property for which the credit is claimed. A tax credit
is also available for the purchase of hybrid vehicles, fuel cell
vehicles, alternative fuel vehicles and advanced lean burn vehicles. The
provision applies to vehicles placed in service after December 31, 2005,
in the case of qualified fuel cell motor vehicles, before January 1,
2015; in the case of qualified hybrid motor vehicles that are
automobiles and light trucks and in the case of advanced lean-burn
technology vehicles, before January 1, 2011; in the case of qualified
hybrid motor vehicles that are medium and heavy trucks, before January
1, 2010; and in the case of qualified alternative fuel motor vehicles,
before January 1, 2011.
19. Exclusion of utility conservation subsidies.--Non-business
customers can exclude from gross income
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subsidies received from public utilities for expenditures on energy
conservation measures.
20. Credit to holders of clean renewable energy bonds.--This provision
provides for up to $800 million in aggregate issuance of Clean Renewable
Energy Bonds (CREBs) through December 31, 2008. Taxpayers holding CREBs
on a credit allowance date are entitled to a tax credit in lieu of
interest.
21. Deferral of gain from dispositions of transmission property to
implement FERC restructuring policy.--Utilities that sell their
transmission assets to a FERC-approved independent transmission company
are allowed a longer recognition period for their gains from sale.
Rather than paying tax on any gain from the sale in the year that the
sale is completed, utilities will have 8 years to pay the tax on any
gain from the sale. The rule expires at the end of 2007.
22. Credit for investment in clean coal facilities.--Three investment
tax credits for clean coal facilities are available: a 15 percent and 20
percent investment tax credit for clean coal facilities producing
electricity; and a 20 percent credit for industrial gasification
projects. Integrated gasification combined cycle (IGCC) projects get a
20 percent investment tax credit and other advanced coal-based projects
that produce electricity get a 15 percent credit. The Secretary of the
Treasury may allocate up to $800 million for IGCC projects and up to
$500 million for other advanced coal-based technologies and up to $350
million for industrial gasification.
23. Temporary 50 percent expensing for equipment used in the refining
of liquid fuels.--Taxpayers may expense 50 percent of the cost of
refinery investments which increase the capacity of an existing refinery
by at least 5 percent or increase the throughput of qualified fuels by
at least 25 percent. Qualified fuels include oil from shale and tar
sands. Investments must be placed in service before January 1, 2012.
24. Natural gas distribution pipelines treated as 15-year property.--
The depreciation period is shortened to 15 years for any gas
distribution lines the original use of which occurred after April 11,
2004 and before January 1, 2011. The provision does not apply to any
property which the taxpayer or a related party had entered into a
binding contract for the construction thereof or self-constructed on or
before April 11, 2005.
25. Amortize all geological and geophysical expenditures over 2
years.--Geological and geophysical amounts incurred in connection with
oil and gas exploration in the United States may be amortized over two
years for non-integrated oil companies and five years for certain major
integrated oil companies. In the case of abandoned property, any
remaining basis may no longer be recovered in the year of abandonment of
a property as all basis is recovered over the two-year amortization
period.
26. Allowance of deduction for certain energy efficient commercial
building property.--A deduction for energy efficient commercial
buildings that reduce annual energy and power consumption by 50 percent
compared to the American Society of Heating, Refrigerating, and Air
Conditioning Engineers (ASHRAE) standard is allowed. The provision is
effective for property placed in service after December 31, 2005 and
prior to January 1, 2008.
27. Credit for construction of new energy efficient homes.--A credit
is available to eligible contractors for construction of a qualified new
energy-efficient home. The credit applies to homes whose construction is
substantially completed after December 31, 2005 and which are purchased
after December 31, 2005 and prior to January 1, 2009.
28. Credit for energy efficiency improvements to existing homes.--A 10
percent investment tax credit up to $500 is available for expenditures
on insulation, exterior windows and doors that improve the energy
efficiency of homes and meet certain standards. Credits for purchases of
advanced main air circulating fans, natural gas, propane, or oil
furnaces or hot water boilers, and other qualified energy efficient
property are also available. Credit applies to property placed in
service after December 31, 2005 and prior to January 1, 2008.
29. Credit for energy efficient appliances.--Tax credits for the
manufacture of efficient dishwashers, clothes washers, and refrigerators
are available. Credits vary depending on the efficiency of the unit. The
provision is effective for appliances manufactured in 2006 and 2007.
30. Credit for residential purchases/installations of solar and fuel
cells.--A credit, equal to 30 percent of qualifying expenditures, for
purchase for qualified photovoltaic property and solar water heating
property is available. A 30 percent credit for the purchase of qualified
fuel cell power plants is also allowed and applies to property placed in
service after December 31, 2005 and prior to January 1, 2009.
31. Credit for business installation of qualified fuel cells and
stationary microturbine power plants.--A 30 percent business energy
credit for purchase of qualified fuel cell power plants for businesses
and a 10 percent credit for purchase of qualifying stationary
microturbine power plants are allowed.
32. Partial expensing for advanced mine safety equipment.--Qualified
mine safety equipment may me expensed rather depreciated over time.
Provision limited to property placed in service on or before December
31, 2008.
Natural Resources and Environment
33. 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.
34. 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.
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35. 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.
36. Capital gains treatment of certain timber.--Certain timber sales
can be treated as a capital gain rather than ordinary income.
37. Expensing multi-period 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.
38. Historic preservation.--Expenditures to preserve and restore
historic structures qualify for a 20-percent investment tax credit, but
the depreciable basis must be reduced by the full amount of the credit
taken.
