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ANALYTICAL
PERSPECTIVES

BUDGET OF THE UNITED STATES GOVERNMENT

Fiscal Year 1999

THE BUDGET DOCUMENTS
Budget of the United States Government, Fiscal Year 1999
contains the Budget Message of the President and information on
the President’s 1999 budget proposals. In addition, the Budget includes the Nation’s first comprehensive Government-wide Performance Plan.
Analytical Perspectives, Budget of the United States Government, Fiscal Year 1999 contains analyses that are designed to highlight specified subject areas or provide other significant presentations
of budget data that place the budget in perspective.
The Analytical Perspectives volume includes economic and accounting analyses; information on Federal receipts and collections; analyses
of Federal spending; detailed information on Federal borrowing and
debt; the Budget Enforcement Act preview report; current services
estimates; and other technical presentations. It also includes information on the budget system and concepts and a listing of the Federal
programs by agency and account.
Historical Tables, Budget of the United States Government,
Fiscal Year 1999 provides data on budget receipts, outlays, surpluses or deficits, Federal debt, and Federal employment covering
an extended time period—in most cases beginning in fiscal year 1940
or earlier and ending in fiscal year 2003. These are much longer
time periods than those covered by similar tables in other budget
documents. As much as possible, the data in this volume and all
other historical data in the budget documents have been made consistent with the concepts and presentation used in the 1999 Budget,
so the data series are comparable over time.
Budget of the United States Government, Fiscal Year 1999—
Appendix contains detailed information on the various appropriations and funds that constitute the budget and is designed primarily
for the use of the Appropriations Committee. The Appendix contains
more detailed financial information on individual programs and appropriation accounts than any of the other budget documents. It
includes for each agency: the proposed text of appropriations language, budget schedules for each account, new legislative proposals,
explanations of the work to be performed and the funds needed,

and proposed general provisions applicable to the appropriations of
entire agencies or group of agencies. Information is also provided
on certain activities whose outlays are not part of the budget totals.
A Citizen’s Guide to the Federal Budget, Budget of the United States Government, Fiscal Year 1999 provides general information about the budget and the budget process for the general public.
Budget System and Concepts, Fiscal Year 1999 contains an
explanation of the system and concepts used to formulate the President’s budget proposals.
Budget Information for States, Fiscal Year 1999 is an Office
of Management and Budget (OMB) publication that provides proposed
State-by-State obligations for the major Federal formula grant programs to State and local governments. The allocations are based
on the proposals in the President’s budget. The report is released
after the budget and can be obtained from the Publications Office
of the Executive Office of the President, 725 17th Street NW, Washington, DC 20503; (202) 395–7332.
AUTOMATED SOURCES OF BUDGET INFORMATION
The information contained in these documents is available in
electronic format from the following sources:
CD-ROM. The CD-ROM contains all of the budget documents and
software to support reading, printing, and searching the documents.
The CD-ROM also has many of the tables in the budget in
spreadsheet format.
Internet. All budget documents, including documents that are
released at a future date, will be available for downloading in several
formats from the Internet. To access documents through the World
Wide Web, use the following address:
http://www.access.gpo.gov/su_docs/budget/index.html
For more information on access to the budget documents, call tollfree (888) 293–6498.

GENERAL NOTES
1.
2.

All years referred to are fiscal years, unless otherwise noted.
Detail in this document may not add to the totals due to rounding.

U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON 1998
For sale by the U.S. Government Printing Office
Superintendent of Documents, Mail Stop: SSOP, Washington, D.C. 20402–9328

TABLE OF CONTENTS
Page

Economic and Accounting Analyses
1. Economic Assumptions ........................................................................................

3

2. Stewardship: Toward a Federal Balance Sheet .................................................

15

Federal Receipts and Collections
3. Federal Receipts ...................................................................................................

41

4. User Fees and Other Collections ........................................................................

79

5. Tax Expenditures .................................................................................................

89

Special Analyses and Presentations
6. Federal Investment Spending and Capital Budgeting ......................................

123

7. Research and Development Expenditures ..........................................................

163

8. Underwriting Federal Credit and Insurance .....................................................

165

9. Aid to State and Local Governments ..................................................................

213

10. Federal Employment and Compensation ...........................................................

227

11. Strengthening Federal Statistics ........................................................................

233

12. Civil Rights Enforcement Funding .....................................................................

237

Federal Borrowing and Debt
13. Federal Borrowing and Debt ...............................................................................

245

Budget Enforcement Act Preview Report
14. Preview Report .....................................................................................................

259

15. Deficit Reduction Fund ........................................................................................

271

Current Service Estimates
16. Current Services Estimates .................................................................................

275

Other Technical Presentations
17. Trust Funds and Federal Funds .........................................................................

321

18. National Income and Product Accounts .............................................................

339

19. Comparison of Actual to Estimated Totals for 1997 .........................................

345

20. Relationship of Budget Authority to Outlays ....................................................

351

21. Off-Budget Federal Entities and Non-Budgetary Activities .............................

353

Unnecessary or Wasteful Reports to Congress
22. Unnecessary or Wasteful Reports to Congress ..................................................

359
i

Page

Federal Drug Control Funding
23. Federal Drug Control Funding ............................................................................

363

Budget System and Concepts and Glossary
24. Budget System and Concepts and Glossary .......................................................

367

Outlays to the Public
25. Outlays to the Public ...........................................................................................

387

Federal Programs by Agency and Account
26. Federal Programs by Agency and Account .........................................................
List of Charts and Tables ....................................................................................................

ii

389
583

ECONOMIC ASSUMPTIONS

1

1.

ECONOMIC ASSUMPTIONS

Introduction
The prudent fiscal and monetary policies pursued
during this Administration have fostered the healthiest
economy in over a generation. Judged by the yardsticks
of growth, jobs, unemployment, inflation, interest rates
and the stock market, 1997 was a banner year. Real
Gross Domestic Product (GDP) expanded by nearly 4
percent, the Nation’s payrolls increased by 3.2 million
jobs, and the unemployment rate fell to the lowest level
in 24 years. Despite robust growth, inflation edged
down; the rise in the Consumer Price Index excluding
the volatile food and energy components last year was
the smallest since 1965. The combination of low inflation and low unemployment pulled the ‘‘Misery
Index’’—the sum of the inflation and unemployment
rates—to its lowest level in three decades.
Households and businesses have prospered in this
environment. Wages and salaries after adjustment for
inflation have increased faster than at any time in the
past two decades. And thanks to unusually strong productivity growth for this stage of an expansion, profits
also have grown at a healthy pace. The share of profits
in GDP climbed to over 10 percent last year, the highest it has been since 1968.
Financial markets have responded to these favorable
developments by bidding up the prices of bonds and
equities. Long-term interest rates, which move in the
opposite direction from bond prices, fell one-half percentage point last year. At year’s end, the yield on
the 30-year Treasury bond was below 6 percent, the
lowest level in four years. In early January, the rate
fell another one-quarter percentage point to the lowest
level since this maturity was first regularly issued in
1977.
The Dow Jones Industrial Average rose 23 percent
during 1997, which followed a 68 percent gain during
1995–96. Since the end of 1994, the Dow average has
doubled, making this the best three-year performance
in the postwar period and the second best in the 101year history of the Dow. The broader market indexes,
the S&P 500 and the NASDAQ composite index, also
doubled during these three years.
These outstanding financial and nonfinancial achievements—fostered by sound fiscal and monetary policies—have further boosted business and consumer confidence. Businesses last year spent heavily on capacityexpanding new plant and equipment; investment rose
at a double-digit pace after adjustment for inflation.
Consumer optimism soared. According to the University
of Michigan Consumer Sentiment Index, optimism
reached the highest level since the survey began in
the early 1950s. Overseas investors also have expressed
their confidence in the U.S. economy. With many finan-

cial markets around the world in turmoil, foreign investors increasingly turned to the safe haven provided by
U.S. financial markets.
The fundamental forces affecting the economy and
prospective fiscal and monetary policies point to continued healthy economic conditions in the coming years.
The budget is projected to reach balance in 1999—the
first time that has occurred in three decades—and to
remain in balance during the remainder of the 10-year
planning horizon. A stronger dollar is likely to keep
inflation low. While some may have thought that real
growth in the recent past was too fast, in the future
these concerns may well be eased by developments in
Asia. Against this background, monetary policy should
be able to accommodate continued economic growth
with low inflation.
The Administration projects real growth in the next
few years to be around 2.0 percent per year, before
rising to 2.4 percent in 2002–2007. The unemployment
rate, which at current low levels may run the risk
of igniting inflation, is projected to edge up slightly
to a rate that the Administration conservatively estimates to be consistent with stable inflation. Nonetheless, millions of new jobs are expected to be created.
Short-term interest rates are projected to decline and
long-term rates are expected to remain relatively low
as private and public credit demands ease and as expectations of continued low inflation are incorporated into
bond yields. Beyond 1999, the Administration’s economic projections represent expected trends rather than
a definite cyclical pattern.
Private forecasters have a similarly favorable view
of the economic outlook. The January Blue Chip consensus forecast, an average of 50 private forecasts, projected real growth, unemployment and inflation at rates
nearly identical to those used in this budget. The projected interest rates were somewhat higher than in the
budget assumptions. The similarity to the private sector
forecasts is an indication that the Administration’s assumptions are a reasonable, prudent basis for projecting
the budget.
The expansion that began in April 1991 has just completed 82 consecutive months of growth, exceeding 17
of the 20 expansions of this century. By December of
this year, the expansion will become the second longest
U.S. expansion of all time and the longest peacetime
expansion. If it continues through February 2000, this
expansion will set a new longevity record, outlasting
the current record of 106 months of uninterrupted
growth in the 1960s. According to the Blue Chip survey,
most private-sector forecasters now expect this to
happen.
This chapter begins with a review of recent developments and then discusses two statistical issues: the

3

4

ANALYTICAL PERSPECTIVES

growing statistical discrepancy (the difference between
the aggregate measures of output and income) and recent methodological improvements in the calculation of
the Consumer Price Index. The chapter then presents
the Administration’s economic projections, followed by
a comparison with the Congressional Budget Office’s
projections. The following sections present the impact
of changes in economic assumptions since last year on
the projected fiscal balance and the structural deficit.
The chapter concludes with estimates of the sensitivity
of the budget to changes in economic assumptions.
Fiscal and Monetary Policy
When this Administration took office, its first priority
was to reverse the 12-year trend of large, uncontrolled
fiscal deficits. The Administration proposed, and Congress passed, the landmark Omnibus Budget Reconciliation Act of 1993 (OBRA) which set the budget deficit
on a downward path. After having reached a postwar
record of $290 billion in 1992—a huge 4.7 percent of
GDP—the deficit has declined each year, falling to just
$22 billion in 1997—just 0.3 percent of GDP. The last
time the deficit share of GDP was this low was in
1970.
The deficit reductions following OBRA have far exceeded predictions made at the time of its passage.
OBRA was projected to reduce pre-Act deficits by $505
billion over the five years 1994–98. Over the five years
1993–97, the cumulative deficit reduction has been
$811 billion. In other words, OBRA and subsequent
developments have enabled the Treasury to issue $811
billion less debt than would have been required under
previous law. By 1998, the cumulative deficit reduction
from 1994 through 1998 is estimated to be $1.1 trillion,
more than double the original estimate.
While OBRA fundamentally altered the course of fiscal policy towards lower deficits, it was not projected
to eliminate the deficit. In the absence of further action,
deficits were expected to begin to climb once again.
To prevent this and bring the budget into surplus, last
summer the Administration negotiated the Balanced
Budget Agreement with the Congress. This budget proposes to achieve a surplus in 1999—three years earlier
than originally projected. The last budget surplus was
in 1969. OBRA and the Balanced Budget Agreement
together are expected to reduce the deficit by a cumulative total of $3.3 trillion over 1993–2002 compared
with the pre-OBRA baseline.
The economy has outperformed most forecasters’ expectations in recent years and, at the same time, deficits have been much lower than projected. This is more
than a coincidence. Lower deficits contribute to a
healthy, sustainable expansion by reducing interest
rates and boosting interest-sensitive spending in the
economy. Rapid growth of business capital spending expands industrial capacity and boosts productivity
growth. The extra capacity, in turn, prevents shortages
and bottlenecks that might otherwise emerge.
Lower interest rates also raise equity prices, which
reduces the cost of capital to business and increases

household wealth and optimism. The added impetus
to business and consumer spending creates new jobs
and business opportunities. The result is more production, more income, more jobs, more Federal revenues,
and a smaller deficit—a virtuous circle of prosperity.
That has been the experience of the past five years,
and it will be the likely consequence of policies that
achieve budget surpluses, and reduce Government debt.
In this expansion, monetary policy shifted when necessary to prevent inflation from picking up, and shifted
again to prevent the expansion from stalling when that
seemed needed. In 1994 and early 1995, monetary policy tightened when rapid growth raised the possibility
that inflationary pressures were about to build. During
1995 and early 1996, monetary policy eased because
the expansion appeared to be slowing unduly and the
risk of higher inflation had lessened. Since January
1996, monetary policy has remained steady. The sole
adjustment was in March 1997 when the federal funds
rate target was raised one-quarter percentage point to
its current level of 51⁄2 percent.
Stable monetary policy for the past two years has
kept the 3-month Treasury bill rate in a narrow range
around 5 percent. Long-term interest rates have fluctuated in response to the outlook for inflation and the
deficit. When economic growth accelerated during the
first four months of 1997, the yield on the 30-year
Treasury bond edged up 50 basis points to 7.1 percent.
During the remainder of the year, however, the rate
fell over 100 basis points in response to low inflation,
the agreement to balance the budget, the unexpectedly
low 1997 budget deficit, and international developments. By early 1998, the yield had fallen to 5.7 percent.
Recent Developments
Real Growth: The economy expanded an estimated
3.7 percent over the four quarters of 1997, up from
2.8 percent the prior year. As in 1996, the fastest growing sector was business fixed investment. During the
first three quarters of 1997, business spending for new
plant and equipment rose at a 13 percent annual rate
after adjustment for inflation, led by an 18 percent
advance in equipment spending. The biggest gains continued to be for information processing and related
equipment, but businesses invested heavily in other
forms of equipment and in structures as well.
This exceptionally strong business capital spending
has boosted productivity and expanded industrial capacity to meet current and future demands. Manufacturing
capacity rose by more than 5 percent in each of the
past three years. The last time capacity grew this rapidly was in the late 1960s. The extra capacity has
helped keep inflation low by easing the bottlenecks that
might otherwise have developed. In the fourth quarter
of 1997, the manufacturing operating rate was near
its long-term average, even though labor markets were
much tighter than usual.
Growth last year was also supported by robust household spending. Low unemployment, rising real incomes,

1.

5

ECONOMIC ASSUMPTIONS

and large capital gains have provided households with
the resources and willingness to spend heavily, especially on discretionary purchases. Overall consumer
spending after adjustment for inflation rose at a 4 percent annual rate during the first three quarters of the
year; spending on durable goods soared at a 9 percent
pace.
The same factors spurring consumption, along with
relatively low mortgage rates, pushed new home sales
during the first 11 months of 1997 to their highest
level since 1978. Buoyant sales and low inventories of
unsold homes have provided a strong incentive for
builders to start new construction. Housing starts remained at high levels last year, and residential investment, after adjustment for inflation, increased at nearly
a 5 percent annual rate during the first three quarters
of the year.
Government purchases, on balance, made only a
small contribution to GDP growth last year. Federal
government spending in GDP after adjustment for inflation was about unchanged over the first three quarters.
State and local spending rose at only a 2 percent rate
during this period, despite the healthy fiscal surpluses
that have resulted from sharply rising incomes and
profits.
The foreign sector was the primary restraint on
growth last year, trimming real GDP growth by nearly
1 percentage point during the first three quarters of
the year. Although exports expanded rapidly, import
growth was even stronger. The widening of the net
export deficit reflected the relatively faster growth of
domestic demand in the United States than in our trading partners, and also the rise in the dollar. Last year,
the dollar gained 12 percent on a trade-weighted basis
on top of a 4 percent rise during 1996.
Labor Markets: The performance of the labor market last year far exceeded most predictions. At the start
of the year, most forecasters had expected the unemployment rate to rise slightly during 1997. Instead, the
unemployment rate fell 0.6 percentage point to 4.7 percent by December 1997. November’s rate was 4.6 percent. This is the lowest two consecutive months since
March/April 1970. When this Administration took office,
the unemployment rate was 7.3 percent. All demographic groups have benefited from the decline. Thirtyeight states had unemployment rates of 5.0 percent
or less at the end of last year; only five had rates
above 6.0 percent.
The Nation’s payrolls expanded by 3.2 million jobs
last year, the biggest gain since 1994. Since the Administration took office in January 1993, 14.3 million jobs
have been created. Job growth was widespread across
industries last year. The service sector accounted for
most of the new jobs, but manufacturing industries increased their payrolls by over 200,000 jobs. State and
local government payrolls also expanded, while Federal
government employment continued to contract. The
abundance of employment opportunities pushed the employment/population ratio up to 64.1 percent by yearend, the highest level on record.

Inflation: Despite rapid growth and the unusually
low unemployment rate last year, inflation not only
remained low, it actually declined. The broadest measure of inflation, the GDP chain-weighted price index,
rose at just a 1.9 percent annual rate during the first
three quarters of 1997, 0.4 percentage point less than
during the four quarters of 1996. The last time aggregate inflation was this low was in 1964. The Consumer
Price Index (CPI) and the CPI excluding food and energy also increased less in 1997 than in 1996. The
core CPI excluding food and energy rose just 2.2 percent
last year, the slowest rise since 1965. The total CPI
rose even less, 1.7 percent, because of falling energy
prices.
The favorable inflation performance was the result
of several factors. The rise in the dollar has reduced
the costs of imported materials and intensified price
competition from imports. Non-oil import prices have
fallen nearly every month in the past two years. Although the pace of wages and salaries picked up, overall compensation costs were restrained by continued
low health-care inflation. Finally, robust investment in
new plant and equipment has contributed to unusually
strong productivity growth for this stage of an expansion, restraining inflation by offsetting gains in labor
compensation. Unit labor costs have risen very slowly
during the first three quarters of 1997.
The absence of inflation pressures has implications
for the estimate of the level of unemployment that is
consistent with stable inflation. This threshold has been
called the NAIRU, or ‘‘nonaccelerating inflation rate
of unemployment.’’ Economists have been lowering their
estimates of NAIRU in recent years in keeping with
the accumulating experience that lower unemployment
has not led to higher inflation, even after taking into
account the influence of temporary factors. The economic projections for this Budget assume that NAIRU
is 5.4 percent. That is 0.1 percentage point less than
estimated in the 1998 Budget assumptions and 0.3 percentage point less than in the 1997 Budget.
By the end of 1997, the unemployment rate was
about three-quarter percentage point below the current
estimate of NAIRU. In the absence of special factors,
if unemployment remains below NAIRU, inflation
would eventually creep up. The Administration forecast
for real growth over the next three years, however,
is moderate enough to imply that unemployment will
return to 5.4 percent.
Statistical Issues
The U.S. statistical agencies endeavor to produce accurate measures of the economy’s performance. Nonetheless, in recent years serious concerns have been
raised about possible mismeasurement, especially of
real GDP growth and of inflation.
Real Growth: In a perfect statistical world, the value
of output would equal the value of income generated
in its production, that is, GDP would match Gross Domestic Income (GDI). However, because the series are
based on different source data, each with its own gaps

6
and inconsistencies, the two measures are hardly ever
identical. What is particularly unusual now is the wide
and growing difference between product and income
measures.
This ‘‘statistical discrepancy,’’ defined as aggregate
output minus aggregate income, was –$103 billion in
the third quarter of 1997—a nearly record-setting 1.3
percent of nominal GDP. By comparison, in the first
quarter of 1995, the statistical discrepancy was nearly
zero, and two years earlier, in the first quarter of 1993,
it was $71 billion. A swing of this magnitude means
that during the past four and a half years, the annual
average real growth rate measured from the familiar
output side has been about 0.5 percentage point less
than the growth rate measured from the income side.
During the first three quarters of last year, real GDP
rose at a 3.8 percent annual rate but real Gross Domestic Income at a 4.5 percent pace. In the third quarter
of 1997, the divergence widened further. Real GDP
growth was at a 3.1 percent annual rate, but real GDI
surged at a 4.5 percent rate.
The absence of a single, clear picture of the economy’s
actual growth performance is a cause for concern. It
is difficult to know if growth is accelerating or decelerating; if actual growth is above or below the economy’s potential growth rate; or even what the economy’s
potential growth rate is.
Any estimate of potential growth depends on an estimate of trend productivity growth, which itself depends
on recent data on actual growth. When there is a growing divergence between product and income measures,
there is a comparable divergence in estimates of the
productivity trend. For example, measured from the
last cyclical peak to the third quarter of 1997, labor
productivity growth has increased at a 1.1 percent annual rate according to the official productivity statistics
which measure output growth from the product side.
Labor productivity growth measured from the income
side, however, has risen at a 1.5 percent annual rate.
It is unclear whether the product or the income side
provides the more accurate measure of growth. The
Bureau of Economic Analysis recognizes the shortcomings of both measures but believes that GDP is
a more reliable measure of output than GDI (see The
Survey of Current Business, August 1997, page 19).
Other experts believe that GDI, or some figure between
the two measures, may be more accurate.
There is circumstantial evidence to suggest that
growth may be faster than shown by the traditional
GDP measure. The recent combination of low inflation
and a rising profits share suggests that productivity
growth is stronger than reported from the output side.
Moreover, the unexpected strength of Treasury receipts
in the last two years suggests that the output measure,
and even the income measure, may be too low. While
some of the higher receipts are from capital gains generated by the booming stock market, which are excluded from the national income accounts, this source
does not fully account for the surge.

ANALYTICAL PERSPECTIVES

The uncertainty surrounding actual growth and its
trend makes it more difficult to determine appropriate
monetary policy. From a budgetary perspective, estimates of receipts and expenditures have a larger degree
of uncertainty because they are dependent on the forecast for growth. As shown in Table 1–6, ‘‘Sensitivity
of the Budget to Economic Assumptions,’’ errors in forecasting real GDP growth can have a significant effect
on the budget balance.
Inflation: Accurate measurement of inflation has become increasingly important in recent years, even as
inflation has been brought under control. Eliminating
biases of even a few tenths of a percentage point a
year can have important meaning relative to a goal
of price stability when inflation is low, while it may
have less significance when inflation is higher.
In recent years, serious questions have been raised
about the magnitude of bias in the Consumer Price
Index. In December 1996, the Advisory Commission to
Study the Consumer Price Index, appointed by the Senate Finance Committee, reported that the index overstated the actual cost of living by 1.1 percentage points
per year. The Bureau of Labor Statistics (BLS), however, believes that the empirically demonstrated bias
is significantly less.
The BLS has instituted a number of methodological
changes in recent years to improve the accuracy of the
Consumer Price Index, and has announced several more
changes that will be put in place this year and next.
Taken together, these changes are estimated to result
in a 0.7 percentage point slower annual rise in the
CPI by 1999. The changes instituted from 1995–1997
are estimated to have slowed the growth of the CPI
by 0.3 percentage point per year; the forthcoming
changes are expected to trim another 0.4 percentage
point per year. Because the CPI is used to deflate some
nominal spending components of GDP, a slower rise
in the CPI translates into a faster rise in real GDP.
By 1999, measured real GDP growth and, therefore,
productivity growth, is likely to be boosted by 0.2 percentage point per year as a consequence of the cumulative improvements to the CPI since 1995.
Two methodological improvements have been instituted beginning with the release of the CPI for January
1998: an updating of the expenditure weights, and a
better technique for estimating quality improvements
for computers. Together, the two changes are expected
to slow CPI growth by 0.2 percentage point per year.
This year, the BLS updated the expenditure weights
used in the CPI from a 1982–84 basis to 1993–95, using
Consumer Expenditure Survey data. At the same time,
BLS introduced a more accurate geographic sample
based on the 1990 decennial census, and redefined the
groupings of items. In the future, BLS expects to introduce updated expenditure weights more frequently than
in the past, when there were approximately 10 years
between updates.
For computers and peripheral equipment, the BLS
has now begun to use a hedonic regression procedure
to distinguish price from quality changes. The esti-

1.

ECONOMIC ASSUMPTIONS

mated value of an improvement obtained from this regression procedure is deducted from the observed price
change for the product. For example, if the CPI sample
of computer prices shows no change in the retail price
of a new computer, but it is 20 percent better than
the prior model as measured by the hedonic procedure,
the CPI will report a corresponding drop in price for
this model. A similar procedure has been adopted for
estimating computer prices in the Producer Price Index
and in the National Income and Product Accounts. It
is especially important to measure accurately, and on
a timely basis, the extraordinary leaps in computer
power that must be a part of a meaningful measure
of computer prices.
For 1999, BLS has announced that it will select items
to be sampled on a product rather than a geographical
basis. This switch will allow more frequent sampling
of categories with rapidly changing product lines, such
as consumer electronics.
A very important change next year will be the replacement of the current fixed-weighted Laspeyres formula by a geometric mean formula for combining individual price quotations at the lower level of aggregation
in the CPI. Under certain assumptions, a CPI calculated using geometric means more closely approximates a cost-of-living index. Unlike the current fixedweighted aggregation, the geometric mean formula allows for shifts in consumer spending patterns in response to changes in relative prices within categories
of goods and services.
Since last April, the BLS has been publishing an
experimental CPI each month that uses geometric
means for all lower level aggregation and has provided
a historical series beginning with December 1990. If
a geometric mean is used for all lower level aggregation, BLS estimates that the growth in the CPI would
be slowed by about one-quarter percentage point per
year. Partial adoption would result in a lesser impact.
BLS is expected to announce shortly which categories
will be shifted to geometric means next year and the
likely impact on the growth of the CPI.
Economic Projections
The economy’s strong performance last year and the
continuation of the virtuous circle of prosperity made
possible by sound fiscal and monetary policies raises
the possibility that actual economic developments may
even be better than the assumptions—as has been the
case in recent years. Nonetheless, it is prudent to base
budget estimates on a conservative set of economic assumptions close to the consensus of private sector forecasts.
Virtuous Circle of Prosperity: The economic assumptions summarized in Table 1–1 are predicated on
the adoption of the policies proposed in this budget.
The swing in the fiscal position from deficit to surplus
is expected to support a continuation of the favorable
economic performance of recent years. The shift from
Federal Government dissaving to saving would pull interest rates down, stimulating private sector invest-

7
ment in new plant and equipment. The economy is
likely to continue to grow, although at a more moderate
pace than during 1997. While job opportunities are expected to remain plentiful, the unemployment rate is
likely to rise gradually to a level consistent with stable
inflation. New job creation would boost incomes and
consumer spending and keep confidence at a high level.
Continued low inflation would enable monetary policy
to support economic growth. Growth, in turn, would
further improve the budget balance.
Real GDP, Potential GDP and Unemployment:
Over the next three years, real GDP is expected to
rise 2.0 percent per year. This shift to more moderate
growth recognizes that by conservative, mainstream assumptions, growth has exceeded the pace that can be
maintained on a sustained basis, which could eventually result in upward pressures on inflation. A slowdown has been expected for this reason. Also, the financial dislocations in Asia could contribute to this slowing
of U.S. growth. From 2001–2007, growth is expected
to average a slightly faster 2.4 percent per year—the
Administration’s estimate of the economy’s potential
growth rate. Real GDP growth in 2008 is projected
to slow to 2.3 percent to reflect the beginning of the
years of slower growth of the workforce as the babyboomers begin to retire.
The net export component of GDP is expected to restrain real growth by about 1 percentage point during
1998, as our export growth is curtailed by slower
growth in Asia and the appreciation of the dollar.
Thereafter, as the effects of the crisis abroad wane,
export growth is likely to pick up slightly. Beginning
with 1999, the foreign sector is not expected to make
a large contribution, positive or negative, to overall
growth.
As has been the case throughout this expansion, during the next six years business fixed investment is expected to be the fastest growing component of GDP.
Although residential investment is also expected to benefit from low mortgage rates, the high level of housing
starts in recent years and underlying demographic
trends may tend to reduce growth. Consumer spending,
especially on durable goods, is also likely to moderate
from the rapid pace of 1997. The fundamental factors
supporting consumer spending are likely to remain favorable, although not quite to the same extent as during 1997. The government component of GDP will hardly grow through 2003. A decline in Federal consumption
and gross investment is projected to be offset by moderate growth in State and local spending.
Continued strong growth of business fixed investment
and the output-increasing effects of methodological improvements to the CPI noted above are expected to
raise the measured trend of productivity growth during
the next six years to 1.3 percent per year. By comparison, during the seven years following the last business
cycle peak in the third quarter of 1990, productivity
growth averaged 1.1 percent per year, as measured
from the GDP side of the accounts.

8

ANALYTICAL PERSPECTIVES

Table 1–1.

ECONOMIC ASSUMPTIONS 1

(Calendar years; dollar amounts in billions)
Projections

Actual
1996

1997

1998

1999

2000

2001

2002

7,636
6,928
110.2

8,080
7,187
112.5

8,430
7,357
114.6

8,772
7,503
116.9

9,142
7,652
119.5

9,547
7,820
122.1

9,993
8,008
124.8

10,454
8,199
127.5

5.6
3.2
2.3

5.5
3.6
1.9

4.0
2.0
2.0

4.1
2.0
2.1

4.3
2.0
2.2

4.6
2.3
2.2

4.6
2.4
2.2

4.6
2.4
2.2

5.1
2.8
2.3

5.8
3.7
2.0

4.3
2.4
1.9

4.1
2.0
2.0

4.2
2.0
2.2

4.4
2.2
2.2

4.7
2.4
2.2

4.6
2.4
2.2

Incomes, billions of current dollars:
Corporate profits before tax .................................................................
Wages and salaries .............................................................................
Other taxable income 2 .........................................................................

677
3,633
1,693

729
3,868
1,786

754
4,057
1,859

768
4,237
1,915

790
4,424
1,975

805
4,623
2,046

830
4,840
2,128

851
5,068
2,213

Consumer Price Index (all urban): 3
Level (1982–84 = 100), annual average ..............................................
Percent change, fourth quarter over fourth quarter ............................
Percent change, year over year ..........................................................

157.0
3.2
2.9

160.7
2.0
2.4

164.1
2.2
2.1

167.7
2.2
2.2

171.5
2.3
2.3

175.5
2.3
2.3

179.5
2.3
2.3

183.6
2.3
2.3

Gross Domestic Product (GDP):
Levels, dollar amounts in billions:
Current dollars ......................................................................................
Real, chained (1992) dollars ................................................................
Chained price index (1992 = 100), annual average ............................
Percent change, fourth quarter over fourth quarter:
Current dollars ......................................................................................
Real, chained (1992) dollars ................................................................
Chained price index (1992 = 100) ........................................................
Percent change, year over year:
Current dollars ......................................................................................
Real, chained (1992) dollars ................................................................
Chained price index (1992 = 100) ........................................................

2003

Unemployment rate, civilian, percent:
Fourth quarter level ..............................................................................
Annual average ....................................................................................
Federal pay raises, January, percent:
Military 4 ................................................................................................
Civilian 5 ................................................................................................

5.3
5.4

4.8
5.0

5.0
4.9

5.2
5.1

5.4
5.3

5.4
5.4

5.4
5.4

5.4
5.4

2.6
2.4

3.0
3.0

2.8
2.8

3.1
3.1

3.0
3.0

3.0
3.0

3.0
3.0

3.0
3.0

Interest rates, percent:
91-day Treasury bills 6 .........................................................................
10-year Treasury notes ........................................................................

5.0
6.4

5.0
6.4

5.0
5.9

4.9
5.8

4.8
5.8

4.7
5.7

4.7
5.7

4.7
5.7

1

Based on information available as of early December 1997.
Rent, interest, dividend and proprietor’s components of personal income.
Seasonally adjusted CPI for all urban consumers. Two versions of the CPI are now published. The index shown here is that currently used, as required by law, in calculating automatic adjustments to individual income tax brackets. Projections reflect scheduled changes in methodology.
4
Beginning with the 1999 increase, percentages apply to basic pay only; adjustments for housing and subsistence allowances will be determined by the Secretary of Defense.
5
Overall average increase, including locality pay adjustments.
6
Average rate (bank discount basis) on new issues within period.
2
3

Potential GDP growth of 2.4 percent during the projection horizon can be decomposed into the trend
growth of productivity, 1.3 percent per year, plus the
growth of the labor force, estimated at 1.1 percent annually. The Administration’s labor force projection assumes that the population of working age will grow
1.0 percent per year and that the labor force participation rate will edge up 0.1 percent per year.
Both the labor force and participation rate assumptions are lower than recent experience. The participation rate has risen 0.4 percent per year since 1994,
as falling unemployment and rapidly expanding job opportunities have strongly induced job-seeking. But with
the labor force participation rate and employment/population ratio at post-World War II highs, it is prudent
to project a slower rise in the coming years. In addition,
the female participation rate, which had risen sharply
during much of the postwar period, grew much slower
during the 1990s, and this trend is assumed to continue.
The real GDP growth projection of 2.0 percent
through 2000 is consistent with a gradual rise in the
unemployment rate to 5.4 percent. Unemployment is
then projected to remain on a plateau at that level

from 2001 onward, when real GDP growth averages
the Administration’s estimate of the economy’s potential
growth rate.
Inflation: With unemployment expected to be slightly below NAIRU during the next three years, inflation
is projected to creep up by about one-quarter percentage
point by 2000. The CPI is projected to increase 2.3
percent in that year and the subsequent years of the
forecast horizon; the GDP chain-weighted price index
is projected to increase 2.2 percent in 2000 and beyond.
The relatively small 0.1 percentage point difference between the two inflation measures is narrower than in
the past because of recent and forthcoming methodological improvements to both indexes.
Despite the relatively tight labor market in the next
few years, inflation is projected to remain low, partly
because of two temporary factors. The rise in the dollar
is expected to hold down import prices and intensify
price competition from imported goods and services. In
addition, wide profit margins provide a cushion that
will enable firms to absorb cost increases without having to pass them on fully into higher prices.

1.

ECONOMIC ASSUMPTIONS

Moreover, as discussed above, the methodological improvements to the CPI will offset some of the rise that
might otherwise occur. By 1999, the improvements instituted this year and next will trim about 0.4 percentage point off of the annual rise in the CPI. These same
improvements are likely to restrain the rise in the GDP
chain weighted price index by about 0.1 percentage
point per year.
Interest Rates: The assumptions, which were finalized in early December, project a gradual decline in
short- and long-term interest rates consistent with the
improved fiscal balance and low inflation. By 2001 the
91-day Treasury bill rate is expected to be 30 basis
points lower than the fourth quarter 1997 average; the
yield on the 10-year Treasury bond is projected to be
20 basis points lower.
The sharp drop in long-term rates in early 1998 has
already driven long-term rates below the levels anticipated in the economic assumptions. Recent developments, including the improved budget outlook, may
have caused market participants to lower their expectations for inflation and credit demands. The turmoil in
Asian markets may have fostered further portfolio adjustments into the safe haven of U.S. bonds. In light
of these developments, it is possible that long-term
rates will be lower on average than those in the economic assumptions. Financial markets, however, can
be quite volatile; the recent drop in long rates could
prove to be temporary.
Incomes: The moderating of real growth during the
projection horizon is expected to shift the distribution
of national income slightly, augmenting the share going
to labor while trimming the unusually high profits
share in GDP. On balance, total taxable income is projected to decline gradually as a share of GDP.
Between 1997 and 2003, aggregate wages and salaries are projected to rise 31 percent in nominal terms
and 15 percent after adjustment for inflation. Corresponding to the rise in the wage share, corporate
profits before tax are projected to rise just 16 percent
in nominal terms from 1997 to 2003, a markedly slower
pace than in recent years. By 2003, taxable profits as
a share of GDP are projected to be about 1 percentage
point lower than the 30-year high reached during 1997.
The favorable impact of lower interest rates on the
debt service payments of the corporate sector helps to
cushion the impact on profits of the expected shift of
income back toward wages.
Lower interest rates will pull down the share of personal interest income in GDP because the household
sector is a net lender in the economy. Little change
is expected in the shares of other components of taxable
income (dividends, rents and proprietors’ income).
Comparison with CBO
The Congressional Budget Office (CBO) develops economic projections used by Congress in formulating its
budget policy. In the executive branch, the analogous
function is performed jointly by the Treasury, the Coun-

9
cil of Economic Advisers (CEA), and the Office of Management and Budget (OMB). These two sets of economic
projections can be compared with one another, but differences in their preparation should be borne in mind:
• The Administration’s projections always assume
that the President’s policy proposals in the budget
will be adopted in full. In contrast, CBO normally
assumes that current law will continue unchanged; thus, it makes a ‘‘pre-policy’’ or baseline
projection, while the Administration’s projections
are ‘‘post-policy.’’
• The two sets of projections are often prepared at
different times. The Administration’s projections
must be prepared months ahead of the release
of the budget. Differences in the Administration’s
and CBO’s near-term forecasts, therefore, can be
due to the availability of more recent data to CBO;
a direct comparison with the CBO near-term projections is not always meaningful. Timing differences are much less likely to play an important
role in any differences in outyear projections, however.
Table 1–2 presents a summary comparison of the current CBO and Administration projections.
• Real GDP: The projections of real GDP growth
are quite similar. The Administration projects that
real GDP will grow at an average annual rate
of 2.2 percent from 1998 through 2003; CBO
projects a 2.1 percent rate.
• Inflation: Both the Administration and CBO expect inflation to continue at a slow, steady rate
over the next several years. For the chain-weighted GDP price index, CBO assumes that inflation
will average 2.3 percent a year over the
1998–2003 period while the Administration projects a 2.1 percent average for that span; CBO
expects the annual rate of change in the CPI to
average 0.4 percentage point higher than the Administration forecast over the same period.
• Unemployment: CBO projects unemployment to
rise from its fourth quarter average of 4.7 percent
to 5.9 percent by 2003, slightly above its estimate
of the NAIRU. The Administration believes unemployment will average its estimate of the NAIRU,
5.4 percent, during 2001 to 2003.
• Interest rates: Both the Administration and CBO
expect a similar decline to a level of 4.7 percent
by the year 2001 for the 91-day bill rate. The
Administration, however, projects a slightly greater (0.2 percentage point) decline in long-term rates
than does CBO.
• Income distribution: Both CBO and the Administration project a decline in the profits share of
GDP, although both also expect a shift of income
from personal interest income to corporate profits.
In part because the Administration assumes a
slightly larger decline in long-term interest rates
than does CBO, it projects less of a decline in
the profits share. CBO projects a slightly higher
wage and salary share of GDP than does the Ad-

10

ANALYTICAL PERSPECTIVES

Table 1–2.

COMPARISON OF ECONOMIC ASSUMPTIONS
(Calendar years; percent)
Projections
1998

1999

2000

2001

2002

2003

1

Real GDP (chain-weighted):
CBO January .................................................................
1999 Budget ..................................................................

2.3
2.0

1.9
2.0

1.9
2.0

2.0
2.3

2.2
2.4

2.3
2.4

Chain-weighted GDP Price Index: 1
CBO January .................................................................
1999 Budget ..................................................................

2.1
2.0

2.2
2.1

2.4
2.2

2.5
2.2

2.4
2.2

2.5
2.2

Consumer Price Index (all-urban): 1
CBO January .................................................................
1999 Budget ..................................................................

2.4
2.2

2.5
2.2

2.7
2.3

2.8
2.3

2.8
2.3

2.8
2.3

Unemployment rate: 2
CBO January .................................................................
1999 Budget ..................................................................

4.8
4.9

5.1
5.1

5.4
5.3

5.6
5.4

5.8
5.4

5.9
5.4

Interest rates: 2
91-day Treasury bills:
CBO January ............................................................
1999 Budget ..............................................................

5.3
5.0

5.2
4.9

4.8
4.8

4.7
4.7

4.7
4.7

4.7
4.7

10-year Treasury notes:
CBO January ............................................................
1999 Budget ..............................................................

6.0
5.9

6.1
5.8

6.0
5.8

5.9
5.7

5.9
5.7

5.9
5.7

Taxable income 3 (share of GDP):
CBO January .................................................................
1999 Budget ..................................................................

79.0
79.1

78.3
78.9

77.7
78.6

77.3
78.3

77.0
78.0

76.7
77.8

1
2
3

Percent change, fourth quarter over fourth quarter.
Annual averages, percent.
Taxable personal income plus corporate profits before tax.

ministration. Overall, CBO’s taxable income share
of GDP declines from 79.1 percent for 1997 to
76.7 percent for 2003; the Administration’s assumptions also show a decline, but only to 77.8
percent for 2003. Both forecasts thus recognize
that the 1997 share is historically high, in large
measure reflecting the discrepancy in recent GDP
and GDI growth rates discussed earlier in this
Chapter.
CBO has a good economic forecasting record. During
much of the 1980s, its forecasts were more accurate
than those of the Administrations then in office. The
record over the last five years, however, has been more
mixed. Since it took office in 1993, this Administration
has placed high priority on careful and prudent economic forecasts. Economic performance in the last four
years has been better than assumed by the Administration, while exceeding CBO’s assumptions by an even
wider margin. The Administration’s cautious approach
to forecasting is one of the reasons that actual deficits
have consistently come in below expectations since
1993.
The differences in economic assumptions between the
Administration and CBO have been small—smaller
than they were under previous Administrations, and
well within the usual range of error in such projections.
CBO’s assumptions and those used in this Budget are
unusually close, and both are similar to private sector
forecasts such as the Blue Chip consensus. However,
even small differences in economic assumptions can
yield sizable differences in budget projections when extended over a long planning horizon. Given the positive

economic outlook in the United States—steady growth,
robust job creation, and low inflation and interest rates
with none of the excesses that foreshadow an economic
downturn—there are sound reasons for believing that
the Administration’s projection is likely to be close to
the actual outcome.
Impact of Changes in the Economic
Assumptions
The economic assumptions underlying this budget are
similar to those of last year. Both budgets anticipated
that achieving a balanced budget would result in a
significant decline in interest rates that would serve
to extend the economic expansion at a moderate pace,
while helping to maintain low, steady rates of inflation
and unemployment. A shift to a balanced budget and
the ensuing lower interest rates were also expected to
shift income from interest to profits. This would have
favorable effects on budget receipts and the deficit, because profits are on average taxed more heavily than
interest income.
The changes in the economic assumptions since last
year’s budget have been relatively modest, as Table
1–3 shows. The differences are primarily the result of
more favorable economic experience in 1997 than was
anticipated. Economic growth was stronger than expected in 1997, while inflation and unemployment were
lower. Because of this favorable experience, the projected annual averages for the unemployment and inflation rates have been reduced slightly. At the same time,
interest rates are again assumed to decline in this

1.