39. 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.
40. Exclusion of gain or loss on sale or exchange of certain
brownfield sites.--In general, an organization that is otherwise exempt
from federal income tax is taxed on income from any trade or business
regularly carried on by the organization that is not substantially
related to the organization's exempt purpose. The AJCA of 2004 created a
special exclusion from unrelated business taxable income of the gain or
loss from the sale or exchange of certain qualifying brownfield
properties. The exclusion applies regardless of whether the property is
debt-financed. In order to qualify, a minimum amount of remediation
expenditures must be incurred by the organization.
Agriculture
41. 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.
42. Expensing multi-period 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.
43. 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.
44. Capital gains treatment of certain income.--Certain agricultural
income, such as unharvested crops, can be treated as capital gains
rather than ordinary income.
45. 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.
46. 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.
47. 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 Energy Tax Incentives Act of
2005 extends the income tax credit, excise tax credit, and payment
provisions through December 31, 2008 and adds a credit for small agri-
biodiesel producers. The conference agreement also creates a similar
income tax credit, excise tax credit and payment system for renewable
diesel, however there is no credit for small producers of renewable
diesel. Renewable diesel means diesel fuel derived form biomass using
thermal depolymerization process.
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.
48. Credit union income.--The earnings of credit unions not
distributed to members as interest or dividends are exempt from income
tax.
49. 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.
50. 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
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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.
51. 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.
52. 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.
53. 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.
54. Exclusion of interest spread of financial institutions.--Consumers
and non-profit organizations pay for some deposit-linked services, such
as check cashing, by accepting a below-market interest rate on their
demand deposits. If they received a market rate of interest on those
deposits and paid explicit fees for the associated services, they would
pay taxes on the full market rate and (unlike businesses) could not
deduct the fees. The government thus foregoes tax on the difference
between the risk-free market interest rate and below-market interest
rates on demand deposits, which under competitive conditions should
equal the value added of deposit services.
55. 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.
56. 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.
57. 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.
58. 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.
59. 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.
60. Capital gains exclusion on home sales.--A homeowner can exclude
from tax up to $500,000
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($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.
61. 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. Appendix A provides
a fuller explanation of this new addition to the tax expenditure budget.
62. 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.
63. 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.
64. 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 Appendix A.
65. 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.
66. 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.
67. 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.
The Jobs Growth Tax Relief Reconciliation Act (JGTRRA) lowered the top
tax rate on capital gains from 20 percent to 15 percent, which is
effective through 2010. For taxpayers in the 15 percent or below
ordinary tax bracket, JGTRRA lowered the tax rate on capital gains to 5
percent (0 percent in 2008). These lower rates apply to assets held for
more than one year.
Previously, 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.
68. 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.
69. 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.
70. 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.
71. 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
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be treated as ordinary losses. Such losses would, thus, not be subject
to the $3,000 annual capital loss write-off limit.
72. 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 Appendix A.
73. 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 Appendix A.
74. 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 extent 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 2009, 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 2009.
75. 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 rate is considered a tax expenditure
under this concept.
76. 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.
77. 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.
78. 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
79. 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.
80. 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 2006, the maximum
amount of the parking exclusion is $250 (indexed) per month. The tax
expenditure estimate does not include parking at facilities owned by the
employer.
81. 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 2006, the maximum amount of
the exclusion is $105 (indexed) per month.
82. 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.
83. Exclusion of interest on bonds for Financing of Highway Projects
and Rail-Truck Transfer Facilities.--This provision provides for $15
billion of tax-exempt bond authority to finance qualified highway or
surface freight transfer facilities. The authority to issue these bonds
expires on December 31, 2015.
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Community and Regional Development
84.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.
85. 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.
86. 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.
87. Empowerment zones 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. Empowerment zone and renewal community
designations expire at the end of 2009. 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 2007.
The Gulf Opportunity Zone Act of 2005 added several provisions
targeted to encourage the redevelopment of areas affected by hurricanes
Katrina, Rita and Wilma, including some provisions that have already
been listed elsewhere in this table. Gulf Opportunity Zone Act
provisions not listed elsewhere include additional tax-exempt bond
financing authority, accelerated depreciation of investment in both
structures and equipment, partial expensing for certain demolition and
clean-up costs, increased carryback of certain net operating losses,
increased authority to allocate low-income housing tax credits and new
markets tax credits within the affected areas and other provisions.
88. New markets tax credit.--Taxpayers who make qualified equity
investments in a community development entity (CDE), which then makes
qualified investments in low-income communities, are eligible for a tax
credit received over 7 years. 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 the primary
mission of which is to serve or provide investment capital for low-
income communities/individuals; a CDE must be accountable to residents
of low-income communities. 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 2008.
Credit authority is allocated to CDEs through a competitive application
process.
89. Expensing of environmental remediation costs.--Taxpayers who clean
up certain hazardous substances at a qualified site may expense the
clean-up 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, 2007 to be eligible for expensing.
90. Credit to holders of Gulf Tax Credit Bonds.--Taxpayers that own
Gulf Tax Credit 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. The maximum amount that can be issued is $200 million
in the case of Louisiana, $100 million in the case of Mississippi, and
$50 million in the case of Alabama.
Education, Training, Employment, and Social Services
91.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).
92. HOPE tax credit.--The non-refundable HOPE tax credit allows a
credit for 100 percent of an eligible student's first $1,100 of tuition
and fees and 50 percent of the next $1,100 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 2006, the credit is phased out
ratably for taxpayers with modified AGI between $90,000 and $110,000
($45,000 and $55,000 for singles), indexed.
93. 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, up to a maximum credit per return is $2,000.
The credit is phased out ratably for taxpayers with modified AGI between
$90,000 and $110,000 ($45,000 and $55,000 for singles) (indexed
beginning in 2002). The credit applies to both undergraduate and
graduate students.
94. 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
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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 2006
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).
95. 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 2006, the maximum deduction is phased down
ratably for taxpayers with modified AGI between $105,000 and $135,000
($50,000 and $65,000 for singles), indexed.
96. Deduction for Higher Education Expenses.--The maximum annual
deduction for qualified higher education expenses is $4,000 in 2007 for
taxpayers with 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, 2007.
97. 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.
98. Student-loan bonds.--Interest earned on State and local bonds
issued to finance student loans is tax-exempt. The volume of all such
private activity bonds that each State may issue annually is limited.
99. 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.
100. 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 2007.
101. 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
$94,700 and $124,700 ($63,100 and $78,100 for singles) in 2006.
102. Dependent students age 19 or older.--Taxpayers may claim personal
exemptions for dependent children who are over the age of 18 or under
the age of 24 and who (1) reside with the taxpayer for over half the
year (with exceptions for temporary absences from home, such as for
school attendance), (2) are full-time students, and (3) do not claim a
personal exemption on their own tax returns.
103. 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.
104. 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.
105. 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). Provision expires at end of
December 31, 2007.
106. 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.
107. Work opportunity tax credit.--Employers can claim a tax credit
for qualified wages paid to individuals who begin work on or before
December 31, 2007 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.
Employees must work at least 120 hours to be eligible for the credit.
Employers must reduce their deduction for wages paid by the amount of
the credit claimed. The Katrina Emergency Tax Relief Act of 2005
expanded WOTC eligibility to Hurricane Katrina Employees, defined as
persons whose principal places of abode on August 28, 2005 were in the
core disaster area and who beginning on such date and through August 28,
2007, are hired for a position principally located in the core disaster
area; and beginning on such date and through December 31, 2005, are
hired for a position regardless of its location. The usual certification
process rules are waived for Hurricane Katrina employees. The Tax Relief
and Health Care Act of 2006 modified the Work opportunity tax credit
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by changing definitions of the Food Stamp and Ex-Convict target groups
and adding persons eligible for the Welfare-to-work credit as a new WOTC
target group with a $10,000 ceiling on qualified first year wages and a
50 percent credit on qualified second year wages up to $10,000. Under
the 2006 Act, qualified employees hired through December 31, 2007, are
eligible for the modified WOTC credit..
108. 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. Employees must work at least 400
hours to be eligible for the credit. The maximum credit is $8,500 per
employee. The credit applies to wages paid to employees who are hired on
or before December 31, 2006. The Tax Relief and Health Care Act of 2006
modified the Welfare to Work credit by making qualified long-term family
assistance recipients a WOTC target group after December 31, 2007.
109. 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 employer's costs for the child care are a deductible
business expense.
110. Employer-provided child care credit.--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.
111. 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.
112. Adoption credit and exclusion.--Taxpayers can receive a
nonrefundable tax credit for qualified adoption expenses. The maximum
credit is $10,960 per child for 2006, and is phased-out ratably for
taxpayers with modified AGI between $164,410 and $204,410. 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.
113. 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.
114. Child credit.--Taxpayers with children under age 17 can qualify
for a $1,000 partially 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).
115. 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. In 2006, 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.
116. 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.
117. 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.
118. 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.
119. 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.
120. Provide an employee retention credit to employers affected by
hurricane Katrina, Rita, and Wilma.--Businesses located within the Gulf
Opportunity (GO) Zone on August 28, 2005 are eligible for a 40 percent
tax credit on the first $6,000 in qualified wages paid to qualified
employees employed within the GO Zone. Qualified wages are those paid by
an eligible employer to an eligible employee on any day after August 28,
2005 and before January 1, 2006 during the period beginning on the date
on which the trade or business first became inoperable at the principal
place of employment of the employee by reason of hurricane Katrina and
ending on the date on which such trade or business resumed significant
operations at such prin
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cipal place of employment. Similar rules apply to the Rita GO Zone and
the Wilma GO Zone with initial effective dates of September 23, 2005,
and October 23, 2005, respectively.
Health
121. 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.
122. 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.
123. Medical and health savings accounts.--Individual contributions to
Archer Medical Savings Accounts (Archer MSAs) and Health Savings
Accounts (HSAs) are allowed as a deduction in determining adjusted gross
income whether or not the individual itemizes deductions. Employer
contributions to Archer MSAs and HSAs are excluded from income and
employment taxes. Archer MSAs and HSAs require that the individual have
coverage by a qualifying high deductible health plan. Earnings from the
accounts are excluded from taxable income. Distributions from the
accounts used for medical expenses are not taxable. The rules for HSAs
are generally more flexible than for Archer MSAs and the deductible
contribution amounts are greater (in 2007, $2850 for taxpayers with
individual coverage and $5,650 for taxpayers with family coverage).
Thus, HSAs have largely replaced MSAs.
124. 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.
125. Hospital construction bonds.--Interest earned on State and local
government debt issued to finance hospital construction is excluded from
income subject to tax.
126. 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.
127. 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.
128. 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.
129. 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.
130. Distributions for premiums for health and long-term care
insurance.--This provision provides for tax-free distributions of up to
$3,000 from governmental retirement plans for premiums for health and
long term care premiums of public safety officers.