11

ECONOMIC ASSUMPTIONS

Table 1–3.

COMPARISON OF ECONOMIC ASSUMPTIONS IN THE 1998 AND 1999 BUDGETS
(Calendar years; dollar amounts in billions)
1997

Nominal GDP:
1998 Budget assumptions 1 ...........................................................
1999 Budget assumptions .............................................................
Real GDP (percent change): 2
1998 Budget assumptions .............................................................
1999 Budget assumptions .............................................................
GDP price index (percent change): 2
1998 Budget assumptions .............................................................
1999 Budget assumptions .............................................................
Consumer Price Index (percent change): 2
1998 Budget assumptions .............................................................
1999 Budget assumptions .............................................................
Civilian unemployment rate (percent): 3
1998 Budget assumptions .............................................................
1999 Budget assumptions .............................................................
91-day Treasury bill rate (percent): 3
1998 Budget assumptions .............................................................
1999 Budget assumptions .............................................................
10-year Treasury note rate (percent): 3
1998 Budget assumptions .............................................................
1999 Budget assumptions .............................................................
1
2
3

1998

1999

2000

2001

2002

2003

8,005
8,080

8,379
8,430

8,786
8,772

9,226
9,142

9,686
9,547

10,167
9,993

10,674
10,454

2.0
3.6

2.0
2.0

2.3
2.0

2.3
2.0

2.3
2.3

2.3
2.4

2.3
2.4

2.5
1.9

2.6
2.0

2.6
2.1

2.6
2.2

2.6
2.2

2.6
2.2

2.6
2.2

2.6
2.4

2.7
2.1

2.7
2.2

2.7
2.3

2.7
2.3

2.7
2.3

2.7
2.3

5.3
5.0

5.5
4.9

5.5
5.1

5.5
5.3

5.5
5.4

5.5
5.4

5.5
5.4

5.0
5.0

4.7
5.0

4.4
4.9

4.2
4.8

4.0
4.7

4.0
4.7

4.0
4.7

6.1
6.4

5.9
5.9

5.5
5.8

5.3
5.8

5.1
5.7

5.1
5.7

5.1
5.7

Adjusted for July 1997 NIPA revisions.
Fourth quarter-to-fourth quarter.
Calendar year average.

budget, but the decline is smaller in percentage points,
in part because the deficit has already fallen much
faster than expected.
The net effects on the budget of these modifications
in the economic outlook are shown in Table 1–4. The
largest effects come from higher receipts during
1998–2002 due to higher projected levels of taxable in-

Table 1–4.

comes. In all years through 2003, there are higher outlays for interest due to the smaller expected decline
in interest rates, offset by lower outlays for cost-ofliving adjustments to Federal programs due to lower
rates of inflation. A more favorable economic outlook
since last year improves the budget balance by $38
billion for 1998 and by $15 billion in 2003.

EFFECTS ON THE BUDGET OF CHANGES IN ECONOMIC ASSUMPTIONS SINCE LAST YEAR
(In billions of dollars)
1998

1999

2000

2001

2002

2003

1,630.0
1,677.9

1,714.3
1,745.0

1,775.4
1,796.8

1,855.1
1,846.8

1,947.3
1,874.5

2,032.4
1,964.5

Deficit (–) or surplus ...........................................................................................
Changes due to economic assumptions:
Receipts .......................................................................................................................
Outlays:
Inflation ....................................................................................................................
Unemployment ........................................................................................................
Interest rates ...........................................................................................................
Interest on changes in borrowing ...........................................................................

–47.9

–30.7

–21.4

8.3

72.8

67.8

27.9

28.4

18.2

7.5

2.0

–4.2

–4.4
–5.4
0.7
–1.0

–8.1
–4.2
3.4
–2.8

–12.4
–2.4
7.3
–4.2

–16.8
–1.0
10.6
–5.1

–20.8
–1.0
12.7
–5.8

–25.3
–1.1
13.7
–6.5

Total, outlay decreases (net) .............................................................................

–10.1

–11.8

–11.7

–12.4

–14.9

–19.2

Increase in surplus or reduction in deficit .........................................................
Budget totals under 1999 Budget economic assumptions and policies:
Receipts .......................................................................................................................
Outlays .........................................................................................................................

38.0

40.2

29.9

19.9

17.0

15.0

1,657.9
1,667.8

1,742.7
1,733.2

1,793.6
1,785.0

1,862.6
1,834.4

1,949.3
1,859.6

2,028.2
1,945.4

Deficit (–) or surplus ...........................................................................................

–10.0

9.5

8.5

28.2

89.7

82.8

Budget totals under 1998 Budget economic assumptions and 1999 Budget
policies:
Receipts .......................................................................................................................
Outlays .........................................................................................................................

12

ANALYTICAL PERSPECTIVES

Structural vs. Cyclical Balance
When the economy is operating above potential as
it is currently estimated to be, receipts are higher than
they would be if resources were less fully employed,
and outlays for unemployment-sensitive programs (such
as unemployment compensation and food stamps) are
lower. As a result, the deficit is smaller or the surplus
is larger than it would be if unemployment were at
NAIRU. The portion of the surplus or deficit that can
be traced to such factors is called the cyclical surplus
or deficit. The remainder, the portion that would remain with unemployment at NAIRU (consistent with
a 5.4 percent unemployment rate), is called the structural surplus or deficit.
Changes in the structural balance give a better picture of the impact of budget policy on the economy
than does the unadjusted budget balance. The level
of the structural balance also gives a clearer picture
of the stance of fiscal policy, because this part of the
surplus or deficit will persist even when the economy
returns to normal operating levels.
In the early 1990’s, large swings in net outlays for
deposit insurance (the S&L bailouts) had substantial
impacts on deficits, but had little concurrent impact
on economic performance. It therefore became customary to remove deposit insurance outlays as well as
the cyclical component of the surplus or deficit from
the actual surplus or deficit to compute the adjusted
structural balance. This is shown in Table 1–5.
Because unemployment is projected to be quite close
to NAIRU over the forecast horizon, the cyclical component of the surplus is small. For the period 1997
through 2000, the unemployment rate is slightly below
the estimated NAIRU of 5.4 percent, resulting in cyclical surpluses. Deposit insurance net outlays are relatively small and do not change greatly from year to
year. The adjusted structural surplus or deficits in this
budget display much the same pattern of year-to-year
changes as the actual deficits. The most significant
point illustrated by this table is the fact that of the
$268 billion reduction in the actual budget deficit between 1992 and 1997 (from $290 billion to $22 billion),
35 percent ($94 billion) resulted from cyclical improvement in the economy. The rest of the reduction
stemmed primarily from policy actions—mainly those
in the Omnibus Budget Reconciliation Act of 1993,
which reversed a projected continued steep rise in the
Table 1–5.

deficit and set the stage for the remarkable cyclical
improvement that has occurred.
Sensitivity of the Budget to Economic
Assumptions
Both receipts and outlays are affected by changes
in economic conditions. This sensitivity seriously complicates budget planning, because errors in economic
assumptions lead to errors in the budget projections.
It is therefore useful to examine the implications of
alternative economic assumptions.
Many of the budgetary effects of changes in economic
assumptions are fairly predictable, and a set of rules
of thumb embodying these relationships can aid in estimating how changes in the economic assumptions
would alter outlays, receipts, and the surplus or deficit.
Economic variables that affect the budget do not usually change independently of one another. Output and
employment tend to move together in the short run:
a higher rate of real GDP growth is generally associated with a declining rate of unemployment, while weak
or negative growth is usually accompanied by rising
unemployment. In the long run, however, changes in
the average rate of growth of real GDP are mainly
due to changes in the rates of growth of productivity
and labor supply, and are not necessarily associated
with changes in the average rate of unemployment.
Inflation and interest rates are also closely interrelated:
a higher expected rate of inflation increases interest
rates, while lower expected inflation reduces rates.
Changes in real GDP growth or inflation have a much
greater cumulative effect on the budget over time if
they are sustained for several years than if they last
for only one year.
Highlights of the budget effects of the above rules
of thumb are shown in Table 1–6.
If real GDP growth is lower by one percentage point
in calendar year 1998 only and the unemployment rate
rises by one-half percentage point, the fiscal 1998 deficit would increase by $9.1 billion; receipts in 1998
would be lower by about $7.5 billion, and outlays would
be higher by about $1.5 billion, primarily for unemployment-sensitive programs. In 1999, the receipts shortfall
would grow further to about $16.2 billion, and outlays
would increase by about $5.5 billion relative to the
base, even though the growth rate in calendar 1999
equals the rate originally assumed. This is because the
level of real (and nominal) GDP and taxable incomes
would be permanently lower and unemployment higher.

ADJUSTED STRUCTURAL BALANCE
(In billions of dollars)
1992

1993

1994

1995

1996

1997

1998

1999

Unadjusted deficit (–) or surplus .......................................................
Cyclical component .......................................................................

–290.4
–72.5

–255.0
–57.2

–203.1
–27.8

–163.9
–8.4

–107.4
–4.2

–21.9
21.4

–10.0
30.1

9.5
19.6

Structural deficit (–) or surplus .........................................................
Deposit insurance outlays .............................................................

–217.9
–2.3

–197.8
–28.0

–175.3
–7.6

–155.5
–17.9

–103.2
–8.4

–43.4
–14.4

–40.1
–4.5

Adjusted structural deficit (–) or surplus ...........................................

–220.3

–225.8

–182.9

–173.4

–111.6

–57.8

–44.6

2000

2001

2002

2003

8.5
9.0

28.2
..........

89.7
..........

82.8
..........

–10.0
–4.5

–0.4
–1.9

28.2
–1.4

89.8
–1.2

82.8
–0.3

–14.5

–2.3

26.7

88.6

82.5

1.

ECONOMIC ASSUMPTIONS

The budget effects (including growing interest costs associated with higher deficits or smaller surpluses)
would continue to grow slightly in later years.
The budget effects are much larger if the real growth
rate is assumed to be one percentage point less in each
year (1998–2003) and the unemployment rate to rise
one-half percentage point in each year. With these assumptions, the levels of real and nominal GDP would
be below the base case by a growing percentage. The
budget balance would be worsened by $153.3 billion
relative to the base case by 2003.
The effects of slower productivity growth are shown
in a third example, where real growth is one percentage
point lower per year while the unemployment rate is
unchanged. In this case, the estimated budget effects
mount steadily over the years, but more slowly, resulting in a $130.2 billion worsening of the budget balance
by 2003.
The effects of an abrupt and sustained one percentage
point increase in the level of the unemployment rate
(due, say, to a sudden rise in labor force participation
relative to the base case), with no change in the level
or growth rate of real GDP, are shown in a fourth
example. In this case, unemployment-sensitive outlays
would increase by amounts rising from $6.5 billion in
1998 to $12.4 billion in 2003. The effects on the surplus
would be smaller (a $7.9 billion reduction in 2003),
however, because under current law, federal unemployment tax collections would gradually rise during a period of sustained higher unemployment rates.
Joint changes in interest rates and inflation have
a smaller effect on the deficit than equal percentage
point changes in real GDP growth, because their effects
on receipts and outlays are substantially offsetting. An
example is the effect of a one percentage point higher
rate of inflation and one percentage point higher interest rates during calendar year 1998 only. In subsequent
years, the price level and nominal GDP would be one

13
percent higher than in the base case, but interest rates
are assumed to return to their base levels. Outlays
for 1998 rise by $5.8 billion and receipts by $8.7 billion,
for a decrease of $2.8 billion in the 1998 deficit. In
1999, outlays would be above the base by $14.2 billion,
due in part to lagged cost-of-living adjustments; receipts
would rise $17.6 billion above the base, however, resulting in a $3.4 billion improvement in the budget balance.
In subsequent years, the amounts added to receipts
would continue to be larger than the additions to outlays.
If the rate of inflation and the level of interest rates
are higher by one percentage point in all years, the
price level and nominal GDP would rise by a cumulatively growing percentage above their base levels. In
this case, the effects on receipts and outlays mount
steadily in successive years, adding $62.6 billion to outlays and $106.5 billion to receipts in 2003, for a net
increase in the surplus of $43.9 billion.
The table also shows the interest rate and the inflation effects separately, and rules of thumb for the added
interest cost associated with changes in the budget surplus or deficit (increased or reduced borrowing). The
effects of changes in economic assumptions in the opposite direction are approximately symmetric to those
shown in the table. The impact of a one percentage
point lower rate of inflation or higher real growth would
have about the same magnitude as the effects shown
in the table, but with the opposite sign.
These rules of thumb are computed while holding
the income share composition of GDP constant. Because
different income components are subject to different
taxes and tax rates, estimates of total receipts can be
affected significantly by changing income shares. However, the relationships between changes in income
shares and changes in growth, inflation, and interest
rates are too complex to be reduced to simple rules.

14

ANALYTICAL PERSPECTIVES

Table 1–6.

SENSITIVITY OF THE BUDGET TO ECONOMIC ASSUMPTIONS
(In billions of dollars)

Budget effect

Real Growth and Employment
Budgetary effects of 1 percent lower real GDP growth:
For calendar year 1998 only: 1
Receipts .....................................................................................................
Outlays .......................................................................................................

1998

1999

2000

2001

2002

2003

–7.5
1.5

–16.2
5.5

–18.7
6.8

–19.0
8.2

–19.5
9.8

–20.1
11.6

Decrease in surplus (–) ........................................................................
Sustained during 1998–2003: 1
Receipts .....................................................................................................
Outlays .......................................................................................................

–9.1

–21.8

–25.5

–27.2

–29.3

–31.7

–7.5
1.5

–24.0
7.1

–43.4
14.0

–63.6
22.3

–85.2
32.6

–108.0
45.3

Decrease in surplus (–) ........................................................................
Sustained during 1998–2003, with no change in unemployment:
Receipts .....................................................................................................
Outlays .......................................................................................................

–9.1

–31.1

–57.4

–86.0

–117.8

–153.3

–7.5
0.2

–24.3
1.1

–44.5
2.9

–66.1
5.9

–89.4
10.1

–114.4
15.8

Decrease in surplus (–) ........................................................................
Budgetary effects of 1 percent higher unemployment rate:
Sustained during 1998–2003, with no change in real GDP:
Receipts .....................................................................................................
Outlays .......................................................................................................

–7.7

–25.4

–47.4

–71.9

–99.5

–130.2

*
6.5

0.9
9.4

2.2
10.1

3.2
10.7

3.9
11.4

4.5
12.4

Decrease in surplus (–) ........................................................................
Inflation and Interest Rates
Budgetary effects of 1 percentage point higher rate of:
Inflation and interest rates during calendar year 1998 only:
Receipts .....................................................................................................
Outlays .......................................................................................................

–6.5

–8.5

–7.9

–7.5

–7.5

–7.9

8.7
5.8

17.6
14.2

17.5
11.9

16.2
11.5

17.0
11.1

17.9
10.5

Increase in surplus (+) ..........................................................................
Inflation and interest rates, sustained during 1998–2003:
Receipts .....................................................................................................
Outlays .......................................................................................................

2.8

3.4

5.6

4.7

5.9

7.4

8.7
5.9

26.7
20.7

45.4
32.8

63.8
44.0

84.1
53.6

106.5
62.6

2.8

6.0

12.7

19.8

30.5

43.9

1.2
5.5

2.9
16.0

3.7
21.7

4.0
25.1

4.3
27.5

4.6
29.1

Decrease in surplus (–) ........................................................................
Inflation only, sustained during 1998–2003:
Receipts .....................................................................................................
Outlays .......................................................................................................

–4.3

–13.0

–17.9

–21.2

–23.2

–24.4

7.5
0.4

23.8
4.7

41.7
11.1

59.8
18.9

79.8
26.1

101.9
33.5

Increase in surplus (+) ..........................................................................
Interest Cost of Higher Federal Borrowing
Outlay effect of $100 billion additional borrowing during 1998 ........................

7.1

19.0

30.6

41.0

53.7

68.3

2.9

5.5

5.6

5.8

6.0

6.3

Increase in surplus (+) ..........................................................................
Interest rates only, sustained during 1998–2003:
Receipts .....................................................................................................
Outlays .......................................................................................................

* $50 million or less.
1
The unemployment rate is assumed to be 0.5 percentage point higher per 1.0 percent shortfall in the level of real GDP.

2. STEWARDSHIP: TOWARD A FEDERAL BALANCE SHEET
Introduction
A balanced assessment of the Government’s financial
condition requires several alternative perspectives. This
chapter presents a framework for such analysis.
The usual business accounting techniques do not
work well for the Government. A full evaluation of the
Government’s financial condition must consider a
broader range of information than would usually be
shown on a business balance sheet, and no one of the
tables in this chapter should be treated as if it were
‘‘the balance sheet’’ of the Federal Government. Rather,
this chapter taken as a whole provides an overview
of the Government’s financial resources—the current
and future claims on them, and what the taxpayer gets
in exchange for this commitment of resources. In this
way, the presentation that follows offers the kind of
information that a financial analyst would expect to
find on a balance sheet, taking into account the Government’s unique task and circumstances.
Because of the differences between Government and
business, and because there are serious limitations in
the available data, this chapter’s findings should be
interpreted with considerable caution. The conclusions
are tentative and subject to future revision.
The presentation consists of three parts:
• The first part reports on what the Federal Government owns and what it owes. Table 2–1 summarizes this information. The assets and liabilities
in this table are a useful starting point for a financial analysis of the Federal Government, but they
are only a partial reflection of the full range of
Government resources and responsibilities. The
assets include only items that are actually owned
by the Government; but the Government can also
rely on taxes and other means to meet future obligations. The liabilities in the table are limited
to the binding commitments resulting from prior
Government actions; but the Government’s financial responsibilities are considerably broader than
this.
• The second part presents possible future paths
for the Federal budget extending well into the
next century, including an extension of the proposals in the 1999 Budget. The information is summarized in Table 2–2. The analysis in this part
offers the clearest indication of the long-run financial burdens that the Government faces, and the

resources that will be available to meet them.
Some future claims on the Government receive
special emphasis because of their importance to
individuals’ retirement plans. Table 2–3 summarizes the condition of the social security and Medicare trust funds and how that condition has
changed since 1996.
• The third part of the presentation features information on broader economic and social conditions
which the Government affects in some degree by
its actions. Table 2–4 is a summary of national
wealth highlighting the different categories of Federal investment that have contributed to wealth.
Table 2–5 is a sample of economic and social indicators. No single statistic can capture all the ramifications of Federal actions, so a set of indicators
is needed to encompass the full range of Government activities and interests. Table 2–5 is intended to illustrate what might be learned from
a more complete set of indicators.
Relationship with FASAB Objectives
The framework presented here meets the stewardship
objective 1 for Federal financial reporting recommended
by the Federal Accounting Standards Advisory Board
and adopted for use by the Federal Government in September 1993.
Federal financial reporting should assist report users in
assessing the impact on the country of the Government’s
operations and investments for the period and how, as a
result, the Government’s and the Nation’s financial conditions have changed and may change in the future. Federal
financial reporting should provide information that helps the
reader to determine:
3a. Whether the Government’s financial position improved
or deteriorated over the period.
3b. Whether future budgetary resources will likely be sufficient to sustain public services and to meet obligations as
they come due.
3c. Whether Government operations have contributed to
the Nation’s current and future well-being.

The experimental presentation here explores one possible approach for meeting this objective at the Government-wide level.
1
Objectives of Federal Financial Reporting, Statement of Federal Financial Accounting
Concepts Number 1, September 2, 1993. The other objectives relate to budgetary integrity,
operating performance, and systems and controls.

15

16

ANALYTICAL PERSPECTIVES

QUESTIONS AND ANSWERS ABOUT THE GOVERNMENT’S ‘‘BALANCE SHEET’’
1. According to Table 2–1, the Government’s liabilities exceed its assets. No business could
operate that way. Why can’t the Government run like a business?
Because the Federal Government is not a business. It has fundamentally different objectives,
and so must operate in different ways.
The primary goal of every business is to earn a profit. But in our free market system, the
Federal Government leaves almost all activities at which a profit could be earned to the private
sector. In fact, the vast bulk of the Federal Government’s operations are such that it would be
difficult or impossible to charge prices for them—let alone prices that would cover expenses. The
Government undertakes these activities not to improve its balance sheet, but to benefit the Nation—its people and businesses—to foster not only monetary but also nonmonetary values. No
business would—or should—sacrifice its own balance sheet to bolster that of the rest of the
country.
To illustrate, one of the Federal Government’s most valuable assets is its holdings of gold. The
price of gold generally fluctuates counter to the state of the economy—if inflation is rapid and
out of control, the price of gold rises; but when inflation slows and steadies, the price of gold
falls. One source of the deterioration of the Federal Government’s balance sheet since the 1980s
has been a decline in the price of gold, which has reduced the value of the Government’s gold
holdings. But that price decline—and the resulting deterioration of the Government’s balance
sheet—was a direct consequence of Federal policies to reduce inflation, for the benefit of the people and businesses of the United States. No business would undertake such a policy of worsening its own balance sheet.
Similarly, the Federal Government invests in education and research. The Government earns no
direct return from these investments; but the Nation and its people are made richer. A
business’s motives for investment are quite different; business invests to earn a profit for itself,
not others.
Because the Federal Government’s objectives are different, its balance sheet behaves differently,
and should be interpreted differently.
2. But doesn’t Table 2–1 say that the Government is insolvent?
No. Just as the Federal Government’s responsibilities are of a different nature than those of a
private business, so are its resources. Its solvency must be evaluated in different terms.
What the table shows is that those Federal obligations that are most comparable to the liabilities of a business corporation exceed the estimated value of the assets the Federal Government
actually owns. However, the Government has access to other resources through its sovereign
powers, which include taxation, seignorage and other means. These powers give the Government
the ability to meet its present obligations and those it will incur through future operations.
The financial markets clearly recognize this reality. The Federal Government’s implicit credit
rating is the best in the United States; lenders are willing to lend it money at interest rates substantially below those charged to private borrowers. This would not be true if the Government
were really insolvent. In countries where governments totter on the brink of true insolvency,
lenders are either unwilling to lend them money, or do so only in return for a substantial interest premium.