Income Security
131. 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.
132. Workers' compensation benefits.--Workers compensation provides
payments to disabled workers. These benefits, although income to the
recipients, are not subject to the income tax.
133. 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.
134. 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.
135. Military disability pensions.--Most of the military pension
income received by current disabled retired veterans is excluded from
their income subject to tax.
136. 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.
137. 401(k) plans.--Individual taxpayers can make tax-preferred
contributions to certain types of employer-provided 401(k) plans (and
401(k)-type plans like 403(b) plans and the Federal government's Thrift
Savings Plan). In 2006, an employee could exclude up to $15,000
(indexed) of wages from AGI under a qualified arrangement with an
employer's 401(k) plan. 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.
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138. 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 $4,000 in 2006, and $5,000 in 2008 (indexed thereafter) and allows
taxpayers over age 50 to make additional ``catch-up'' contributions of
$1,000.
Taxpayers whose AGI is below $85,000 ($65,000 for non-joint filers) in
2006 can claim a deduction for IRA contributions. The IRA deduction is
phased out for taxpayers with AGI between $75,000 and $85,000 ($50,000
and $60,000 for non-joint). The phase-out range increases annually until
it reaches $80,000 to $100,000 in 2007. 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.
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.
139. 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.
140. 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 $44,000 in 2006. 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.
141. 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.
142. 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.
143. 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.
144. 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.
145. Additional deduction for the blind.--Taxpayers who are blind may
take an additional $1,250 standard deduction if single, or $1,000 if
married in 2006.
146. Additional deduction for the elderly.--Taxpayers who are 65 years
or older may take an additional $1,250 standard deduction if single, or
$1,000 if married in 2006.
147. 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.
148. 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.
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149. 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 $8,080 of earned income in 2006. The credit
is 40 percent of the first $11,340 of income for a family with two or
more qualifying children. The credit is phased out beginning when the
taxpayer's income exceeds $14,810 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 $32,001 ($36,348 if two or more qualifying children are
present), $34,001 (or $38,348) 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 2006, the credit is 7.65
percent of the first $5,380 of earned income. When the taxpayer's income
exceeds $6,740 (8,740 if married), the credit is phased out at the rate
of 7.65 percent. It is completely phased out at $12,120 ($14,120 for
married) of modified adjusted gross income.
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 2006 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.
150. Additional exemption for housing Hurricane Katrina displaced
individuals.--This provision, introduced by the Katrina Emergency Tax
Relief Act of 2005, provides an additional exemption of $500 for each
Hurricane Katrina displaced individual for whom the taxpayer is
providing shelter in his or her home, for a maximum additional exemption
amount is $2,000.
Social Security
151. 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.
152. 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.
153. 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
154. Veterans death benefits and disability compensation.--All
compensation due to death or disability paid by the Veterans
Administration is excluded from taxable income.
155. Veterans pension payments.--Pension payments made by the Veterans
Administration are excluded from gross income.
156. G.I. Bill benefits.--G.I. Bill benefits paid by the Veterans
Administration are excluded from gross income.
157. Tax-exempt mortgage bonds for veteran.--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
158. 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.
159. 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.
160. 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
161. U.S. savings bonds.--Taxpayers may defer paying tax on interest
earned on U.S. savings bonds until the bonds are redeemed.
[[Page 313]]
Appendix A
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.
DIFFERENCES BETWEEN OFFICIAL TAX EXPENDITURES AND THOSE BASED ON
COMPREHENSIVE INCOME
As discussed in the main body of the chapter, tax expenditures are
measured relative to normal law or reference law baselines that deviate
from a comprehensive concept of income. Consequently, tax expenditures
identified in the Budget can differ from those that would be identified
under a comprehensive income tax baseline. This appendix compares major
tax expenditures listed in the tax expenditure budget with those implied
by a comprehensive income baseline.
Current budgetary practice excludes from the list of tax expenditures
those provisions that over-tax certain items of income because the
original motivation for the analysis was to identify tax provisions that
substitute 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.
Major Tax Expenditures from the Traditional 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 and only once. Thus, it would not
levy a separate tax on corporate income leading to the double taxation
of corporate profits.
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 such as
housing, automobiles, and major appliances.
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
Furthermore, comprehensive income does not necessarily represent an
ideal tax base; economic efficiency would be improved by deviating from
comprehensive income as a tax base by reducing the tax on capital income
to spur economic growth further or by subsidizing certain types of
activities to correct for market failures. 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.
Table 1 classifies 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 reflect the hybrid nature of the existing tax system
and arise out of policy decisions to reduce the high tax rate on capital
income that would otherwise arise. Even these relatively clear-cut
items, how
[[Page 314]]
ever, can raise ambiguities in light of the absence of integration of
the corporate and individual tax systems. For example, 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 because the income is taxed first at the
corporate level. A similar line of reasoning suggests that in the case
of corporations, expensing \7\ of R&E or accelerated depreciation are
not tax expenditures because they offset the corporate tax penalty.
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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 continue to 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 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 benefits 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 any proceeds 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.
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
Panel B displays items that probably are tax expenditures, but that
raise additional issues. Current law, for instance, allows deductions
for home mortgage interest and for property taxes on owner-occupied
housing. The tax expenditure budget includes both of these provisions. A
comprehensive tax base would allow both deductions, but it would also
include imputed gross rental income. Current law does not include gross
rental income, however, and so on this basis the home mortgage interest
deduction and the deduction for property taxes on owner-occupied housing
are properly tax expenditures under a comprehensive income tax base. \9\
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.