2. STEWARDSHIP: TOWARD A FEDERAL BALANCE SHEET

QUESTIONS AND ANSWERS ABOUT THE GOVERNMENT’S ‘‘BALANCE SHEET’’—Continued
However, the Federal Government’s balance sheet was clearly worsened by the budget policies of
the 1980s. Under President Clinton, the deterioration in the balance sheet has been halted, and
with the recently enacted agreement to balance the budget, the excess of Government liabilities
over assets should begin to shrink.
3. The Government does not comply with the accounting requirements imposed on private
businesses. Why can’t the government keep a proper set of books?
Because the Government is not a business, and its primary goal is not to earn profits and to enhance its own wealth, accounting standards designed to illuminate how much a business earns
and how much equity it has would be misleading, and would not provide useful information. In
recent years, the Federal Accounting Standards Advisory Board has developed, and the Federal
Government has adopted, an accounting framework that reflects the Government’s functions
and answers the questions for which it should be accountable. This framework addresses the
Government’s budgetary integrity, operating performance, stewardship, and systems and controls. The Board has also developed, and the Government has adopted, a full set of accounting
standards. Federal agencies are issuing audited financial reports that follow these standards; a
Government-wide consolidated financial report for fiscal year 1997 following these standards is
scheduled to be issued later this year.
This chapter addresses the ‘‘stewardship objective’’—assessing the interrelated financial
condition of the Federal Government and of the Nation. The data in this chapter are intended to
develop a fuller understanding of the trade-offs and connections between making the Federal
Government ‘‘better off’’ and making the Nation ‘‘better off.’’ There is no ‘‘bottom line’’ for the
Government comparable to the net worth of a business corporation. Some analysts may find the
absence of a bottom line to be frustrating. But pretending that there is such a number—when
there clearly is not—does not advance the understanding of Government finances.
4. Why isn’t social security shown as a liability in Table 2–1?
Social security benefits are a political and moral responsibility of the Federal Government, but
they are not a liability. In the past, the Government has unilaterally decreased as well as increased benefits, and the Social Security Advisory Council has recently suggested further reforms that would change benefits, if enacted by Congress. When the amount in question can be
changed unilaterally, it is not ordinarily considered a liability.
There are a number of other Federal programs that are quite similar in their promises to social
security, including Medicare and veterans benefits, to name only two. These programs are not
usually considered to be liabilities. Treating social security differently from these programs
would be hard to justify. There is no bright line dividing social security from Government’s other
income maintenance programs.
A similar problem arises on the tax side. If social security benefits were to be treated as liabilities, logic would suggest that the earmarked social security payroll tax receipts that finance
those benefits ought to be considered assets. However, no other tax receipts are counted as
assets, and drawing a line between social security taxes and other taxes would be questionable.

17

18

ANALYTICAL PERSPECTIVES

QUESTIONS AND ANSWERS ABOUT THE GOVERNMENT’S ‘‘BALANCE SHEET’’—Continued
5. It is all very well to balance the budget, but can this be a permanent solution? When the
baby-boom generation retires, won’t the deficit return larger and meaner than ever before?
The aging of the U.S. population, which will become dramatically evident when the babyboomers retire, poses serious long-term problems for the Federal budget and its major entitlement programs. However, balancing the budget will leave the country much better prepared to
address these problems.
Once the budget comes into balance, it will be possible to preserve that balance for some time to
come (under an extension of the economic and technical assumptions used for this budget). Far
from being an exercise in futility, balancing the budget now is one of the key steps towards
keeping it in balance when the baby-boomers retire.
The second part of this chapter and the charts that accompany it show how the budget is likely
to fare under various possible alternative scenarios.
6. Would it be sensible to permit a deficit so long as it was no larger than the amount spent
on Federal investments?
Gross Federal investment in physical capital was $114 billion in 1997. This was considerably
larger than the 1997 Federal deficit, but that does not necessarily mean that the 1997 deficit
was ‘‘too small.’’
First of all, the Government consumes capital each year in the process of providing goods and
services to the public. The rationale for using Federal borrowing to finance investment applies
only to net investment, after depreciation is subtracted, because only net investment augments
the assets available to offset the increase in debt resulting from the borrowing. As discussed in
Chapter 6 of this volume, net investment in physical capital owned by the Federal Government
is estimated to have been negative in 1997 and to be negative again in 1998 and 1999. Thus,
even more deficit reduction would be required by this proposed criterion than is required to balance the present budget. The Federal Government also funds substantial amounts of physical
capital that it does not own, such as highways and research facilities, and it funds investment in
intangible ‘‘capital’’ such as education or the conduct of research and development. A private
business would never borrow to spend on assets that would be owned by someone else. However,
such spending is a principal function of Government. Chapter 6 shows that when these investments are also included, net investment is estimated to be positive in 1999, but by only a moderate amount.
There is another hitch in the logic of borrowing to invest. Businesses expect investments to earn
a profit from which to repay the financing costs. In contrast, the Federal Government does not
generally expect to receive a direct payoff (in the form of higher tax receipts) from its investments, whether or not it owns them. In this sense, Government investments are no different
from other Government expenditures, and the fact that they provide services over a longer
period is no justification for excluding them when calculating the deficit.
Finally, the Federal Government has responsibilities for supporting the overall financial and
economic well-being of the Nation. In this broader context, it might want to manage its fiscal
policy so as to augment private saving and investment by paying for its own investments from
current revenues, instead of borrowing in the credit market and crowding out private investment. Considerations other than the size of Federal investment need to be weighed in choosing
the appropriate level of the surplus or deficit.

2. STEWARDSHIP: TOWARD A FEDERAL BALANCE SHEET

What Can Be Learned from a Balance Sheet
Approach
The budget is an essential tool for allocating resources within the Federal Government and between
the public and private sectors. The standard budget
presentation, however, with its focus on annual outlays,
receipts, and the deficit, does not provide all the information needed for a full analysis of the Government’s
financial and investment decisions. Information about
Federal assets and liabilities, and budget projections
beyond the usual forecast horizon are needed for such
analysis. We must also examine the effects on society
and the economy of Government policies to evaluate
how well the Federal Government is performing. A
business may ultimately be judged by the bottom line
in its balance sheet, but for the National Government,
the ultimate test is how its actions affect the country.
The data needed to judge its performance go beyond
a simple measure of net assets. Consider, for example,
Federal investments in education or infrastructure,
which generate returns that flow mainly to households,
private businesses or other levels of government, rather
than back to the Federal Treasury. From the standpoint
of the Federal Government’s ‘‘bottom line,’’ these investments might appear to be unnecessary or even wasteful; but they make a real contribution to the economy
and to people’s lives. A framework for evaluating Federal finances needs to take Federal investments into
account, even when the return they earn accrues to
someone other than the Federal Government.
A good starting point to evaluate the Government’s
finances is to examine its assets and liabilities. An illustrative tabulation of net assets is presented below
in Table 2–1, based on data from a variety of public
and private sources. It has sometimes been suggested
that the Federal Government’s assets, if fully accounted
for, would exceed its debts. Table 2–1 clearly shows
that this is not correct. The Federal Government’s assets are less than its debts; the sharp increase in deficits in the 1980s caused Government debts to increase
far more than Government assets.
But that is not the end of the story. The Federal
Government has resources that go beyond the assets
that normally appear on a conventional balance sheet—
including the Government’s sovereign powers to tax,
regulate commerce, and set monetary policy. However,
these powers call for special treatment in financial
analysis. The best way to incorporate them is to make
a long-run projection of the Federal budget. The budget
provides a comprehensive measure of the Government’s
annual cash flows, and projecting it forward shows how
the Government’s sovereign powers are expected to generate cash flows in the future.
On the other side of the ledger are the Government’s
binding obligations—such as Treasury debt, and the
present discounted value of Federal obligations to pay
pension benefits to Government retirees and current

19
employees when they retire. These obligations have
counterparts in the business world, and would be expected to appear on a business balance sheet. Accrued
obligations for government insurance policies and the
estimated present value of failed loan guarantees and
deposit insurance claims are also analogous to private
liabilities, and are included with the other Government
liabilities. Taken together, these formal obligations are
only a subset of the Government’s financial responsibilities.
The Government has established a broad range of
programs that dispense cash and other benefits to individual recipients. The Government is not constitutionally obligated to continue payments under these
programs; the benefits can be modified or even ended
at any time, subject to the decisions of the elected representatives in Congress. Many such changes occurred
in last year’s Balanced Budget Agreement. Allowing for
such changes, however, it is likely that many of these
programs will remain Federal obligations in some form
for the foreseeable future. Again, the best way to see
how future responsibilities line up with future resources
is to project the Federal budget forward far enough
in time to capture the long-run effects of current and
past decisions. Projections of this sort are presented
below.
The budget, even when projected far into the future,
does not show whether the public is receiving value
for its tax dollars. Information on that point requires
performance measures for government programs supplemented by appropriate information about conditions
in the U.S. economy and society. Some such data are
currently available, but far more need to be developed
to obtain a full picture. Examples of what might be
done are also shown below.
The presentation that follows consists of a series of
tables and charts. All of them taken together function
as a Federal balance sheet. The schematic diagram,
Chart 2–1, shows how they fit together. The tables
and charts should be viewed as an ensemble, the main
elements of which can be grouped together in two broad
categories—assets/resources and liabilities/responsibilities.
• Reading down the left-hand side of the diagram
shows the range of Federal resources, including
assets the Government owns, tax receipts it can
expect to collect, and national wealth that provides the base for Government revenues.
• Reading down the right-hand side reveals the full
range of Federal obligations and responsibilities,
beginning with Government’s acknowledged liabilities based on past actions, such as the debt held
by the public, and going on to include future budget outlays. This column ends with a set of indicators highlighting areas where Government activity
might require adjustment.

20

ANALYTICAL PERSPECTIVES

Chart 2-1. A BALANCE SHEET PRESENTATION FOR THE FEDERAL GOVERNMENT
ASSETS/RESOURCES

LIABILITIES/RESPONSIBILITIES

Federal Assets

Federal Liabilities

Financial Assets
Gold and Foreign Exchange
Other Monetary Assets
Mortgages and Other Loans
Less Expected Loan Losses
Other Financial Assets

Financial Liabilities
Currency and Bank Reserves
Debt Held by the Public
Miscellaneous
Guarantees and Insurance
Deposit Insurance
Pension Benefit Guarantees
Loan Guarantees
Other Insurance
Federal Pension Liabilities

Physical Assets
Fixed Reproducible Capital
Defense
Nondefense
Inventories
Non-reproducible Capital
Land
Mineral Rights

Resources/Receipts
Projected Receipts
Addendum: Real GDP Projections

Federal
Governmental
Assets
and Liabilities
(Table 2-1)

Net Balance

Long-Run
Federal
Budget
Projections
(Table 2-2)

Change in Trust
Fund Balances
(Table 2-3)

National Assets/Resources
Federally Owned Physical Assets
State & Local Physical Assets
Federal Contribution
Privately Owned Physical Assets
Education Capital
Federal Contribution
R&D Capital
Federal Contribution

National
Wealth
(Table 2-4)

Social
Indicators
(Table 2-5)

Responsibilities/Outlays
Discretionary Outlays
Mandatory Outlays
Social Security
Health Programs
Other Programs
Net Interest
Deficit

National Needs/Conditions
Indicators of economic, social,
educational, and environmental
conditions to be used as a guide
to Government investment and
management.

21

2. STEWARDSHIP: TOWARD A FEDERAL BALANCE SHEET

PART I—THE FEDERAL GOVERNMENT’S ASSETS AND LIABILITIES
prices have declined. 2 Currently, the total real value
of Federal assets is estimated to be only about 14 percent greater than it was in 1960. Meanwhile, Federal
liabilities have increased by 170 percent in real terms.
The sharp decline in the Federal net asset position
was principally due to large Federal budget deficits
along with a drop in asset values. Currently, the net
excess of liabilities over assets is about $3.3 trillion,
or $12,000 per capita.

Table 2–1 summarizes what the Government owes
as a result of its past operations along with the value
of what it owns, for a number of years beginning in
1960. The values of assets and liabilities are measured
in terms of constant FY 1997 dollars. For most of this
period, Government liabilities have exceeded the value
of assets, but until the early 1980s the disparity was
relatively small, and it was growing slowly (see chart
2–2).
In the late 1970s, a speculative run-up in the prices
of oil, gold, and other real assets temporarily boosted
the value of Federal holdings, but since then those

Table 2–1

2
This temporary improvement highlights the importance of the other tables in this presentation. What is good for the Federal Government as an asset holder is not necessarily
favorable to the economy. The decline in inflation in the early 1980s reversed the speculative
runup in gold and other commodity prices. This reduced the balance of Federal net assets,
but it was good for the economy and the nation as a whole.

GOVERNMENT ASSETS AND LIABILITIES *

(As of the end of the fiscal year, in billions of 1997 dollars)
1960

1965

1970

1975

1980

1985

1990

1991

1992

1993

1994

1995

1996

1997

ASSETS

Financial Assets:
Gold and Foreign Exchange
Other Monetary Assets ..........
Mortgages and Other Loans
less Expected Loan Losses
Other Financial Assets ..........

103
39
127
–1
61

72
55
163
–3
81

61
33
211
–4
65

136
15
211
–9
66

336
39
290
–17
82

161
25
356
–17
106

202
32
289
–19
159

181
23
293
–21
190

178
41
270
–23
222

178
41
240
–25
201

178
32
228
–27
188

184
32
201
–23
185

168
44
176
–22
185

142
44
160
–34
182

Subtotal ..............................
Physical Assets:
Fixed Reproducible Capital:
Defense ..............................
Nondefense ........................
Inventories ..............................
Nonreproducible Capital:
Land ...................................
Mineral Rights ....................

329

370

365

419

731

631

663

666

688

636

599

579

551

494

931
138
264

911
212
228

886
249
212

723
273
188

627
296
230

788
319
263

817
337
229

831
340
208

828
342
202

815
343
186

803
346
177

777
351
158

754
349
140

732
357
127

91
329

126
304

157
250

243
348

309
632

332
712

328
476

299
451

267
426

251
404

247
374

245
350

243
395

244
413

Subtotal ..........................

1,752

1,781

1,755

1,776

2,094

2,414

2,187

2,128

2,064

2,000

1,947

1,880

1,882

1,872

Total Assets ............

2,081

2,151

2,119

2,195

2,825

3,046

2,851

2,794

2,752

2,636

2,546

2,459

2,433

2,366

230
999
26

253
985
28

279
836
30

284
822
43

285
1,063
67

302
1,886
93

360
2,589
139

365
2,792
127

383
3,049
119

413
3,200
118

439
3,286
116

446
3,371
120

454
3,410
123

474
3,358
144

1,254

1,266

1,145

1,148

1,415

2,281

3,088

3,284

3,551

3,731

3,840

3,937

3,988

3,976

..........

..........

............

............

2

9

69

76

39

13

9

5

2

1

..........
..........
31

..........
..........
28

............
2
22

43
6
20

31
12
27

43
10
17

42
15
19

46
24
19

51
27
19

66
30
18

32
32
17

20
28
17

54
32
16

30
38
16

31
794
2,079
2

29
1,006
2,300
–149

24
1,193
2,362
–243

70
1,355
2,573
–378

72
1,781
3,268
–443

79
1,766
4,126
–1,080

146
1,694
4,927
–2,077

165
1,682
5,132
–2,338

135
1,693
5,380
–2,628

127
1,628
5,486
–2,851

90
1,603
5,532
–2,986

69
1,614
5,620
–3,161

104
1,566
5,658
–3,226

85
1,568
5,629
–3,263

12

–765

–1,184

–1,751

–1,938

–4,517

–8,286

–9,228

–10,259

–11,012

–11,426

–11,982

–12,117

–12,150

0.1

–4.6

–6.3

–8.7

–8.5

–17.8

–30.1

–33.9

–37.0

–39.2

–39.7

–41.3

–40.9

–39.8

LIABILITIES

Financial Liabilities:
Currency and Bank Reserves
Debt held by the Public .........
Miscellaneous .........................
Subtotal ..............................
Insurance Liabilities:
Deposit Insurance ..................
Pension Benefit Guarantee
Corp. ..................................
Loan Guarantees ...................
Other Insurance .....................
Subtotal ..............................
Federal Pension Liabilities .........
Total Liabilities ................
Balance .............................
Per Capita (in 1997
dollars) .....................
Ratio to GDP (in percent) ..........................

* This table shows assets and liabilites for the Government as a whole, including the Federal Reserve System. Therefore, it does not break out separately the assets held in Government accounts, such as social security, that
are the obligation of specific Government agencies. Estimates for FY 1997 are extrapolated in some cases.

22

ANALYTICAL PERSPECTIVES

Chart 2-2. NET FEDERAL LIABILITIES
PERCENT OF GDP
50

40

30

20

10

0

-10
1960

1966

1972

Assets
The assets in Table 2–1 reflect a comprehensive list
of the financial and physical resources owned by the
Federal Government. The list corresponds to items that
would appear on a typical balance sheet.
Financial Assets: According to the Federal Reserve
Board’s Flow-of-Funds accounts, the Federal Government’s holdings of financial assets amounted to about
$500 billion at the end of FY 1997. Government-held
mortgages and other loans (measured in constant dollars) reached a peak in the mid-1980s. Since then, the
value of Federal loans has declined. The holdings of
mortgages, in particular, have declined sharply over
the last five years, as the holdings acquired from failed
Savings and Loan institutions have been liquidated.
The face value of mortgages and other loans overstates their economic worth. OMB estimates that the
discounted present value of future losses and interest
subsidy on these loans is over $30 billion as of 1997.
These estimated losses are subtracted from the face
value of outstanding loans to obtain a better estimate
of their economic worth.
Over time, variations in the price of gold have accounted for major swings in this category. Since the
end of Fiscal Year 1980, gold prices have fallen and
the real value of U.S. gold and foreign exchange holdings has dropped by 58 percent.
Reproducible Capital: The Federal Government is a
major investor in physical capital. Government-owned

1978

1984

1990

1996

stocks of fixed capital amounted to over $1.0 trillion
in 1997 (OMB estimate). About two-thirds of this capital took the form of defense equipment or structures.
Non-reproducible Capital: The Government owns significant amounts of land and mineral deposits. There
are no official estimates of the market value of these
holdings. Researchers in the private sector have estimated what they are worth and these estimates are
extrapolated in Table 2–1. Private land values fell
sharply in the early 1990s, although they have risen
somewhat since 1993. It is assumed here that federal
land shared in the decline and the subsequent recovery.
Oil prices have fluctuated but are about the same now
as they were in 1990.
Total Assets: The total real value of Government assets is lower now than at the end of the 1980s, principally because of declines in the real value of gold,
land, and minerals. Even so, the Government’s holdings
are vast. At the end of 1997, the value of Government
assets is estimated to have been about $2.4 trillion.
Liabilities
Table 2–1 includes only those liabilities that would
appear on a business balance sheet. These include various forms of Federal debt, Federal pension obligations
to its workers, and an imputed liability for Federal
insurance and loan guarantee programs.
Financial Liabilities: Financial liabilities amounted
to about $4.0 trillion at the end of 1997. The largest

23

2. STEWARDSHIP: TOWARD A FEDERAL BALANCE SHEET

component was Federal debt held by the public,
amounting to around $3.4 trillion. This measure of Federal debt is net of the holdings of the Federal Reserve
System (about $400 billion at the end of FY 1997).
Although independent in its policy deliberations, the
Federal Reserve is part of the Federal Government,
and its assets and liabilities are included here in the
Federal totals. In addition to debt held by the public,
the Government’s financial liabilities include $474 billion in currency and bank reserves, which are mainly
obligations of the Federal Reserve System, and $144
billion in miscellaneous liabilities.
Guarantees and Insurance Liabilities: The Federal
Government has contingent liabilities arising from loan
guarantees and insurance programs. When the Government guarantees a loan or offers insurance, initial outlays may be small or, if a fee is charged, they may
even be negative; but the risk of future outlays associated with such commitments can be very large. In the
past, the cost of such risks was not recognized until
after a loss was realized. In Table 2–1 rough estimates
are shown for the accrued liability resulting from such
obligations. Of these, about half were for Federal loan
guarantees, while the Pension Benefit Guarantee Corporation and other Federal insurance programs ac-

counted for most of the rest. The resolution of the many
failures in the Savings and Loan and banking industries has helped to reduce the losses in this category
by about half since 1990.
Federal Pension Liabilities: The Federal Government
owes pension benefits to its retired workers and to current employees who will eventually retire. The amount
of these liabilities is large. As of 1997, the discounted
present value of the benefits is estimated to have been
around $1.6 trillion. 3
The Balance of Net Liabilities
Because of its sovereign powers, the Government
need not maintain a positive balance of net assets, and
the rapid buildup in liabilities since 1980 has not damaged Federal creditworthiness. However, from 1980 to
1992, the balance between Federal liabilities and Federal assets did deteriorate at a very rapid rate. In 1980,
the negative balance was less than 10 percent of GDP;
by 1992 it was 37 percent of GDP. Between then and
now, there has been little further increase. Last year,
the net balance as a percentage of GDP fell for the
second straight year; and it ended the year at under
40 percent of GDP. As the budget reaches balance, the
ratio of net liabilities to GDP will continue to decline.

PART II—THE BALANCE OF RESOURCES AND RESPONSIBILITIES
As noted in the preceding section, a business-type
accounting of assets and liabilities misses the role of
the Government’s unique sovereign powers, including
taxation, seignorage, and regulation. Therefore, the best
way to examine the balance between future Government obligations and resources is by projecting the
budget. The budget offers the most comprehensive
measure of the Government’s financial burdens and its
resources. By projecting total receipts and outlays, it
is possible to examine whether there will be sufficient
resources to support all of the Government’s ongoing
obligations.
This part of the presentation describes long-run projections of the Federal budget extending beyond the
normal budget horizon. Forecasting the economy and
the budget over such a long period is highly uncertain.
Future budget outcomes depend on a host of unknowns—constantly changing economic conditions, unforeseen international developments, unexpected demographic shifts, the unpredictable forces of technological
advance, and evolving political preferences. Those uncertainties increase the further ahead projections are
pushed. Even so, long-run budget projections are needed to assess the full implications of current action or
inaction, and to sound warnings about future problems
that could be avoided by timely action. The Federal
Government’s responsibilities extend well beyond the
next decade. There is no time limit on Government’s
3
These pension liabilities are expressed as the actuarial present value of benefits accruedto-date based on past and projected salaries. The cost of retiree health benefits is not
included. The 1997 liability is extrapolated from recent trends.

constitutional responsibilities, and programs like social
security are clearly intended to continue indefinitely.
It is evident even now that there will be mounting
challenges to the budget after the turn of the century.
By 2008, the first of the huge baby-boom generation
born after World War II will become eligible for early
retirement under social security. In the years that follow there will be serious strains on the budget because
of increased expenditures for both social security and
Medicare. Long-range projections can help indicate how
serious these strains might become and what is needed
to withstand them.
The retirement of the baby-boomers dictates the timing of the problem, but the underlying cause is deeper.
The growth of the U.S. population has been slowing
down, and because of that and because people are living
longer, a change is inevitably coming in the ratio of
retirees to workers. The budgetary pressure from these
trends is temporarily in abeyance. In the 1990s, the
large baby-boom cohort has been moving into its prime
earning years, while the retirement of the much smaller
cohort born during the Great Depression has been holding down the rate of growth in the retired population.
The suppressed budgetary pressures are likely to burst
forth when the baby-boomers begin to retire. However,
even after the baby-boomers have passed from the
scene later in the century, a higher ratio of retirees
to workers is expected to persist because of the underlying declines in fertility and mortality, with concomitant

24
problems for the retirement programs. These same
problems are gripping other developed nations, even
those that never experienced a baby-boom; in fact, those
nations that did not have baby-booms are facing their
demographic pressures already.
The Long-Range Outlook for the Budget.—Since
this Administration first took office, there have been
major changes in the long-run budget outlook. In January 1993, the deficit was clearly on an unsustainable
trajectory. Had the policies then in place continued unchanged, the deficit would have steadily mounted not
only in dollar terms, but relative to the size of the
economy. 4 The deficit would have exceeded 10 percent
of GDP by 2010—a level unprecedented for peacetime—
and continued sharply upward, driving the debt to
unsustainable levels.
The Omnibus Budget Reconciliation Act of 1993
(OBRA 1993) changed that. Not only did it reduce the
near-term deficit, but, aided by the strong economy that
it helped to create, it also reduced the long-term deficit.
Prior to enactment of last year’s Balanced Budget
Agreement, the deficit was expected to remain at
around 1.5 percent of GDP through 2010. But still,
a longer-term budget problem remained. After 2010,
the deficit was projected to begin an unsustainable rise
that would reach 20 percent of GDP shortly after 2050
if uncorrected.
The Balanced Budget Agreement, enacted last year
by the President and the Congress, took the next major
step. The Agreement is now expected to eliminate the
deficit in 1999, and the policies proposed in this Budget
would, if continued in the long run, preserve a balanced
budget for many years. Deficits will reemerge in the
long run, though they would be relatively small as a
percentage of the economy until well into the next century. Ultimately, as described in greater detail below,
even these small deficits, pushed by demographic factors, could create compounding deficit pressures in the
very long run.
This greatly improved long-run deficit outlook contrasts with the generally prevailing opinion among
budget experts—at least prior to the enactment of last
year’s Balanced Budget Agreement—that the long-run
outlook for the deficit is bleak. For example, the 1994
report of the Bipartisan Commission on Entitlement
and Tax Reform found that there is a ‘‘long-term imbalance between the government’s entitlement promises
and the funds it will have available to pay for them.’’
The Congressional Budget Office has observed: ‘‘If the
budgetary pressure from both demography and health
care spending is not relieved by reducing the growth
of expenditures or increasing taxes, deficits will mount
and seriously erode future economic growth.’’ 5 On a
narrower front, the annual trustees’ reports for both
4
Over long periods when the rate of inflation is positive, comparisons of dollar values
are meaningless. Even the low rate of inflation assumed in this budget will reduce the
value of a 1997 dollar by over 50 percent by 2030, and by 70 percent by the year 2050.
For long-run comparisons, it is much more useful to examine the ratio of the deficit and
other budget categories to the expected size of the economy as measured by GDP.
5
Long-Term Budgetary Pressures and Policy Options, March 1997.

ANALYTICAL PERSPECTIVES

the social security and Medicare trust funds have for
some time projected long-run actuarial deficiencies.
One sign that the consensus may be shifting as a
result of recent policy actions is provided by the most
recent of a series of reports from the General Accounting Office on the long-run budget outlook. 6 The GAO
observes that, ‘‘Major progress has been made on deficit
reduction . . . While our 1995 simulations showed deficits
exceeding 20 percent of GDP by 2024 . . ., our updated
model results show that this point would not be reached
until nearly 2050.’’ GAO continues to find that
unsustainable deficits will emerge in the long run absent major entitlement reforms, but the date at which
the deficit starts to rise is postponed significantly as
a result of recent actions. That is similar to the analysis
reported here, although the timing of the upswing in
the deficit comes sooner in the GAO report.
Economic and Demographic Projections.—Longrun budget projections require a long-run demographic
and economic forecast—even though any such forecast
is highly uncertain and likely to be at least partly
wrong. The forecast used here extends the Administration’s medium-term economic projections described in
the first chapter of this volume, augmented by the longrun demographic projections from the most recent Social Security Trustees’ Report.
• Inflation, unemployment and interest rates are assumed to hold stable at their values in the last
year of the Administration projections, 2008—2.3
percent per year for the CPI, 5.4 percent for the
unemployment rate, and 5.7 percent for the yield
on 10-year Treasury notes.
• Productivity growth is assumed to continue at the
same rate as it averages in the Administration’s
projections, approximately 1.3 percent per year.
• In line with the most recent projections of the
Social Security Trustees, population growth is expected to slow over the next several decades. This
is consistent with recent trends in the birth rate
and an expected decline in the proportion of
women in their childbearing years. The slowdown
is expected to lower the rate of population growth
from over 1 percent per year to about half that
rate by the year 2020.
• Labor force participation is also expected to decline as the population ages and the proportion
of retirees in the population increases. Over the
next decade, however, the Administration projects
a higher rate of labor force participation than in
the latest Trustees’ Report. That difference is preserved in the long-run projections below.
• The real rate of economic growth is determined
by the expected growth of the labor force (assuming a stable unemployment rate) plus productivity
growth. Because labor force growth is expected
to slow and productivity growth is assumed to
be constant, real GDP growth declines after 2008
from around 2.4 percent to 1.4 percent per year.
6

Analysis of Long-Term Fiscal Outlook, October 1997.

25

2. STEWARDSHIP: TOWARD A FEDERAL BALANCE SHEET

Although this result is perfectly logical given population trends, it would result in a very low sustained rate of real economic growth by U.S. historical standards.
The economic projections described above are set by
assumption and do not automatically change in response to changes in the budget outlook. This is unrealistic, but it simplifies comparisons of alternative policies. A more responsive (or dynamic) set of assumptions
would serve mainly to strengthen the same conclusions
reached by the current approach. In their investigations
of the long-run outlook, both CBO and GAO have explored such feedback effects and found that they accelerate the destabilizing effects of sustained budget deficits.
The Deficit Outlook.—Chart 2–3 shows five alternative deficit projections: one based on the policies in
place prior to enactment of OBRA 1993; another incorporating all of the subsequent changes in budget policy
prior to passage of last year’s Balanced Budget Agreement; and three alternative scenarios of the current
policy projection. The chart clearly illustrates the dramatic improvement in the deficit that has already been
achieved. If the budget is balanced in 1999 as is now
expected, it will substantially ease the task of maintaining fiscal stability when the retirement bulge hits after
2008.

Table 2–2 shows long-range projections for the major
categories of spending under current policy assumptions. The table shows that the entitlement programs
are expected to absorb an increasing share of budget
resources.
• Under current policy, social security benefits, driven by the retirement of the baby-boom generation,
rise from 4.5 percent of GDP in 2000 to 6.3 percent in 2030 and to 6.5 percent by 2050.
• Medicare rises from 2.4 percent of GDP in 2000
to 4.6 percent in 2030 and 5.0 percent by 2050.
• Federal Medicaid spending goes up from 1.3 percent of GDP in 2000 to 3.2 percent in 2030 and
5.3 percent in 2050.
• Partially offsetting these increases in entitlement
programs, discretionary spending falls as a share
of GDP, from 6.3 percent in 2000 to 3.7 percent
in 2030 and 2.8 percent in 2050, as real economic
growth outpaces the growth in these programs (assumed to equal inflation).
Long-range projections such as these are subject to
enormous uncertainy. Detailed analysis of the sensitivity of the results to key assumptions follows later, but
Chart 2–3 highlights two of the key risks to the outlook.
A projection of the conventional current-services budget
shows small surpluses through 2054. However, the
budget moves sharply to deficit thereafter as the fundamental demographic forces reassert themselves, and
by 2070 the deficit exceeds the worst figures of the

Chart 2-3. LONG-RUN DEFICIT PROJECTIONS
SURPLUS (+)/DEFICIT (-) AS A PERCENT OF GDP
10
DISCRETIONARY
GROWS WITH
POPULATION

5
CURRENT SERVICES

0
-5
CONTINUED
RAPID
MEDICARE
GROWTH

-10
-15
PRE-OBRA BASELINE

OUTLOOK BEFORE
BALANCED BUDGET
AGREEMENT

-20
-25
-30

1980

1990

2000

2010

2020

2030

2040

2050

2060

2070

26

ANALYTICAL PERSPECTIVES

Table 2–2.

LONG-RUN BUDGET PROJECTIONS OF 1999 BUDGET POLICY
(Percent of GDP)
1995

2000

2005

2010

2020

2030

2040

2050

2060

2070

Current services:
Receipts ................................................................................................................................
Outlays ..................................................................................................................................
Discretionary .....................................................................................................................
Mandatory .........................................................................................................................
Social security ..............................................................................................................
Medicare .......................................................................................................................
Medicaid .......................................................................................................................
Other ............................................................................................................................
Net interest .......................................................................................................................
Surplus or deficit (–) .............................................................................................................
Federal debt held by the public ...........................................................................................
Primary surplus or deficit (–) ...............................................................................................

18.8
21.1
7.6
10.3
4.6
2.2
1.2
2.3
3.2
–2.3
50.1
0.9

19.8
19.7
6.3
10.8
4.5
2.4
1.3
2.6
2.6
0.1
42.1
2.7

19.7
18.5
5.5
11.1
4.5
2.5
1.5
2.6
1.8
1.2
30.3
3.0

19.8
17.5
4.9
11.6
4.7
2.8
1.8
2.3
1.0
2.3
15.8
3.3

20.0
17.7
4.2
13.9
5.6
3.7
2.5
2.1
–0.5
2.3
–9.2
1.8

20.1
18.5
3.7
16.1
6.3
4.6
3.2
2.0
–1.3
1.6
–22.0
0.3

20.2
18.8
3.2
17.2
6.4
5.0
4.0
1.8
–1.5
1.4
–26.8
–0.2

20.3
19.6
2.8
18.4
6.5
5.0
5.3
1.6
–1.6
0.7
–27.6
–0.9

20.2
21.7
2.5
20.2
6.7
5.1
6.8
1.6
–1.0
–1.4
–15.6
–2.4

20.2
25.5
2.2
22.3
6.8
5.3
8.7
1.5
1.0
–5.2
18.9
–4.3

Continued rapid Medicare growth:
Receipts ................................................................................................................................
Outlays ..................................................................................................................................
Discretionary .....................................................................................................................
Mandatory .........................................................................................................................
Social security ..............................................................................................................
Medicare .......................................................................................................................
Medicaid .......................................................................................................................
Other ............................................................................................................................
Net interest .......................................................................................................................
Surplus or deficit (–) .............................................................................................................
Federal debt held by the public ...........................................................................................
Primary surplus or deficit (–) ...............................................................................................

18.8
21.1
7.6
10.3
4.6
2.2
1.2
2.3
3.2
–2.3
50.1
0.9

19.8
19.7
6.3
10.8
4.5
2.4
1.3
2.6
2.6
0.1
42.1
2.7

19.7
18.5
5.5
11.1
4.5
2.5
1.5
2.6
1.8
1.2
30.3
3.0

19.8
17.5
4.9
11.6
4.7
2.8
1.8
2.3
1.0
2.3
15.8
3.3

20.0
17.9
4.2
14.1
5.6
3.9
2.5
2.1
–0.4
2.1
–8.5
1.6

20.1
19.7
3.7
16.9
6.3
5.4
3.2
2.0
–0.9
0.4
–15.5
–0.5

20.2
21.4
3.2
18.6
6.4
6.4
4.0
1.8
–0.4
–1.2
–6.4
–1.6

20.3
24.8
2.8
20.9
6.5
7.5
5.3
1.7
1.1
–4.5
20.6
–3.4

20.2
31.0
2.5
23.9
6.7
8.9
6.8
1.5
4.5
–10.7
81.9
–6.2

20.2
40.5
2.2
27.4
6.8
10.4
8.7
1.5
10.9
–20.2
193.8
–9.3

Discretionary grows with population:
Receipts ................................................................................................................................
Outlays ..................................................................................................................................
Discretionary .....................................................................................................................
Mandatory .........................................................................................................................
Social security ..............................................................................................................
Medicare .......................................................................................................................
Medicaid .......................................................................................................................
Other ............................................................................................................................
Net interest .......................................................................................................................
Surplus or deficit (–) .............................................................................................................
Federal debt held by the public ...........................................................................................
Primary surplus or deficit (–) ...............................................................................................

18.8
21.1
7.6
10.3
4.6
2.2
1.2
2.3
3.2
–2.3
50.1
0.9

19.8
19.7
6.3
10.8
4.5
2.4
1.3
2.6
2.6
0.1
42.1
2.7

19.7
18.5
5.5
11.1
4.5
2.5
1.5
2.6
1.8
1.2
30.3
3.0

19.8
17.6
4.9
11.6
4.7
2.8
1.8
2.4
1.0
2.2
15.9
3.2

20.0
18.1
4.5
13.9
5.6
3.7
2.5
2.2
–0.3
1.8
–6.7
1.5

20.1
19.5
4.2
16.1
6.3
4.6
3.2
2.0
–0.8
0.6
–13.9
–0.2

20.2
20.3
3.7
17.2
6.4
5.0
4.0
1.7
–0.6
–0.1
–10.7
–0.7

20.3
21.7
3.4
18.4
6.5
5.0
5.3
1.6
–0.1
–1.4
–0.8
–1.5

20.2
24.5
3.0
20.2
6.7
5.1
6.8
1.6
1.3
–4.3
24.7
–2.9

20.2
29.3
2.7
22.3
6.8
5.3
8.7
1.5
4.2
–9.0
76.2
–4.8

1980s, at over five percent of GDP. Furthermore, if
discretionary spending were to keep pace with population growth as well as inflation—as might be required
for the delivery of government services to that growing
population, or because of threats to national security—
the budget would continue in surplus through only
2032, and the deficit would reach nine percent of GDP
by 2070. Finally, if the slowdown in Medicare costs
currently projected for the early years of the next century by the Health Care Financing Administration
(HCFA) were not to materialize, budget surpluses
would disappear after 2038, and the deficit would grow
to over 20 percent of GDP by 2070.
The long-run deficit outlook is much improved because of the actions taken by this Administration in
cooperation with the Congress. Eliminating the budget
deficit is expected to set the budget on a solid footing
for many years to come. If these projections are correct,
a balanced budget would not be transitory. Assuming
a continuation of the Administration’s economic and
technical assumptions, the budget remains in balance

for several decades. However, the underlying problems
are not fully eliminated. Table 2–2 shows that a primary, or non-interest, deficit reappears around 2035
even under the current-services case. Although the underlying imbalance is small, it is sufficient to begin
a slow but irreversibly increasing spiral. The recurrence
of the primary deficit means that eventually the pressure of rising entitlement claims will drive the unified
deficit and Federal debt sharply higher relative to
GDP. 7
The keys to these projections are the economic assumptions, which have already been discussed, plus
technical assumptions about Medicare and discretionary
spending. The main reason why other analysts have
reached different conclusions about the deficit is because of differences with these or other assumptions.
The basic results shown here are highly sensitive to
7
The primary or non-interest surplus is the difference between all outlays, excluding
interest, and total receipts. It can be positive even when the total budget is in deficit.
A relatively small primary surplus can stabilize the budget even when the total budget
is in deficit, and similarly, even a small primary deficit can destabilize a budget. The
mathematics are inexorable.

2. STEWARDSHIP: TOWARD A FEDERAL BALANCE SHEET

changes in these underlying assumptions. While Table
2–2 projects a budget that remains under control for
several decades before underlying problems reemerge,
small variations in assumptions can produce considerably more pessimistic—or even more optimistic—outcomes. Various alternative economic and technical assumptions are discussed below. Each alternative focuses
on one of the key uncertainties in the outlook. Generally, the scenarios highlight negative possibilities
rather than positive ones to explore all of the major
risks in the outlook.
1. Discretionary Spending: By convention, the current-services estimates of discretionary spending rise
with the rate of inflation. This assumption, or any
other, is essentially arbitrary, because discretionary
spending is always determined annually through the
legislative process, and no formula can dictate future
spending in the absence of legislation. This assumption
implies that the real value of Federal services is unchanging over time, which has the implication that the
size of the Federal establishment would shrink relative
to the size of the economy. 8 It also presupposes that
the Nation’s defense needs will not vary from their
current projected levels. The relative decline in discretionary spending frees 4.1 percent of GDP for use in
other ways in these projections.
Some budget analysts have assumed alternatively
that discretionary spending would hold constant as a
share of GDP in the long run; this requires it to increase in real terms whenever there is real economic
growth. That is a more generous assumption for Government spending than the current services assumption
used by OMB or CBO. It might be argued that with
rising population and growth in real per capita incomes,
the public demand for Government services—more national parks, better transportation, additional Federal
support for scientific research—will increase as well.
Provision of public person-to-person services might
imply that spending should grow with population as
well as prices. And if Government salaries keep in step
with those in the private sector by rising slightly faster
than overall inflation, then total spending growing only
as fast as inflation implies a shrinking Federal work
force. However, such demands might be met within constant real dollar spending through increased productivity in the Federal sector, such as has allowed the recent
reduction of the Federal workforce by more than
316,000. Spending for provision of ‘‘public goods’’ that
naturally apply to the entire population—such as national defense or information (like the Weather Service)—need not increase just because the economy and
the population grow. Furthermore, an assumption of
a constant discretionary spending share of GDP would
be in sharp contrast with recent experience; since its
peak in 1968, the discretionary spending share of GDP
8
This is not precisely accurate. The real cost of providing the services would be unchanged,
but the quantity of Federal services might or might not decline, depending on productivity.
A significant portion of discretionary spending is Federal payroll costs. In a period of
moderately rising real wages as assumed in the budget assumptions and in the Trustees’
report, these costs would rise somewhat faster than inflation unless the number of employees
were scaled back, which might or might not be offset by productivity gains.