---------------------------------------------------------------------------
\9\ 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 minus(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).
---------------------------------------------------------------------------
The deduction of nonbusiness State and local taxes other than on
owner-occupied homes also is included in Panel B. The 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. \10\ The difficulty is that this presumes that one's
consumption of State and local services relates directly to the amount
of State and local taxes paid. Such a presumption is difficult to
sustain when taxes are levied inconsistently across taxpayers. \11\
---------------------------------------------------------------------------
\10\ Fiscal Year 2003 Budget of the United States Government,
Analytical Perspectives (Washington, D.C.: U.S. Government Printing
Office, 2002) p. 127.
\11\ 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.
---------------------------------------------------------------------------
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.
\12\ 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 (roughly measured) tax
expenditure relative to a comprehensive income baseline. \13\
---------------------------------------------------------------------------
\12\ U.S. Treasury, Blueprints for Basic Tax Reform (Washington, D.C.:
U.S. Government Printing Office, 1977) p. 92.
\13\ 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.
---------------------------------------------------------------------------
The comprehensive income tax base is an objective measure of income.
Traditionally, this measure is modified to reflect a subjective or
social economic policy concern regarding the financial ability of an
individual to pay tax. Absent this modification, provisions such as the
personal exemption and the child tax credit would be treated as tax
expenditures. However, once the definition of income is modified to
reflect the ability of an individual to pay tax, then these and similar
provisions are typically dropped from the list of tax expenditures.
The step-up of basis at death lowers the tax on capital gains for
those who inherit assets. From that perspective it would be a tax
expenditure under a comprehensive income baseline. Nonetheless, there
are ambiguities. Under a comprehensive income baseline, all inflation-
adjusted gains would be taxed as accrued, so there would be no deferred
unrealized gains on assets held at death.
The partial exclusion of Social Security benefits from tax is also
listed in panel B. To the extent Social Security is viewed as a pension,
comprehensive income would include all contributions to Social Security
retirement funds (payroll taxes) and tax accretions to value as they
arise. \14\ Benefits paid out of contributions and the inside build-up
in value, however, would not be
[[Page 315]]
included 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 income and all benefits received
should be included.
---------------------------------------------------------------------------
\14\ 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.
---------------------------------------------------------------------------
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 \15\ reflect exemptions
for lower-income beneficiaries from the tax on 85 percent of Social
Security benefits. \16\ 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-earning 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 \17\ . Hence, the
tax expenditure budget understates the tax advantage accorded Social
Security retirement benefits relative to a comprehensive income
baseline.
---------------------------------------------------------------------------
\15\ 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.
\16\ 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.
\17\ 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
build-up 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.
---------------------------------------------------------------------------
The deduction for U.S. production activities also raises 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 then represent a feature of the baseline tax rate
system because the deduction is equivalent to a lower tax rate. In
addition, it might not be a tax expenditure to the extent it is viewed
as providing relief from the double tax on corporate profits.
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 may serve as proxies
for provisions that would be a tax expenditure under a comprehensive
income base. \18\
---------------------------------------------------------------------------
\18\ 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.
---------------------------------------------------------------------------
For example, under existing law charitable contributions are
deductible, and this deduction is considered on its face a tax
expenditure in the current budget. \19\ 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 and a deduction for
contributions would be a tax expenditure under a comprehensive income
tax base. In contrast, charitable contributions could represent a
transfer of purchasing power from the giver 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 the
charitable deduction 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 is not taxed. \20\
---------------------------------------------------------------------------
\19\ 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.
\20\ If recipients tend to be in lower tax brackets, then the tax
expenditure is smaller than when measured at the donor's tax rates..
---------------------------------------------------------------------------
Medical expenditures may or may not be an element of income. These
expenditures may be viewed as a reduction of net worth (e.g. cost of
earning income) rather than as discretionary spending, and so are not
really consumption and should be excluded from the tax base. However,
expenditures for medical care may be considered as indistinguishable
from other consumption items which are not excluded from a comprehensive
income base.
The exemption of full taxation of Social Security benefits paid to the
disabled also raises issues. Social Security benefits for the disabled
most closely resemble either Government transfers or insurance. From
either perspective, a comprehensive income tax would require that the
benefit be included in income and would allow a deduction for associated
Social Security taxes. If viewed as insurance, an equivalent treatment
would allow the taxpayer to include the premium (i.e., tax) and exclude
the benefit. The deviation between either of these treatments and
current law's treatment (described above) would be a tax expenditure
under a comprehensive income baseline.
In contrast, as described above, the tax expenditure budget displays
the benefit of exempting 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
[[Page 316]]
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 half of the
premium might suggest that half 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.
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.
\21\
---------------------------------------------------------------------------
\21\ 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.
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 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
food-stamps, Medicaid, and public housing, the value of payouts from
insurance policies, \22\ and benefits received from private charities.
Under some theories 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, might measure the income of U.S. residents
properly.
---------------------------------------------------------------------------
\22\ To the extent that premiums are deductible.
---------------------------------------------------------------------------
Negative Tax Expenditures
The passive loss rules, restrictions on the deductibility of capital
losses, and net operating loss (NOL) carry-forward requirements each
would generate a negative tax expenditure, since a comprehensive income
tax would allow full deductibility of losses.
Human capital is generally considered a productive asset, and so its
cost (e.g., certain education and training expenses, including perhaps
the cost of college and professional school) should be amortizable under
a comprehensive income tax, but it is not under current law. \23\
---------------------------------------------------------------------------
\23\ 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.