27
has been cut virtually in half (from 13.6 percent to
6.9 percent in 1997).
Thus, there are arguments on both sides; for purposes
of analysis, the projections in Table 2–2 show both the
standard current services assumptions, with discretionary spending increasing in step with inflation, and
an alternative assumption that allows discretionary
spending to increase for population growth in addition
to general inflation. Chart 2–4 adds a third assumption,
under which discretionary spending grows still more
rapidly, to maintain a constant percentage of GDP
(which is the assumption used by GAO, and is reported
as an alternative by CBO).
2. Health Spending: Some of the most volatile elements in recent budgets have been Federal health
spending for Medicare and Medicaid. Expenditures for
these programs have grown much faster than those
of other entitlements, including social security. After
the last year of the standard budget estimates in 2008,
real per capita growth rates for Medicare benefits in
the current services case are based on the projections
in the latest report of the Medicare Trustees, which
slow down markedly after 2015. Thus, while spending
for Medicare (and Medicaid) is assumed to continue
to grow more rapidly than the overall economy, real
spending on a per capita basis is expected to stabilize
at lower than the historical rates of increase. Also, for
Medicare, the savings in the Balanced Budget Agreement are assumed to lower the level of spending permanently relative to earlier baselines; that is, the Trustees’ prior growth estimates take off from the new lower
base. However, when the Trustees made their projections last summer, they did not include the spending
restraint in Medicare now anticipated over the next
few years as a result of the Balanced Budget Agreement. Had they done so, it is conceivable that they
would also have included a catch-up after 2002 that
would have raised the long-run average growth rate
assumed here. For that reason, the assumptions used
in the current-services case could prove to be optimistic.
Chart 2–5 shows the current-services case, and the
case (shown in Chart 2–3) under which Medicare cost
growth continues without slowing after the end of the
10-year budget window in 2008. It also shows a still
more pessimistic scenario, under which both Medicare
and Medicaid per capita growth rates accelerate by one
percentage point per year, and a more optimistic scenario, under which Medicare and Medicaid per capita
growth rates slow to the rate of growth of GDP per
capita.
3. Productivity: Productivity growth in the U.S. economy slowed down after 1973. The slowdown is responsible for the slower rise in U.S. real incomes since that
time. Productivity growth is affected by changes in the
budget deficit which influence national saving, but
many other factors influence it as well. The deficit in
turn is affected by changes in productivity growth,
which affect the size of the economy and hence future
receipts. Two alternative scenarios illustrate what
would happen to the budget deficit if productivity

28

ANALYTICAL PERSPECTIVES

Chart 2-4. ALTERNATIVE DISCRETIONARY SPENDING ASSUMPTIONS
SURPLUS (+)/DEFICIT (-) AS A PERCENT OF GDP
5
CURRENT SERVICES

0

-5

GROWTH
WITH
POPULATION

-10

-15

GROWTH
WITH
NOMINAL
GDP

-20

-25

-30
2000

2010

2020

2030

2040

2050

2060

2070

Chart 2-5. ALTERNATIVE HEALTH SPENDING ASSUMPTIONS
SURPLUS (+)/DEFICIT (-) AS A PERCENT OF GDP
40
30
PER CAPITA
GROWTH IN LINE
WITH GDP PER CAPITA

20
10

CURRENT SERVICES

0
-10
CONTINUED RAPID
MEDICARE GROWTH

-20
-30

ONE PERCENT
HIGHER REAL
PER CAPITA
GROWTH

-40
-50
2000

2010

2020

2030

2040

2050

2060

2070

29

2. STEWARDSHIP: TOWARD A FEDERAL BALANCE SHEET

growth were either higher or lower than assumed. A
higher rate of growth would make the task of preserving a balanced budget much easier; lower productivity
growth would have the opposite effect. Chart 2–6 shows
how the deficit varies with changes of one-half percentage point of average productivity growth.
4. Population: In the long run, changing demographic
patterns dictate the behavior of the projections.
Changes in population growth feed into real economic
growth through the effect on labor supply and employment. Changing demographics also affect entitlement
spending, contributing to the surge of spending expected for social security and Medicare. The key assumptions underlying the demographic projections are
fertility, mortality and immigration.
• The main reason for the expected slowdown in
population growth is the expected continuation of
a low fertility rate. Since 1990, the number of
births per woman in the United States has averaged between 2.0 and 2.1. This is slightly below
the replacement rate needed to maintain a constant population. The fertility rate was even lower
in the 1970s and 1980s. The demographic projections assume that fertility will average around 1.9
births per woman in the future. Fertility is hard
to predict. Both the baby boom in the 1950s and
the baby bust in the 1970s came as surprise to
demographers. A return to the higher fertility
rates of the past is possible, but so is another

drop in fertility. Although the fertility rate has
never fallen below 1.7 in U.S. history, such low
rates have been observed recently in some European countries. Chart 2–7 shows the effects of
alternative fertility assumptions on the deficit;
higher fertility would contribute eventually to a
larger labor force, and hence increase incomes and
revenues, and reduce the deficit.
• The aging of the U.S. population is due to both
lower fertility, which reduces the number of children per adult, and lengthening lifespans. Since
1970, the average lifespan for U.S. women has
increased from 74.9 years to 79.3 years, and it
is projected to rise to 82.9 years by 2050. Men
do not live as long as women on average, but
their lifespan has also increased from 67.1 years
in 1970 to 72.6 years in 1995, and it is expected
to reach 77.5 years by 2050. Longer lifespans
mean that more people will live to receive social
security and Medicare benefits, and will receive
them for a longer time. If the U.S. population
were to experience no further improvements in
mortality, the shorter lifespans would help to
lower the deficit. Conversely, if the population
lives even longer than now expected, the outlook
for the deficit would worsen. This is illustrated
in Chart 2–8.
• The final demographic factor influencing long-run
projections is the rate of immigration. The United

Chart 2-6. ALTERNATIVE PRODUCTIVITY ASSUMPTIONS

SURPLUS (+)/DEFICIT (-) AS A PERCENT OF GDP
40

HALF
PERCENT
HIGHER
PRODUCTIVITY
GROWTH

30
20
10
0

CURRENT SERVICES

-10
-20
-30

HALF
PERCENT
LOWER
PRODUCTIVITY
GROWTH

-40
-50
-60
-70
-80
2000

2010

2020

2030

2040

2050

2060

2070

30

ANALYTICAL PERSPECTIVES

Chart 2-7. ALTERNATIVE FERTILITY ASSUMPTIONS
SURPLUS (+)/DEFICIT (-) AS A PERCENT OF GDP
3
HIGHER FERTILITY

2
1
0
-1

CURRENT
SERVICES

-2
-3
-4
-5
-6
-7

LOWER FERTILITY

-8
-9
-10
-11
-12
2000

2010

2020

2030

2040

2050

2060

2070

Chart 2-8. ALTERNATIVE MORTALITY ASSUMPTIONS
SURPLUS (+)/DEFICIT (-) AS A PERCENT OF GDP
8
SHORTER LIFE EXPECTANCY

4
CURRENT SERVICES

0
-4
-8
-12
-16

LONGER LIFE
EXPECTANCY

-20
-24
-28
-32
2000

2010

2020

2030

2040

2050

2060

2070

31

2. STEWARDSHIP: TOWARD A FEDERAL BALANCE SHEET

States is an open society. In the 19th century,
a huge wave of immigration helped build the country; and the last two decades of the 20th century
have witnessed another burst of immigration. The
annual net flow of legal immigrants has been
averaging around 850,000 since 1992. This is the
highest absolute rate in U.S. history, but as a
percentage of population it is only about a third
as high as immigration was in 1901–1910. Chart
2–9 illustrates the effects on the deficit of varying
immigration assumptions. In general, faster immigration yields a larger work force, and lower deficits.
5. What To Do With the Budget Surpluses: The current projections show the budget running surpluses for
several decades. These surpluses pay down the debt
held by the public, after which, by the conventions of
current-services budget projections, policy continues unchanged, and so negative debt accumulates for a time
(though demographic pressures soon erode that negative debt again). Thus, the surpluses sharply reduce
net interest expenses in future years, closing the virtuous cycle of deficit reduction and balanced budgets. If
these surpluses were ‘‘spent’’ by increased spending or
reduced taxes, it would worsen the outlook significantly.
Chart 2–10 shows two alternative scenarious: one in
which spending or tax cuts using the surpluses were
purely temporary, and a second in which the additional
budgetary costs grew with inflation over time. If the

spending or tax cuts were purely temporary, the period
of budget surpluses would be shortened by 30 years,
with deficits recurring in 2025; by 2070, the deficit
would grow to 10.8 percent of GDP. If the budgetary
costs grew with inflation, however, budget surpluses
would extend barely beyond the budget window, with
deficits recurring in 2012. By 2070, the deficit would
grow to an unsustainable 17.9 percent of GDP.
Conclusion.—Under President Clinton, the long-run
outlook for the budget deficit has improved significantly. When this Administration took office, the deficit
was projected to begin spiraling out of control early
in the next century, reaching levels never seen before
(except temporarily during major wars). The outlook
now is drastically different. Under current policy assumptions, a period of balanced budgets is expected
to begin in 1999. This period is eventually followed
by a return to deficits of a size that would demand
the attention of policymakers.
Both social security and Medicare continue to
confront long-run deficits in their respective Trust
Funds, which must be addressed. But the favorable
outlook for the unified budget should make it easier
to address these difficult problems.
The budget outlook is based on many assumptions
regarding demographic patterns, economic conditions,
and budget policy. Under alternative assumptions, the
budget outlook could be either more or less favorable,

Chart 2-9. ALTERNATIVE IMMIGRATION ASSUMPTIONS
SURPLUS (+)/DEFICIT (-) AS A PERCENT OF GDP
6

HIGHER NET IMMIGRATION

4
CURRENT SERVICES

2
0
-2
-4
-6

LOWER NET
IMMIGRATION

-8
-10
-12
-14
-16

ZERO NET
IMMIGRATION

-18
-20
-22
-24
-26
2000

2010

2020

2030

2040

2050

2060

2070

32

ANALYTICAL PERSPECTIVES

Chart 2-10. IMPACT OF USING THE SURPLUS
SURPLUS (+)/DEFICIT (-) AS A PERCENT OF GDP
4
CURRENT SERVICES

2
0
-2
-4
-6

SURPLUS USED FOR
ONE-TIME PURPOSES

-8
-10
-12
-14

SURPLUS USED FOR
CONTINUING PURPOSES

-16
-18
-20
2000

2010

2020

2030

and the degree of uncertainty increases with time. A
key policy assumption is that budget discipline is maintained. This favorable outlook could easily be altered
by future policy action, or by unforeseen events.
Actuarial Balance in the Social Security and
Medicare Trust Funds.—The Trustees for the Social
Security and Hospital Insurance Trust Funds issue annual reports that include projections of income and
outgo for these funds over a 75-year period. These projections are based on different methods and assumptions than the long-run budget projections presented
above, although the budget projections do rely on the
social security assumptions for population growth and
labor force growth after the year 2008. Even with these
differences, the message is similar: The retirement of
the baby-boom generation coupled with expected high
rates of growth in per capita health care costs will
exhaust the Trust Funds unless further remedial action
is taken.
The Trustees’ reports feature the 75-year actuarial
balance of the Trust Funds as a summary measure
of their financial status. For each Trust Fund, the balance is calculated as the change in receipts or program
benefits, expressed as a percentage of taxable payroll,
that would be needed to preserve a small positive balance in the Trust Fund at the end of 75 years.
Table 2–3 shows the changes in the 75-year actuarial
balances of the social security and Medicare Trust

2040

2050

2060

2070

Funds since 1996. There were only relatively small
changes in the projected balances last year. The modest
improvement in the Hospital Insurance fund was estimated prior to the passage of the Balanced Budget
Agreement, which made numerous changes in Medicare. Prior to the Agreement the HI Trust Fund was
expected to reach zero in 2001. The reforms in the
Agreement have extended the projected life of the Trust
Fund until 2010.
Achieving a positive 75-year balance may not be sufficient to put the Trust Funds on a self-sustaining basis.
For example, raising the social security payroll tax by
2.2 percentage points would eliminate the 75-year actuarial imbalance in the Social Security Trust Fund, as
seen from Table 2–3. However, even with the higher
taxes, the income to the Fund would be insufficient
to cover program outgo after 2020. Beyond that point
the Trust Fund assets would have to be drawn down.
Even though at the end of 75 years there would still
be a small positive balance in the Trust Fund, one
year later the balance would be gone. Based on the
75-year balance measure, some have claimed that social
security could be ‘‘fixed’’ by a relatively small 2.2 percentage point change in payroll taxes. That statement
ignores the fact that if social security were fixed in
this way, it would remain fixed for only one year.

33

2. STEWARDSHIP: TOWARD A FEDERAL BALANCE SHEET

Table 2–3.

CHANGE IN 75–YEAR ACTUARIAL BALANCE FOR OASDI AND HI TRUST FUNDS
(INTERMEDIATE ASSUMPTIONS)
(As a percent of taxable payroll)
OASI

DI

OASDI

HI

Actuarial balance in 1996 Report .................................................................................
Changes in balance due to changes in:
Valuation period ........................................................................................................
Economic and demographic assumptions ................................................................
Technical and other assumptions .............................................................................

–1.85

–0.34

–2.19

–4.52

–0.07
0.03
0.03

–0.01
0.00
–0.04

–0.08
0.03
0.01

–0.09
0.20
0.09

Total Changes .......................................................................................................
Actuarial balance in 1997 Report .................................................................................

–0.01
–1.84

–0.05
–0.39

–0.04
–2.23

0.20
–4.32

PART III—NATIONAL WEALTH AND WELFARE
Unlike a private corporation, the Federal Government
routinely invests in ways that do not add directly to
its assets. For example, Federal grants are frequently
used to fund capital projects by State or local governments for highways and other purposes. Such investments are valuable to the public, which pays for them
with taxes, but they are not owned by the Federal
Government and would not show up on a conventional
balance sheet.
The Federal Government also invests in education
and research and development (R&D). These outlays
contribute to future productivity and are analogous to
an investment in physical capital. Indeed, economists
have computed stocks of human and knowledge capital
to reflect the accumulation of such investments. Nonetheless, these capital stocks are not owned by the Federal Government, nor would they usually appear on
a balance sheet.
To show the importance of these kinds of issues,
Table 2–4 presents a national balance sheet. It includes
estimates of national wealth classified in three categories: physical assets, education capital, and R&D
capital. The Federal Government has made contributions to each of these categories, and these contributions are shown in the table. Data in this table are
especially uncertain, because of the assumptions needed
to prepare the estimates.
Federal investments are responsible for about 7 percent of total national wealth. This may seem like a
small fraction, but it represents a large volume of capital—$4.4 trillion. The Federal contribution is down
from around 8 percent at the end of the 1980s, and
from around 12 percent in 1960. Much of this reflects
the shrinking size of the defense capital stocks, which
have gone down from 13 percent of GDP to 9 percent
in the last few years.
Physical Assets
The physical assets in the table include stocks of
plant and equipment, office buildings, residential structures, land, and government’s physical assets such as
military hardware, office buildings, and highways.
Automobiles and consumer appliances are also included
in this category. The total amount of such capital is

vast, around $26 trillion in 1997; by comparison, GDP
was only about $8 trillion.
The Federal Government’s contribution to this stock
of capital includes its own physical assets plus $0.6
trillion in accumulated grants to State and local governments for capital projects. The Federal Government has
financed about one-sixth of the physical capital held
by other levels of government.
Education Capital
Economists have developed the concept of human capital to reflect the notion that individuals and society
invest in people as well as in physical assets. Investment in education is a good example of how human
capital is accumulated.
This table includes an estimate of the stock of capital
represented by the Nation’s investment in education.
The estimate is based on the cost of replacing the years
of schooling embodied in the U.S. population aged 16
and over. The idea is to measure how much it would
cost to reeducate the U.S. workforce at today’s prices.
The estimate attempts to measure the replacement
value of education rather than its original cost. This
is more meaningful economically, and is comparable
to the measures of physical capital presented earlier.
Although this is a relatively crude measure, it does
provide a rough order of magnitude of the current value
of the investment in education. According to this measure, the stock of education capital amounted to $31
trillion in 1997, of which about 3 percent was financed
by the Federal Government. It exceeds the total value
of the Nation’s private stock of physical capital. The
main investors in education capital have been State
and local governments, parents, and students themselves (who forgo earning opportunities in order to acquire education).
Even broader concepts of human capital have been
suggested. Not all useful training occurs in a schoolroom or in formal training programs at work. Much
informal learning occurs within families or on the job,
but measuring its value is very difficult. However, labor
compensation amounts to about two thirds of national
income, and thinking of this income as the product
of human capital suggests that the total value of

34

ANALYTICAL PERSPECTIVES

Table 2–4

NATIONAL WEALTH

(As of the end of the fiscal year, in trillions of 1997 dollars)
1960

1965

1970

1975

1980

1985

1990

1991

1992

1993

1994

1995

1996

1997

ASSETS

Publicly Owned Physical Assets:
Structures and Equipment .........................................
Federally Owned or Financed ..............................
Federally Owned ...............................................
Grants to State and Local Governments .........
Funded by State and Local Governments ...........
Other Federal Assets .................................................
Subtotal .........................................................
Privately Owned Physical Assets:
Reproducible Assets ..................................................
Residential Structures ................................................
Nonresidential Plant and Equipment ....................
Inventories .............................................................
Consumer Durables ...............................................
Land ...........................................................................
Subtotal .........................................................
Education Capital:
Federally Financed ....................................................
Financed from Other Sources ...................................

2.1
1.2
1.1
0.1
0.9
0.8

2.4
1.3
1.1
0.2
1.1
0.7

2.9
1.5
1.1
0.3
1.5
0.7

3.5
1.5
1.0
0.5
2.0
0.9

3.7
1.5
0.9
0.6
2.1
1.5

3.9
1.8
1.1
0.7
2.1
1.5

4.2
1.9
1.2
0.8
2.3
1.2

4.3
2.0
1.2
0.8
2.3
1.1

4.3
2.0
1.2
0.8
2.3
1.1

4.4
2.0
1.2
0.8
2.4
1.0

4.5
2.0
1.1
0.8
2.5
1.0

4.6
2.0
1.1
0.9
2.6
0.9

4.7
2.0
1.1
0.9
2.6
0.9

4.7
2.0
1.1
0.9
2.6
0.9

2.9

3.2

3.6

4.4

5.2

5.4

5.5

5.4

5.4

5.4

5.5

5.5

5.6

5.6

6.8
2.6
2.7
0.7
0.8
2.0

7.8
3.0
3.1
0.7
0.9
2.4

9.6
3.6
3.9
0.9
1.2
2.8

12.2
4.6
5.1
1.1
1.4
3.8

15.7
6.2
6.4
1.3
1.6
5.6

16.5
6.5
7.1
1.2
1.8
6.2

18.5
7.3
7.7
1.3
2.2
6.0

18.3
7.2
7.7
1.2
2.2
5.6

18.4
7.3
7.7
1.2
2.2
4.9

18.8
7.5
7.8
1.2
2.3
4.7

19.5
7.8
8.0
1.2
2.3
4.7

19.9
8.0
8.2
1.3
2.4
4.6

20.4
8.2
8.4
1.3
2.5
4.6

21.0
8.5
8.7
1.3
2.5
4.6

8.8

10.2

12.4

16.0

21.2

22.7

24.5

23.8

23.3

23.5

24.1

24.5

25.0

25.6

0.1
6.4

0.1
8.3

0.2
11.0

0.3
12.8

0.4
15.7

0.6
18.8

0.7
23.9

0.8
24.7

0.8
25.4

0.8
26.2

0.8
26.9

0.9
28.0

0.9
29.0

0.9
30.3

Subtotal .........................................................
Research and Development Capital:
Federally Financed R&D ...........................................
R&D Financed from Other Sources ..........................

6.4

8.4

11.3

13.2

16.1

19.4

24.6

25.5

26.2

27.0

27.8

28.9

29.9

31.3

0.2
0.1

0.3
0.2

0.5
0.3

0.5
0.4

0.6
0.5

0.7
0.6

0.8
0.8

0.8
0.9

0.8
0.9

0.8
1.0

0.9
1.0

0.9
1.0

0.9
1.1

0.9
1.2

Subtotal .........................................................

0.3

0.5

0.8

0.9

1.0

1.3

1.6

1.7

1.7

1.8

1.9

1.9

2.0

2.1

Total Assets ..............................................
Net Claims of Foreigners on U.S. .................................
Balance ....................................................
Per Capita (thousands of dollars) .............................
Ratio to GDP .................................................................

18.4
–0.1
18.5
102.5
723.2

22.3
–0.2
22.5
115.8
693.2

28.1
–0.2
28.2
137.7
733.6

34.5
–0.0
34.5
159.7
789.0

43.5
–0.3
43.8
191.9
841.7

48.8
0.0
48.8
203.9
803.1

56.2
0.8
55.4
221.2
803.6

56.4
0.8
55.6
219.6
807.7

56.6
0.9
55.7
217.5
783.5

57.7
1.1
56.6
218.8
779.3

59.2
1.3
57.9
221.6
770.1

60.8
1.4
59.5
225.4
776.7

62.5
1.9
60.6
227.7
769.2

64.5
2.2
62.3
231.9
760.6

0.5
12.1

0.6
11.2

0.8
10.1

1.2
9.5

2.2
9.3

3.2
9.3

3.9
8.5

4.1
8.4

4.1
8.4

4.3
8.2

4.4
8.1

4.5
7.9

4.7
7.8

4.8
7.7

ADDENDA:

Total Federally Funded Capital .................................
Percent of National Wealth .......................................

human capital might be two times the estimated value
of physical capital. Thus, the estimates offered here
are in a sense conservative, because they reflect only
the costs of acquiring formal education and training.
Research and Development Capital
Research and development can also be thought of
as an investment, because R&D represents a current
expenditure that is made in the expectation of earning
a future return. After adjusting for depreciation, the
flow of R&D investment can be added up to provide
an estimate of the current R&D stock. 9 That stock
is estimated to have been about $2.0 trillion in 1997.
Although this is a large amount of research, it is a
relatively small portion of total National wealth. About
half of this stock was funded by the Federal Government.
9
R&D depreciates in the sense that the economic value of applied research and development tends to decline with the passage of time, as still newer ideas move the technological
frontier.

Liabilities
When considering how much the United States owes
as a Nation, the debts that Americans owe to one another cancel out. This means they do not belong in
Table 2–4, but it does not mean they are unimportant.
An unwise buildup in debt, most of which was owed
to other Americans, was partly responsible for the recession of 1990–1991 and the sluggishness of the early
stages of the recovery that followed. The only debt that
appears in Table 2–4 is the debt that Americans owe
to foreign investors. America’s foreign debt has been
increasing rapidly in recent years, because of the continuing imbalance in the U.S. current account, but even
so the size of this debt is small compared with the
total stock of U.S. assets. It amounted to about 31⁄2
percent of national wealth in 1997.
Most Federal debt does not appear in Table 2–4 because it is held by Americans; only that portion of the
Federal debt held by foreigners is included. However,
comparing the Federal Government’s net liabilities with

2. STEWARDSHIP: TOWARD A FEDERAL BALANCE SHEET

total national wealth gives another indication of the
relative magnitude of the imbalance in the Government’s accounts. Currently, the Federal net asset imbalance, as estimated in Table 2–1, amounts to 5.2
percent of total U.S. wealth as shown in Table 2–4.
Trends in National Wealth
The net stock of wealth in the United States at the
end of 1997 was about $62 trillion. Since 1980, it has
increased in real terms at an annual rate of 2.0 percent
per year—less than half the 4.4 percent real growth
rate it averaged from 1960 to 1980. Public capital formation slowed down even more between the two periods. Since 1980, public capital has increased at an annual rate of only 0.5 percent, compared with 2.9 percent
over the previous 20 years.
The net stock of private nonresidential plant and
equipment grew 1.8 percent per year from 1980 to 1997
compared with 4.4 percent in the 1960s and 1970s,
and the stock of business inventories increased less
than 0.1 percent per year. However, private nonresidential fixed capital has increased more rapidly since
1992—2.4 percent per year—reflecting the recent investment boom.
The accumulation of education capital, as measured
here, has also slowed down since 1980, but not nearly
as much. It grew at an average rate of 4.7 percent
per year in the 1960s and 1970s, about the same as
the average rate of growth in private physical capital
during the same period. Since 1980, education capital
has grown at a 4.0 percent annual rate. This reflects
the extra resources devoted to schooling in this period,
and the fact that such resources were rising in relative
value. R&D stocks have grown at about the same rate
as education capital since 1980.
Other Federal Influences on Economic Growth
Many Federal policies contributed to the slowdown
in capital formation that occurred after 1980. Federal
investment policies obviously were important, but the
Federal Government also contributes to wealth in ways
that cannot be easily captured in a formal presentation.
Monetary and fiscal policies affect the rate and direction of capital formation. Regulatory and tax policies
affect how capital is invested, as do the Federal Government’s credit assistance policies.
One important channel of influence is the Federal
budget deficit, which determines the size of the Federal
Government’s borrowing requirement. Smaller deficits
in the 1980s would have resulted in a smaller gap
between Federal liabilities and assets than is shown
in Table 2–1. It is also likely that, had the more than
$3 trillion in added Federal debt since 1980 been avoided, a significant share of these funds would have gone
into private investment. National wealth might have
been 2 to 4 percent larger in 1997 had fiscal policy
avoided the buildup in the debt.
Social Indicators
There are certain broad responsibilities that are
unique to the Federal Government. Especially impor-

35
tant is the Government’s role in fostering healthy economic conditions, promoting health and social welfare,
and protecting the environment. Table 2–5 offers a
rough cut of information that can be useful in assessing
how well the Federal Government has been doing in
promoting these general objectives.
The indicators shown here are only a limited subset
drawn from the wide array of available data on conditions in the United States. In choosing indicators for
this table, priority was given to measures that were
consistently available over an extended period. Such
indicators make it easier to draw valid comparisons
and evaluate trends. In some cases, however, this
meant choosing indicators with significant limitations.
The individual measures in this table are influenced
in varying degrees by many Government policies and
programs, as well as by external factors beyond the
Government’s control. They are not outcome indicators,
because they do not measure the direct results of Government activities, but they do provide a quantitative
measure of the progress or lack of progress in reaching
some of the ultimate values that government policy is
intended to promote.
Such a table can serve two functions. First, it highlights areas where the Federal Government might need
to modify its current practices or consider new approaches. Where there are clear signs of deteriorating
conditions, corrective action might be appropriate. Second, the table provides a context for evaluating other
data on Government activities. For example, Government actions that weaken its own financial position
may be appropriate when they promote a broader social
objective.
An example of this occurs during economic recessions
when reductions in tax collections lead to increased
government borrowing that adds to Federal liabilities.
This decline in Federal net assets, however, provides
an automatic stabilizer for the private sector. State and
local governments and private budgets are strengthened by allowing the Federal budget to go deeper into
deficit. More stringent Federal budgetary controls could
be used to hold down Federal borrowing during such
periods, but only at the risk of aggravating the downturn and weakening the other sectors.
The Government cannot avoid making such tradeoffs because of its size and the broad ranging effects
of its actions. Monitoring these effects and incorporating them in the Government’s policy making is a major
challenge.
An Interactive Analytical Framework
No single framework can encompass all of the factors
that affect the financial condition of the Federal Government. Nor can any framework serve as a substitute
for actual analysis. Nevertheless, the framework presented here offers a useful way to examine the financial
aspects of Federal policies. Increased Federal support
for investment, the reduction in Federal absorption of
saving through deficit reduction, and other Administration policies to enhance economic growth are expected

36

ANALYTICAL PERSPECTIVES

Table 2–5.
General categories

ECONOMIC AND SOCIAL INDICATORS

Specific measures

Economic:
Living Standards ...........

Economic security ........

Employment prospects

Wealth creation ............
Innovation .....................
Social:
Families ........................
Safe communities .........

Health and illness .........

Learning ........................

Participation ..................

Environment:
Air quality ......................
Water quality ................

1960

1965

1970

Real GDP per person (1992 dollars) ................................ 12,512 14,792 16,521
Average annual percent change ........................................
0.3
5.0
–1.1
Median income (1994 dollars):
All households ................................................................
NA
NA 33,181
Married couple families .................................................. 28,617 33,330 39,951
Female householder, no spouse present ..................... 14,461 16,203 19,348
Income share of middle three quintiles (%) ......................
54.0
53.9
53.6
Poverty rate (%) 1 ...............................................................
22.2
17.3
12.6
Inflation and unemployment:
Civilian unemployment (%) ............................................
5.5
4.5
4.9
CPI-U (year over year % change) ................................
1.7
1.6
5.7
Increase in total payroll employment (millions) .................
–0.5
2.9
–0.5
Managerial or professional jobs (% of civilian employment) ...............................................................................
NA
NA
NA
Net national saving rate (% of GDP) ................................
10.8
12.5
8.7
Patents issued to U.S. residents (thousands) ...................
42.0
53.9
50.1
Multifactor productivity (average annual percent change)
0.4
3.0
–0.2
Children living with female Householder, no spouse
present (% of all children) .............................................
Violent crime rate (per 100,000 population) 2 ...................
Murder rate (per 100,000 population) 2 .............................
Juvenile crime (murders and nonnegligent manslaughter
per 100,000 persons age 14–17) ..................................
Infant mortality (per 1,000 live births) 3 .............................
Low birthweight (<2,500 gms) babies (%) ........................
Life expectancy at birth (years) .........................................
Cigarette smokers (% population 18 and oover) ..............
Bed disability days (average days per person) ................
High school graduates (% of population 25 and older) ...
College graduates (% of population 25 and older) ..........
National assessment of educational progress: 4
Mathematics—high school seniors ................................
Science—high school seniors ........................................
Voting for President (% eligible population) ......................
Voting for Congress (% of eligible population) .................
Individual charitable giving per capita (1997 dollars) .......
Population living in counties with ozone levels exceeding
the standard (millions) ...................................................
Population served by secondary treatment or better (millions) ...............................................................................

1975

1980

1985

1990

1991

1992

1993

1994

1995

1996

1997

17,896 20,252 22,345 24,559 24,058 24,447 24,738 25,352 25,630 25,998 26,833
–1.6
–1.4
2.8
0.3
–2.0
1.6
1.2
2.5
1.1
1.4
3.2
32,943 33,763 34,439 35,945 34,705 34,261 33,922 34,158 35,082 35,492
41,506 44,118 45,350 47,893 47,225 46,847 46,695 47,598 48,452 49,707
19,107 19,841 19,918 20,325 19,228 19,039 18,940 19,307 20,272 19,911
53.8
53.6
52.2
51.2
51.4
51.0
48.9
49.0
49.1
48.9
12.3
13.0
14.0
13.5
14.2
14.8
15.1
14.5
13.8
13.7

NA
NA
NA
NA
NA

8.5
9.1
0.4

7.1
13.5
0.2

7.2
3.6
2.5

5.5
5.4
0.3

6.7
4.2
–0.8

7.4
3.0
1.1

6.8
3.0
2.8

6.1
2.6
3.9

5.6
2.8
2.2

5.4
3.0
2.5

5.0
2.3
3.2

NA
6.7
51.4
0.8

NA
7.5
40.8
–2.3

24.1
6.2
43.4
0.5

25.8
4.4
53.0
–0.2

26.3
4.3
57.8
–1.0

26.2
3.1
58.8
1.5

26.8
3.4
61.2
0.5

27.5
4.3
64.3
0.7

28.3
5.1
64.5
NA

28.8
5.7
69.4
NA

29.1
6.4
NA
NA

9
160
5

10
199
5

12
364
8

16
482
10

18
597
10

21
557
8

22
732
9

22
758
10

23
758
9

23
747
10

23
714
9

23
685
8

24
634
7

NA
597
7

NA
26.0
7.7
69.7
NA
6.0
44.6
8.4

NA
24.7
8.3
70.2
42.4
6.2
49.0
9.4

NA
20.0
7.9
70.8
39.5
6.1
55.2
11.0

NA
16.1
7.4
72.6
36.4
6.6
62.5
13.9

13
12.6
6.8
73.7
33.2
7.0
68.6
17.0

10
10.6
6.8
74.7
30.1
6.1
73.9
19.4

24
9.2
7.0
75.4
25.5
6.2
77.6
21.3

27
8.9
7.1
75.5
25.6
6.5
78.4
21.4

26
8.5
7.1
75.8
26.5
6.3
79.4
21.4

30
8.4
7.2
75.5
25.0
6.7
80.2
21.9

29
8.0
7.3
75.7
NA
6.2
80.9
22.2

24
7.6
7.3
75.8
NA
NA
81.7
23.0

NA
7.2
7.4
76.1
NA
NA
81.7
23.6

NA
6.3
NA
NA
NA
NA
NA
NA

NA
NA
62.8
58.5
210

NA
NA
NA
NA
251

NA
305
NA
43.5
301

302
293
NA
NA
320

300
286
52.8
47.6
349

301
288
NA
NA
367

305
290
NA
33.1
448

306
292
NA
NA
448

307
294
55.1
50.8
441

307
294
NA
NA
439

306
294
NA
37.4
434

307
295
NA
NA
465

307
296
48.9
45.7
NA

NA
NA
NA
NA
NA

NA

NA

NA

NA

NA

76

63

70

43

51

50

71

NA

NA

NA

NA

NA

NA

NA

134

155

157

159

162

164

166

168

NA

1

The poverty rate does not reflect noncash government transfers such as Medicaid or food stamps.
Not all crimes are reported, and the fraction that go unreported may have varied over time, the figures for 1997 are preliminary estimates based on partial reporting.
3
The figure for 1997 is based on preliminary data through April.
4
Some data from the national educational assessments have been interpolated.
2

to promote national wealth and improve the future financial condition of the Federal Government. As that
occurs, the efforts will be revealed in these tables.
TECHNICAL NOTE: SOURCES OF DATA AND METHOD OF ESTIMATING
Federally Owned Assets and Liabilities
Assets
Financial Assets: The source of data is the Federal
Reserve Board’s Flow-of-Funds Accounts. Two adjustments were made to these data. First, U.S. Government
holdings of financial assets were consolidated with the
holdings of the monetary authority, i.e., the Federal
Reserve System. Second, the gold stock, which is valued
in the Flow-of-Funds at a constant historical price, is
revalued using the market value for gold.

Physical Assets
Fixed Reproducible Capital: Estimates were developed from the OMB historical data base for physical
capital outlays. The data base extends back to 1940
and was supplemented by data from other selected
sources for 1915–1939. The source data are in current
dollars. To estimate investment flows in constant dollars, it is necessary to deflate the nominal investment
series. This was done using price deflators for Federal
purchases of durables and structures from the National
Income and Product Accounts. These price deflators are

2. STEWARDSHIP: TOWARD A FEDERAL BALANCE SHEET

available going back as far as 1940. For earlier years,
deflators were based on historical statistics for constant
price public capital formation. The capital stock series
were adjusted for depreciation on a straight-line basis,
assuming useful lives of 46 years for water and power
projects; 40 years for other direct Federal construction;
and 16 years for major nondefense equipment and for
defense procurement.
Fixed Nonreproducible Capital: Historical estimates
for 1960–1985 were based on estimates in Michael J.
Boskin, Marc S. Robinson, and Alan M. Huber, ‘‘Government Saving, Capital Formation and Wealth in the
United States, 1947–1985,’’ published in The Measurement of Saving, Investment, and Wealth, edited by Robert E. Lipsey and Helen Stone Tice (The University
of Chicago Press, 1989).
Estimates were updated using changes in the value
of private land from the Flow-of-Funds Balance Sheets
and in the Producer Price Index for Crude Energy Materials. The Bureau of Economic Analysis is in the process of preparing satellite accounts to accompany the
National Income and Product Accounts that will report
on changes in mineral deposits for the Nation as a
whole, but this work is not yet completed.
Liabilities
Financial Liabilities: The principal source of data is
the Federal Reserve’s Flow-of-Funds Accounts.
Contingent Liabilities: Sources of data are the OMB
Deposit Insurance Model and the OMB Pension Guarantee Model. Historical data on contingent liabilities
for deposit insurance were also drawn from the Congressional Budget Office’s study, The Economic Effects
of the Savings and Loan Crisis, issued January 1992.
Pension Liabilities: For 1979–1996, the estimates are
the actuarial accrued liabilities as reported in the annual reports for the Civil Service Retirement System,
the Federal Employees Retirement System, and the
Military Retirement System (adjusted for inflation). Estimates for the years before 1979 are not actuarial;
they are extrapolations. The estimate for 1997 is a projection.
Long-Run Budget Projections
The long-run budget projections are based on longrun demographic and economic projections. A spreadsheet model of the Federal budget developed at OMB
computes the budgetary implications of this forecast.
Demographic and Economic Projections: For the years
1998–2008 the assumptions are identical to those used
in the budget. As always, these budget assumptions
reflect the President’s policy proposals. The long-run
projections extend these budget assumptions by holding
constant inflation, interest rates, and unemployment at
the levels assumed in the final year of the budget.
Population growth and labor force participation are extended using the intermediate assumptions from the
1997 social security trustees’ report. The projected rate
of growth for real GDP is built up from the labor force
assumptions and an assumed rate of productivity
growth. The assumed rate of productivity growth is held

37
constant at the average rate of growth implied by the
budget’s economic assumptions. Income shares of GDP
are held constant at their levels in the last year of
the Administration forecast with one exception: wages
and salaries decline gradually as a share of GDP
through 2028.
Budget Projections: For the budget period, the projections follow the budget. Beyond the budget horizon,
receipts are projected using simple rules of thumb linking income taxes, payroll taxes, excise taxes, and other
receipts to projected tax bases derived from the economic forecast. Outlays are computed in different ways.
Discretionary spending grows at the rate of inflation.
Social security, Medicare, and Federal pensions are projected using the most recent actuarial forecasts available at the time the budget was prepared. These projections are repriced using Administration inflation assumptions. Other entitlement programs are projected
based on rules of thumb linking program spending to
elements of the economic and demographic forecast
such as the poverty rate.
Surpluses after 2008 were assumed to be used to
reduce taxes or increase spending, leaving the budget
recisely in balance.
Alternative Scenarios: The alternative budget scenarios are intended to illustrate the impact of variations in key assumptions underlying the projections.
• Discretionary. The alternatives for discretionary
spending assume that discretionary budget authority after 2008 grows with inflation and total
population growth, or with nominal GDP growth.
• Health care costs. The high scenario for health
care costs assumes that Medicare and Medicaid
real spending per beneficiary grows one percent
faster than in the basic projections, while the low
cost scenario assumes that real spending per beneficiary grows at the rate of real GDP per capita.
The scenario eliminating the Medicare trustees’
assumed slowdown in costs holds real growth per
beneficiary at an average of 2.4 percent annually
for Medicare Parts A and B combined.
• Productivity. The scenarios for productivity growth
assume that productivity grows one-half percentage point faster or slower than in the basic projections.
• Fertility. The scenarios for fertility assume that
the total fertility rate rises to 2.2 or falls to 1.6,
consistent with the social security trustees’ range
for fertility in their high and low cost assumptions.
• Life expectancy. The scenarios for life expectancy
are consistent with the high and low life expectancy assumptions in the long run population projections published by the Bureau of the Census.
The high scenario assumes that life expectancy
rises to 86.4 years for males and 92.3 years for
females in 2050. The low scenario assumes that
life expectancy falls slightly to 70.9 years for
males and 78.8 years for females in 2050.

38

ANALYTICAL PERSPECTIVES

• Immigration. The scenarios for higher and lower
immigration assume that net immigration is
1,350,000 persons per year and 450,000 persons
per year, 50 percent higher and lower than the
900,000 persons assumed in the basic projections.
National Balance Sheet Data
Publicly Owned Physical Assets: Basic sources of data
for the federally owned or financed stocks of capital
are the investment flows described in Chapter 6. Federal grants for State and local government capital were
included together with adjustments for inflation and
depreciation in the same way as described above for
direct Federal investment. Data for total State and local
government capital come from the unrevised capital
stock data prepared by the Bureau of Economic Analysis.
Privately Owned Physical Assets: Data are from the
Flow-of-Funds national balance sheets and from the private net capital stock estimates prepared by the Bureau
of Economic Analysis. Values for 1997 were extrapolated using investment data from the National Income
and Product Accounts.
Education Capital: The stock of education capital is
computed by valuing the cost of replacing the total
years of education embodied in the U.S. population 16
years of age and older at the current cost of providing
schooling. The estimated cost includes both direct expenditures in the private and public sectors and an
estimate of students’ forgone earnings, i.e., it reflects
the opportunity cost of education.
For this presentation, Federal investment in education capital is a portion of the Federal outlays included in the conduct of education and training. This
portion includes direct Federal outlays and grants for
elementary, secondary, and vocational education and
for higher education. The data exclude Federal outlays
for physical capital at educational institutions and for
research and development conducted at colleges and
universities because these outlays are classified elsewhere as investment in physical capital and investment
in R&D capital. The data also exclude outlays under
the GI Bill; outlays for graduate and post-graduate education spending in HHS, Defense and Agriculture; and
most outlays for vocational training.
Data on investment in education financed from other
sources come from educational institution reports on
the sources of their funds, published in U.S. Department of Education, Digest of Education Statistics.
Nominal expenditures were deflated by the implicit
price deflator for GDP to convert them to constant dollar values. Education capital is assumed not to depreciate, but to be retired when a person dies. An education capital stock computed using this method with

different source data can be found in Walter McMahon,
‘‘Relative Returns To Human and Physical Capital in
the U.S. and Efficient Investment Strategies,’’ Economics of Education Review, Vol. 10, No. 4, 1991. The method is described in detail in Walter McMahon, Investment in Higher Education, 1974.
Research and Development Capital: The stock of R&D
capital financed by the Federal Government was developed from a data base that measures the conduct of
R&D. The data exclude Federal outlays for physical
capital used in R&D because such outlays are classified
elsewhere as investment in federally financed physical
capital. Nominal outlays were deflated using the GDP
deflator to convert them to constant dollar values.
Federally funded capital stock estimates were prepared using the perpetual inventory method in which
annual investment flows are cumulated to arrive at
a capital stock. This stock was adjusted for depreciation
by assuming an annual rate of depreciation of 10 percent on the outstanding balance for applied research
and development. Basic research is assumed not to depreciate. The 1993 Budget contains additional details
on the estimates of the total federally financed R&D
stock, as well as its national defense and nondefense
components (see Budget for Fiscal Year 1993, January
1992, Part Three, pages 39–40).
A similar method was used to estimate the stock
of R&D capital financed from sources other than the
Federal Government. The component financed by universities, colleges, and other nonprofit organizations is
based on data from the National Science Foundation,
Surveys of Science Resources. The industry-financed
R&D stock component is from that source and from
the U.S. Department of Labor, The Impact of Research
and Development on Productivity Growth, Bulletin
2331, September 1989.
Experimental estimates of R&D capital stocks have
recently been prepared by BEA. The results are described in ‘‘A Satellite Account for Research and Development,’’ Survey of Current Business, November 1994.
These BEA estimates are lower than those presented
here primarily because BEA assumes that the stock
of basic research depreciates, while the estimates in
Table 2–3 assume that basic research does not depreciate. BEA also assumes a slightly higher rate of depreciation for applied research and development, 11 percent, compared with the 10 percent rate used here.
Social Indicators
The main sources for the data in this table are the
Government statistical agencies. Generally, the data
are publicly available in the President’s annual Economic Report and the Statistical Abstract of the United
States.