---------------------------------------------------------------------------
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 measure income properly, as seen by the equivalence between
borrowing and reduced lending. \24\ 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.
---------------------------------------------------------------------------
\24\ See Bradford, Untangling the Income Tax, p. 41.
---------------------------------------------------------------------------
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 and so 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. \25\
---------------------------------------------------------------------------
\25\ 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.
---------------------------------------------------------------------------
DIFFERENCES BETWEEN OFFICIAL TAX EXPENDITURES AND TAX EXPENDITURES
RELATIVE TO A CONSUMPTION TAX BASE
This section compares tax expenditures listed in the tax expenditure
budget with those implied by a comprehensive consumption tax baseline.
It first discusses some of the difficulties encountered in contemplating
current tax provisions as part of a comprehensive consumption tax. Next,
it assesses which of the thirty largest income tax expenditures would be
tax expenditures under the consumption tax baseline, concluding that
about half would remain under a consumption tax baseline. Most that fall
off the list are incentives for saving and investment.
The section next discusses some major differences between current law
and a comprehensive consumption tax baseline. These differences include
the consumption
[[Page 317]]
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 can be viewed as 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. Some
issues arise which are also 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 discussed earlier in the context of the comprehensive
income tax is determining whether a particular expenditure, such as
spending on medical care and charitable donations, is an item of
consumption.
Also, 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 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 an
investment's income (or yield) is equivalent to consumption tax
treatment with respect to the normal rate of return on new investment;
expensing generates a tax reduction that offsets in present value terms
the tax paid on the investment's future normal returns. Because of this
equivalence, in the context of consumption taxes, a yield exemption
approach is sometimes called a tax prepayment approach. That is, tax is
paid on an asset's purchase price rather than on the consumption flow
that it generates.
However, a yield exemption approach differs from a pure consumption
tax with respect to the distribution of income and Government revenue.
Pure profits in excess of the normal rate of return would be taxed under
a consumption tax because pure profits are an element of cash flow;
however, pure profits would not be taxed under a yield exemption tax
system. The question arises whether an exemption of certain kinds of
investment income, and certain investment tax credits, should 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.
Considering provisions individually can be misleading. The hybrid
character of the existing tax system reflects many provisions that might
be good policy 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.
In addition, provisions can interact even once an appropriate
treatment is determined. For example, if financial flows are excluded
from the tax base, then the deduction for home mortgage interest would
be a tax expenditure except that current law generally taxes interest
income. When combined with the mortgage interest deduction, this offsets
the inclusion of 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, the effects of these transactions would cancel out
in the economy as a whole. The classification below generally views
available capital gains tax relief as consistent with a broad-based
consumption tax because they lower tax rate on capital income is
consistent with a consumption-based tax.
Such considerations suggest that, as with an income tax, computing the
current tax's deviations from ``the'' base of a consumption tax is
difficult because deviations cannot always be uniquely determined,
making it problematic to do a consistent accounting of the differences
between the current tax base and a consumption tax
[[Page 318]]
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 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 tax expenditures from the Budget
classified according to whether they would be considered a tax
expenditure under a consumption tax. One of the thirty items clearly
would be a tax expenditure (shown in panel A) under a consumption tax,
while an additional six (those in panel B) probably would be tax
expenditures.
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.
In one respect the deductibility of home mortgage interest is a strong
candidate for inclusion as a tax expenditure. A consumption tax would
seek to tax the entire value of the flow of services from housing, and
so would not allow a deduction for home mortgage interest. This would be
the case regardless of whether the tax base included the annual flow of
housing services, or instead used a tax-prepayment or yield exemption
approach (discussed more completely below) to taxing housing services. A
deduction for interest would be allowed under a consumption tax applied
to both real and financial cash flows, but current law does not require
the homeowner to take into income the proceeds of a home loan, nor does
it allow a deduction for principal repayments.
From another perspective, however, the home mortgage interest
deduction would not be a tax expenditure under a consumption tax. Under
a consumption tax, the interest income accruing to the mortgage lender
generally would not be taxed (at least in present value terms). As
interest income is subject to tax under current law, the homeowner's
mortgage interest deduction could be viewed as counterbalancing the
lender's inclusion, eliminating interest flows from the tax base, as
would be appropriate under many types of consumption taxes. \26\
---------------------------------------------------------------------------
\26\ 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..
---------------------------------------------------------------------------
The deductibility of property taxes on owner-occupied housing also is
a strong candidate for inclusion as a tax expenditure under a
consumption tax baseline, although there is a bit of ambiguity. Property
taxes would be deducted under a consumption tax under which the base
allowed expensing of the cost of the house and included the rental value
of the house in the annual tax base. But, as discussed above in the
income tax section, this deduction nonetheless is a strong candidate for
inclusion as a tax expenditure because the current tax system does not
impute the consumption value of housing services to the homeowner's tax
base.
Under a consumption tax based on the yield exemption or tax prepayment
approach to housing, property taxes would not be deducted by the
homeowner because the cash flows (positive and negative) related to the
investment are simply ignored for tax purposes--they are outside the tax
base. Their deduction under current law would represent a tax
expenditure. As discussed below, current law's taxation of housing
approximates a yield exemption approach; no deduction of the purchase
price of the house, no tax on the house's service flow. Consequently,
the deduction for property taxes probably would be a tax expenditure
relative to a consumption base.
As discussed in the section on comprehensive income, whether the
deduction for State and local income taxes gives rise to a tax
expenditure under a consumption tax depends on whether the services paid
for with these taxes constitute consumption value to the taxpayer. If
there is not a firm relationship between the taxes paid and the services
received, then the deduction may not be viewed as a tax expenditure.
Property taxes on assets other than housing would seem to be best
thought of using the model discussed above for housing. These taxes
typically are paid on assets, such as automobiles and boats, yielding a
stream of services that current federal tax law fails to impute to
income.
The tax expenditures for Social Security benefits discussed in the
section on comprehensive income measure 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. \27\ Thus, the
existing tax expenditure is correct conceptually, but is not measured
properly relative to a comprehensive income tax. A similar analysis
would
[[Page 319]]
apply to the exclusion of Social Security benefits of dependents and
retirees.
---------------------------------------------------------------------------
\27\ The current tax expenditure estimates reflect 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.
---------------------------------------------------------------------------
There is a strong case for viewing the child tax credit and the earned
income tax credit as social welfare programs (transfers). As such, they
would be tax expenditures relative to a consumption baseline. 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 panel 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.
There also is the issue of how to tax medical insurance premiums.
Under current law, employees may exclude insurance premiums paid for by
employers from 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 included in the tax base
because they represent consumption. Yet an alternative perspective would
support excluding the premium from the tax base as long as the value of
any medical services paid for by the insurance policy were included. 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.
Current law does not tax the annual rental value of owner-occupied
housing. In contrast, the annual rental value of the housing would be
taxed under a consumption tax. Hence, from one perspective, the
exclusion of the net annual rental value of owner-occupied housing would
be a tax expenditure relative to a consumption tax baseline.
However, a consumption tax that included in its base the annual rental
value of housing also would allow the homeowner a deduction for the
price of the house in the year it was purchased; the investment in
housing would be expensed. Current law fails to allow such a deduction,
raising doubt about classifying as a tax expenditure the exclusion of
net rental income from owner-occupied housing. Indeed, it is possible to
interpret current law as applying the tax pre-payment or yield exemption
method to housing, so it is not clear whether the failure to tax the
rental income from housing represents a tax expenditure.
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 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. 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 possible tax
expenditures include 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
theories 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 gross 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
provisions are called negative tax expenditures.
A large item on this list would be the inclusion of capital income in
the current individual income tax
[[Page 320]]
base, including the income earned on inside-build up in Social Security
accounts. The revenue from the corporate income tax, or more generally a
measure of the double tax on corporate profits, also would be a negative
tax expenditure. Depreciation allowances, even if accelerated, would be
a negative tax expenditure since consumption tax treatment generally
requires 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 net operating loss 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).
Human capital is a productive asset, and so 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 Alternative Minimum Tax
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, 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. \28\ 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. \29\
The estimates are shown in tables in the body of the main text, e.g.,
Table 19-1.
---------------------------------------------------------------------------
\28\ 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.
\29\ 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.
---------------------------------------------------------------------------
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 deduction
for property taxes and for home mortgage interest. \30\
---------------------------------------------------------------------------
\30\ 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.
---------------------------------------------------------------------------
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 tax expenditures 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 income
tax advantage to housing; they overlook the additional exclusion of
implicit net rental income. To the extent 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. On the other
hand, a homeowner with a mortgage approximately matching the value of
the house might make interest payments that exceed the implicit rental
income. The treatment of owner-occupied housing has been revised
beginning in the 2006 budget, which now includes an item for the
exclusion of net rental income of homeowners. \31\
---------------------------------------------------------------------------
\31\ 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.
---------------------------------------------------------------------------
[[Page 321]]
Appendix Table 3, as well as the tables in the body of the main text,
e.g., Tables 19-1 and 19-2, 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. \32\
---------------------------------------------------------------------------
\32\ National Income and Production Accounts, Table 2.4.
---------------------------------------------------------------------------
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 A 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 $34
billion in the years 2007 through in 2011. 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.
[[Page 322]]
Appendix Table 1. COMPARISON OF CURRENT TAX EXPENDITURES WITH THOSE IMPLIED BY A COMPREHENSIVE INCOME TAX \1\
--------------------------------------------------------------------------------------------------------------------------------------------------------
Revenue Effect
Description 2008
--------------------------------------------------------------------------------------------------------------------------------------------------------
A. Tax Expenditure Under a Comprehensive Income Tax
Accelerated depreciation of machinery and equipment (normal tax method)............................................................ 64,670
Capital gains (except agriculture, timber, iron ore, and coal)..................................................................... 51,960
Net exclusion of pension contributions and earnings: Employer plans................................................................ 48,480
Net exclusion of pension contributions and earnings: 401(k) plans.................................................................. 43,970
Capital gains exclusion on home sales.............................................................................................. 38,890
Exclusion of net imputed rental income on owner-occupied housing................................................................... 35,680
Exclusion of interest on public purpose State and local bonds...................................................................... 27,150
Exclusion of interest on life insurance savings.................................................................................... 21,925
Deferral of income from controlled foreign corporations (normal tax method)........................................................ 12,770
Accelerated depreciation on rental housing (normal tax method)..................................................................... 12,300
Net exclusion of pension contributions and earnings: Keogh plans................................................................... 11,890
Net exclusion of pension contributions and earnings: Individual Retirement Accounts................................................ 6,650
Exclusion of workers' compensation benefits........................................................................................ 5,830
Expensing of research and experimentation expenditures (normal tax method)......................................................... 5,280
Credit for low-income housing investments.......................................................................................... 4,940
B. Possibly a Tax Expenditure Under a Comprehensive Income Tax, But With Some Qualifications
Deductibility of mortgage interest on owner-occupied homes......................................................................... 89,430
Step-up basis of capital gains at death............................................................................................ 35,900
Child tax credit................................................................................................................... 32,341
Deductibility of nonbusiness State and local taxes other than on owner-occupied homes.............................................. 27,900
Exclusion of Social Security benefits for retired workers.......................................................................... 18,930
Deduction for U.S. production activities........................................................................................... 13,810
Deductibility of State and local property tax on owner-occupied homes.............................................................. 12,620
Earned income tax credit........................................................................................................... 5,340
C. Uncertain
Exclusion of employer contributions for medical insurance premiums and medical care................................................ 160,190
Deductibility of charitable contributions, other than education and health......................................................... 45,760
Social Security benefits for the disabled.......................................................................................... 5,620
Deductibility of charitable contributions, health.................................................................................. 5,160
Deductibility of charitable contributions, education............................................................................... 5,120
Deductibility of medical expenses.................................................................................................. 4,920
D. Probably Not a Tax Expenditure Under a Comprehensive Income Tax
Exception from passive loss rules for $25,000 of rental loss....................................................................... 7,520
--------------------------------------------------------------------------------------------------------------------------------------------------------
\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.
[[Page 323]]
Appendix Table 2. COMPARISON OF CURRENT TAX EXPENDITURES WITH THOSE IMPLIED BY A COMPREHENSIVE CONSUMPTION TAX \1\
--------------------------------------------------------------------------------------------------------------------------------------------------------
Revenue Effect
Description 2008
--------------------------------------------------------------------------------------------------------------------------------------------------------
A. Tax Expenditure Under a Consumption Base
Exclusion of workers' compensation benefits........................................................................................ 5,830
B. Probably a Tax Expenditure Under a Consumption Base
Deductibility of mortgage interest on owner-occupied homes......................................................................... 89,430
Child tax credit................................................................................................................... 32,341
Deductibility of nonbusiness State and local taxes other than on owner-occupied homes.............................................. 27,900
Exclusion of Social Security benefits for retired workers.......................................................................... 18,930
Deductibility of State and local property tax on owner-occupied homes.............................................................. 12,620
Earned income tax credit........................................................................................................... 5,340
C. Uncertain
Exclusion of employer contributions for medical insurance premiums and medical care................................................ 160,190
Deductibility of charitable contributions, other than education and health......................................................... 45,760
Exclusion of net imputed rental income on owner-occupied housing................................................................... 35,680
Social Security benefits for disabled.............................................................................................. 5,620
Credit for low-income housing investments.......................................................................................... 4,940
Deductibility of medical expenses.................................................................................................. 4,920
Deductibility of charitable contributions, health.................................................................................. 5,160
Deductibility of charitable contributions, education............................................................................... 5,120
D. Not a Tax Expenditure Under a Consumption Base
Accelerated depreciation of machinery and equipment (normal tax method)............................................................ 64,670
Capital gains (except agriculture, timber, iron ore, and coal)..................................................................... 51,960
Net exclusion of pension contributions and earnings: Employer plans................................................................ 48,480
Net exclusion of pension contributions and earnings: 401(k) plans.................................................................. 43,970
Capital gains exclusion on home sales.............................................................................................. 38,890
Step-up basis of capital gains at death............................................................................................ 35,900
Exclusion of interest on public purpose State and local bonds...................................................................... 27,150
Exclusion of interest on life insurance savings.................................................................................... 21,925
Deduction for U.S. production activities........................................................................................... 13,810
Deferral of income from controlled foreign corporations (normal tax method)........................................................ 12,770
Accelerated depreciation on rental housing (normal tax method)..................................................................... 12,300
Net exclusion of pension contributions and earnings: Keogh plans................................................................... 11,890
Exception from passive loss rules for $25,000 of rental loss....................................................................... 7,520
Net exclusion of pension contributions and earnings: Individual Retirement Accounts................................................ 6,650
Expensing of research and experimentation expenditures (normal tax method)......................................................... 5,280
--------------------------------------------------------------------------------------------------------------------------------------------------------
\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\
----------------------------------------------------------------------------------------------------------------
Revenue Loss
Provision ---------------------------------------------------------------------
2006 2007 2008 2009 2010 2011 2012
----------------------------------------------------------------------------------------------------------------
Imputed Rent On Owner-Occupied Housing.... 28,780 32,110 35,680 39,440 43,596 48,190 53,269
Double Tax on corporate profit \2\........ -33,530 -34,930 -36,160 -37,280 -38,435 -39,625 -40,852
----------------------------------------------------------------------------------------------------------------
\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.
[[Page 324]]
Appendix B
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. This Appendix
responds to the report of the Senate Governmental Affairs Committee on
GPRA4 \33\ calling 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.
---------------------------------------------------------------------------
\33\ Committee on Government Affairs, United States Senate,
``Government Performance and Results Act of 1993'' (Report 103-58,
1993).
---------------------------------------------------------------------------
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. \34\ 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 of policy instruments means that tax expenditures
can be flexible and can have very different economic effects.
---------------------------------------------------------------------------
\34\ Although this chapter 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.
---------------------------------------------------------------------------
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, personal exemptions, deductions, credits,
and phase-outs 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.
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 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 on 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.
[[Page 325]]
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.,
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
benefiting 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 pro
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duction 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 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 benefiting 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.
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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.