FEDERAL RECEIPTS AND COLLECTIONS

39

3.

FEDERAL RECEIPTS

Receipts (budget and off-budget) are taxes and other
collections from the public that result from the exercise
of the Government’s sovereign or governmental powers.
The difference between receipts and outlays determines
the surplus or deficit.
Growth in receipts.—Total receipts in 1999 are estimated to be $1,742.7 billion, an increase of $84.9 billion

Table 3–1.

or 5.1 percent relative to 1998. This increase is largely
due to assumed increases in incomes resulting from
both real economic growth and inflation. Receipts are
projected to grow at an average annual rate of 3.9
percent between 1999 and 2003, rising to $2,028.2 billion.
As a share of GDP, receipts are projected to decline
from 19.9 percent in 1998 to 19.6 percent in 2003.

RECEIPTS BY SOURCE—SUMMARY
(In billions of dollars)
Estimate

Source

1997 actual
1998

1999

2000

2001

2002

2003

Individual income taxes .....................................................................
Corporation income taxes .................................................................
Social insurance and retirement receipts .........................................
(On-budget) ...................................................................................
(Off-budget) ...................................................................................
Excise taxes ......................................................................................
Estate and gift taxes .........................................................................
Customs duties ..................................................................................
Miscellaneous receipts ......................................................................

737.5
182.3
539.4
(147.4)
(392.0)
56.9
19.8
17.9
25.5

767.8
190.8
571.4
(155.4)
(416.0)
55.5
20.4
18.4
33.5

791.5
198.0
595.9
(161.8)
(434.1)
72.0
20.5
18.2
46.7

804.6
202.9
623.0
(169.1)
(453.9)
69.6
21.6
19.5
52.2

833.4
209.2
649.0
(176.3)
(472.7)
71.6
22.6
20.4
56.4

877.1
214.7
677.8
(183.5)
(494.3)
74.0
24.4
22.4
59.0

915.5
220.4
706.5
(189.9)
(516.6)
74.6
25.6
24.0
61.4

Total receipts ...............................................................................
(On-budget) ...............................................................................
(Off-budget) ...............................................................................

1,579.3
(1,187.3)
(392.0)

1,657.9
(1,241.9)
(416.0)

1,742.7
(1,308.6)
( 434.1)

1,793.6
(1,339.7)
(453.9)

1,862.6
(1,389.9)
(472.7)

1,949.3
(1,455.0)
(494.3)

2,028.2
(1,511.5)
(516.6)

Table 3–2.

CHANGES IN RECEIPTS
(In billions of dollars)
Estimate
1998

1

1999

2000

2001

2002

2003

Receipts under tax rates and structure in effect January 1, 1998 ......................................................
Social security (OASDI) taxable earnings base increases:.
$68,400 to $70,800 on Jan. 1, 1999 .....................................................................................................
$70,800 to $74,100 on Jan. 1, 2000 .....................................................................................................
$74,100 to $76,800 on Jan. 1, 2001 .....................................................................................................
$76,800 to $79,800 on Jan. 1, 2002 .....................................................................................................
$79,800 to $82,800 on Jan. 1, 2003 .....................................................................................................
Proposals 2 ......................................................................................................................................................

1,657.9

1,728.7

1,774.4

1,837.3

1,918.0

1,991.8

................
................
................
................
................
–0.1

1.1
................
................
................
................
12.9

3.0
1.6
................
................
................
14.7

3.3
4.1
1.3
................
................
16.7

3.6
4.5
3.3
1.4
................
18.5

3.9
4.9
3.7
3.7
1.4
18.7

Total, receipts under existing and proposed legislation ................................................................

1,657.9

1,742.7

1,793.6

1,862.6

1,949.3

2,028.2

1

These estimates assume a social security taxable earnings base of $68,400 through 2003.
2
Net of income offsets.

41

42

ANALYTICAL PERSPECTIVES

ENACTED LEGISLATION
Several laws were enacted in 1997 that have an effect
on governmental receipts. The major legislative changes
affecting receipts are described below.
Airport and Airway Trust Fund Tax Reinstatement Act of 1997.—This Act reinstated, through September 30, 1997, aviation excise taxes that expired on
December 31, 1996. The reinstated taxes on commercial
air transportation included a 10-percent excise tax on
domestic passenger tickets, a $6-per-person international departure tax, and a 6.5-percent domestic air
freight excise tax. The reinstated taxes also included
an excise tax on fuels used in general aviation of 17.5
cents per gallon for jet fuel and 15 cents per gallon
for aviation gasoline. In addition, the Act authorized
the Treasury Department to transfer to the Airport and
Airway Trust Fund any aviation excise taxes collected
during the fourth quarter of calendar year 1996 but
not remitted to the Federal government during that
period.
Taxpayer Relief Act of 1997. —This Act, together
with the Balanced Budget Act of 1997, implements the
bipartisan budget agreement announced on May 2,
1997. The legislation includes, with certain modifications, the key features of the Administration’s proposals
to give middle-income families the tax relief they need
to help raise their children, save for the future, and
pay for postsecondary education. In addition, the provisions of the Act promote a fairer tax system and encourage economic growth, while being fiscally responsible.
The major provisions of the Act are described below.
Family Tax Relief
Provide tax credit for dependent children.—A credit
is allowed for each dependent child under the age of
17. The credit equals $400 for 1998 and rises to $500
for 1999 and subsequent years. The credit is phased
out for taxpayers with adjusted gross income (AGI) in
excess of the following thresholds: $110,000 for married
taxpayers filing a joint return, $75,000 for a single taxpayer or head of household, and $55,000 for married
taxpayers filing a separate return. The amount of the
credit and the thresholds are not indexed for inflation.
The phase-out rate is $50 for each $1,000 of modified
AGI (or fraction thereof) in excess of the threshold.
For low-income families with three or more children,
a refundable child credit is available to the extent that
their income and employee payroll taxes exceed their
earned income tax credit.
Education Tax Incentives
Provide tax credits for higher education tuition expenses.—Taxpayers are allowed to claim a per-student
nonrefundable tax credit (Hope Credit) for qualified tuition and fees for enrollment of the taxpayer, the taxpayer’s spouse or the taxpayer’s dependent in a postsecondary degree or certificate program. To be eligible

for the credit, a student must be enrolled on at least
a half-time basis. The Hope Credit is equal to 100 percent of the first $1,000 of qualified expenses and 50
percent of the next $1,000 of qualified expenses, for
a maximum credit of $1,500 per student. The maximum
credit is indexed for inflation. The Hope Credit is available for expenses paid after December 31, 1997, for
education furnished in academic periods beginning after
that date, and is available for only the first two years
of a student’s post-secondary education. Alternatively,
taxpayers are allowed a nonrefundable Lifetime Learning Credit for all postsecondary education, including
graduate education. The credit is equal to 20 percent
of qualified tuition and fees paid during the taxable
year on behalf of the taxpayer, the taxpayer’s spouse,
or the taxpayer’s dependent. A maximum credit of
$1,000 per family is provided for expenses paid after
June 30, 1998 and before January 1, 2003; the maximum credit increases to $2,000 per family effective for
expenses paid after December 31, 2002. There is no
limit on the number of years for which the Lifetime
Learning Credit may be claimed. With respect to an
eligible student, a taxpayer may elect either the Hope
Credit, the Lifetime Learning Credit, or the exclusion
from gross income for withdrawals from an education
savings account (discussed below), but only one of these
preferences may be used in a taxable year. Both credits
are phased out for married taxpayers filing a joint return with modified AGI between $80,000 and $100,000
and for single taxpayers and heads of households with
modified AGI between $40,000 and $50,000. The phaseout ranges will be indexed for inflation beginning in
2002.
Provide deduction for student loan interest.—Interest
paid on a qualified education loan during the first 60
months that payment is required is deductible for income tax purposes, effective for payments due and paid
after December 31, 1997. The maximum allowable deduction is $1,000 in 1998, $1,500 in 1999, $2,000 in
2000 and $2,500 in 2001 and subsequent years. The
maximum amount is not indexed for inflation. In addition, the deduction is phased out ratably for single taxpayers with AGI between $40,000 and $55,000 and for
married taxpayers filing a joint return with AGI between $60,000 and $75,000. The phase-out ranges are
indexed for inflation beginning after 2002.
Expand tax preferences provided qualified State tuition programs.—Qualified State tuition programs (programs eligible for tax-exempt status and deferral of
tax on earnings) are expanded to include State programs where individuals prepay for room and board,
in addition to tuition, fees, books and supplies. This
Act also expands the definition of eligible institution,
expands the definition of ‘‘member of the family’’ with
regard to tax-free rollovers of credits or account balances, and clarifies the estate and gift tax treatment
of contributions to such programs. These modifications
generally are effective after December 31, 1997.

3.

43

FEDERAL RECEIPTS

Provide penalty-free withdrawals from Individual Retirement Accounts (IRAs) for education expenses.—Penalty-free withdrawals are permitted from IRAs for
qualified higher education expenses of the taxpayer,
the taxpayer’s spouse, and the children and grandchildren of the taxpayer and the taxpayer’s spouse. The
provision applies to distributions made after December
31, 1997 with respect to expenses paid after that date
for education furnished in academic periods beginning
after that date.
Establish education savings accounts for children
under 18.—Effective for taxable years beginning after
December 31, 1997, taxpayers may contribute up to
$500 per year, per beneficiary under age 18, to an
education savings account. Earnings on contributions
accumulate tax-free and distributions are excludable
from gross income to the extent that the distribution
does not exceed qualified higher education expenses incurred during the year the distribution is made. The
earnings portion of a distribution not used to cover
qualified education expenses is includable in the gross
income of the beneficiary and is generally subject to
an additional 10-percent tax. However, prior to the beneficiary reaching age 30, tax-free (and penalty-free) rollovers of account balances may be made to an education
IRA benefitting another family member. The contribution limit is phased out ratably for married couples
filing a joint return with AGI between $150,000 and
$160,000 and for single taxpayers and heads of households with AGI between $95,000 and $110,000. If a
taxpayer uses tax-free education savings account withdrawals for a student’s qualified education expenses
in a taxable year, neither the Hope Credit nor the
Lifetime Learning Credit may be claimed in that year
for the same student’s education expenses.
Extend exclusion for employer-provided educational
assistance.—Certain amounts paid by an employer for
undergraduate educational assistance expenses are excluded from the employee’s gross income for income
and payroll tax purposes. This exclusion, which was
scheduled to expire with respect to undergraduate education beginning after June 30, 1997, is extended to
apply to undergraduate education courses beginning before June 1, 2000. The exclusion is limited to $5,250
of undergraduate educational assistance with respect
to an individual during a calendar year.
Modify limit on qualified section 501(c)(3) private activity bonds.—Interest on State and local government
bonds generally is excluded from income if the bonds
are issued to finance activities carried out and paid
for with revenues of these governments. Interest on
bonds issued by these governments to finance activities
of other persons, e.g., private activity bonds, is taxable
unless a specific exception is provided in law. One such
exception is for private activity bonds issued by certain
tax-exempt organizations (section 501(c)(3) organizations) to finance activities that do not constitute an
unrelated trade or business. The $150 million limit on
the amount of outstanding bonds issued by an organization for other than hospital purposes is repealed, effec-

tive for section 501(c)(3) bonds isued after August 5,
1997 that are used to finance capital expenditures incurred after that date.
Enhance deduction for corporate contributions of computer technology and equipment.—Under current law
augmented deductions are provided for certain corporate contributions of inventory property and scientific
equipment. The amount of augmented deduction available to a corporation making these contributions is
equal to its basis in the donated property plus onehalf of the amount of ordinary income that would have
been realized if the property had been sold. However,
the amount of augmented deduction cannot exceed
twice the basis of the donated property. Effective for
contributions made in taxable years beginning after
1997 and before January 1, 2000, the list of contributions that qualify for the augmented deduction is expanded to include gifts of computer technology and
equipment to be used within the United States for educational purposes in any of grades K-12.
Provide tax credit for holders of qualified zone academy bonds.—Certain financial institutions that hold
qualified zone academy bonds are provided a nonrefundable tax credit in an amount equal to a credit
rate (set by the Department of Treasury) multiplied
by the face amount of the bond. The tax credit is includable in the gross income of the holder as interest. A
qualified zone academy bond is any bond issued by
a State or local government, provided that (1) 95 percent of the proceeds are used for the purpose of renovating, providing equipment to, developing course materials for use at, or training teachers and other school
personnel in a qualified zone academy and (2) private
entities have promised to contribute to the qualified
zone academy certain equipment, technical assistance
or training, employee services, or other property or
services with a value equal to at least 10 percent of
the bond proceeds. A total of $400 million of qualified
zone academy bonds may be issued in each of 1998
and 1999. The bond cap is allocated each year to the
States according to their respective populations of individuals below the poverty line; any unused allocation
may be carried into subsequent years.
Savings and Investment Incentives
Expand Individual Retirement Accounts (IRAs).—
Under prior law, eligibility for a deductible IRA was
phased out for a single taxpayer with AGI between
$25,000 and $35,000 and a married taxpayer filing a
joint return with AGI between $40,000 and $50,000,
if the individual (or the individual’s spouse) was an
active participant in an employer-sponsored retirement
plan. Under this Act, the AGI thresholds and phaseout ranges are doubled over time. For 1998, eligibility
is phased out for single taxpayers with AGI between
$30,000 and $40,000, and for couples filing a joint return with AGI between $50,000 and $60,000. For 1999
through 2002, the phase-out ranges are increased by
$1,000 per year. For 2003, eligibility is phased out for
single taxpayers with AGI between $40,000 and

44
$50,000, and for couples filing a joint return with AGI
between $60,000 and $70,000. For 2004 and later years,
the phase-out ranges are increased by $5,000 per year
until the phase-out range is $50,000 to $60,000 for single taxpayers (2005 and subsequent years) and $80,000
to $100,000 for couples filing a joint return (2007 and
subsequent years). Spouses of individuals who are active participants in an employer-sponsored retirement
plan, but who are not themselves active participants,
are permitted to make deductible contributions to an
IRA. This spousal deduction is phased out for taxpayers
with AGI between $150,000 and $160,000.
A new, tax-free nondeductible IRA called the ‘‘Roth
IRA’’ is created. Eligibility for participation in these
IRAs is phased out for single taxpayers with AGI between $95,000 and $110,000 and for married couples
filing a joint return with AGI between $150,000 and
$160,000. Taxpayers with AGI of less than $100,000
are eligible to roll over or convert an existing IRA to
a Roth IRA. Distributions from the Roth IRA generally
are tax free if (i) made more than 5 years after an
account has been established, and (ii) made after age
591⁄2, upon death or disability, or for first-time homebuyer expenses (up to a $10,000 lifetime cap). The same
exceptions to the 10-percent early withdrawal tax apply
to Roth IRAs and deductible IRAs, and these prior law
exceptions have been expanded to include withdrawals
for qualified first-time homebuyer expenses and qualified education expenses. Annual contributions to all
IRAs for an individual may not exceed $2,000.
Reduce tax rate on capital gains.—The maximum capital gains tax rate for individuals is reduced from 28
percent to 20 percent (10 percent for individuals in
the 15-percent tax bracket) effective May 7, 1997. The
prior law maximum tax rate of 28 percent is retained
for collectibles and, effective July 29, 1997, for assets
held between 1 year and 18 months. Real estate depreciation recapture generally is taxed at a maximum rate
of 25 percent. Beginning in 2001, assets acquired after
December 31, 2000 and held for 5 years will be taxed
at favorable rates of 8 percent (those in the 15-percent
bracket) and 18 percent (those in other tax brackets).
A taxpayer holding a capital asset or an asset used
in his/her trade or business on January 1, 2001, may
elect to treat the asset as having been sold on that
date for its fair market value and as having been reacquired at the market price. Taxes must be paid on
any gain realized as a result of the election; losses
are disallowed.
Provide capital gains exclusion on sale of principal
residence.—Under prior law gains on the sale of a taxpayer’s principal residence were subject to the capital
gains tax; however, taxes on the gain could be deferred
through the purchase of a new home of equal or greater
value within a specified period of time. Taxpayers over
55 could elect to take a one-time exclusion of up to
$125,000 of gain from the sale of their home. Effective
for sales on or after May 7, 1997, up to $500,000 of
gain from the sale of a taxpayer’s principal residence
($250,000 for a single taxpayer) is excluded from tax.

ANALYTICAL PERSPECTIVES

The exclusion is allowed each time a taxpayer selling
or exchanging a principal residence meets the eligibility
requirements, but generally no more frequently than
once every two years. To be eligible for the exclusion,
a taxpayer generally must have owned the residence
and occupied it as a principal residence for at least
two of the five years prior to the sale or exchange.
Alternative Minimum Tax (AMT) Provisions
Exempt small corporations from the AMT and conform AMT depreciation lives to the regular tax.—For
taxable years beginning after December 31, 1997, the
corporate AMT is repealed for small businesses. A corporation with average gross receipts of less than $5
million for three taxable years, the last of which begins
after December 31, 1996, is a small business corporation for any taxable year beginning after December 31,
1997. The exemption continues to apply as long as the
business has three-year average gross receipts of less
than $7.5 million. In addition, for property placed in
service after December 31, 1998, the recovery periods
used for purposes of the AMT depreciation adjustment
are equal to the recovery periods used for purposes
of the regular tax under present law.
Estate, Gift, and Generation-Skipping Tax
Provisions
Increase estate and gift tax unified credit.—Under
prior law, a unified estate and gift tax credit of
$192,800 was provided, which effectively exempted the
first $600,000 of cumulative taxable transfers from tax.
Under this Act, a phased-in increase in the unified
credit increases the effective exemption to $1,000,000
in 2006. The effective exemption is $625,000 for decedents dying and gifts made in 1998, $650,000 in 1999,
$675,000 in 2000 and 2001, $700,000 in 2002 and 2003,
$850,000 in 2004, $950,000 in 2005, and $1,000,000
in 2006 and subsequent years.
Provide estate tax exclusion for qualified family-owned
businesses, including farms.—If ‘‘family-owned business
interests’’ comprise more than 50 percent of a decedent’s estate and certain other requirements are met,
the first $1 million in qualified family-owned business
interests may be excluded from a decedent’s taxable
estate. This exclusion, which is effective with respect
to decedents dying after December 31, 1997, is in addition to the unified credit; however, the total amount
excluded from tax is capped at $1.3 million.
Reduce estate tax for certain land subject to permanent conservation easement.—A 40-percent estate tax
exclusion is provided for the value of any land subject
to a qualified conservation easement that meets specified requirements. The maximum allowable exclusion
is $100,000 in 1998, $200,000 in 1999, $300,000 in
2000, $400,000 in 2001 and $500,000 in 2002 and subsequent years. The exclusion may be taken in addition
to the maximum exclusion for qualified family-owned
business interests and applies to decedents dying after
December 31, 1997.

3.

45

FEDERAL RECEIPTS

Prohibit the revaluation of gifts for estate tax purposes
after expiration of 3-year statute of limitations.—Estate
and gift taxes generally must be assessed within 3
years after the filing of the return. In the past, in
order to determine the appropriate tax rate bracket
and unified credit for the estate tax, the Courts generally permitted the revaluation of a gift for which the
statute of limitation period had expired. Effective for
gifts made after August 5, 1997, revaluation of a gift
for which the limitations period has expired is no longer
permitted.
Expiring Provisions
Extend research and experimentation tax credit.—The
20-percent tax credit for certain incremental research
and experimentation expenditures is extended to apply
to expenditures paid or incurred during the period June
1, 1997 through June 30, 1998.
Extend orphan drug tax credit.—The 50-percent nonrefundable tax credit provided for qualified clinical testing expenses paid or incurred in the testing of certain
drugs for rare diseases or conditions (generally known
as ‘‘orphan drugs’’) is permanently extended, effective
for expenses paid or incurred after May 31, 1997.
Extend deduction for contributions of stock to private
foundations.—The deduction for a contribution of property to a private foundation is limited to the adjusted
basis of the contributed property. However, prior law
allowed a taxpayer who contributed qualified appreciated stock to a private foundation before June 1, 1997
to deduct the full fair market value of the stock, rather
than the adjusted basis of the contributed stock. This
Act extends the rule for private foundations through
June 30, 1998.
Extend work opportunity tax credit, with modifications.—Under prior law, an employer hiring individuals
from one or more of seven targeted groups was allowed
a work opportunity tax credit equal to 35 percent of
the first $6,000 in qualified first-year wages paid to
a qualified individual beginning work after September
30, 1996 and before October 1, 1997. For wages paid
to be eligible for the credit, the qualified individual
had to be employed by the employer for at least 180
days (20 days in the case of a qualified summer youth
employee) or 400 hours (120 hours in the case of a
qualified summer youth employee). This Act extends
the credit to apply to wages paid to qualified individuals beginning work after September 30, 1997 and before July 1, 1998. In addition, a credit of 25 percent
is provided for wages paid to a qualified individual
employed at least 120 and fewer than 400 hours, and
the credit is increased to 40 percent for wages paid
to a qualified individual employed for at least 400
hours. Eligibility is extended to members of families
receiving AFDC benefits (or its successor programs) and
to SSI beneficiaries.
Extend Generalized System of Preferences (GSP).—
Under GSP, duty-free access is provided to over 4,000
items from eligible developing countries that meet certain worker rights, intellectual property protection, and

other criteria. This program, which had expired after
May 31, 1997, is temporarily extended through June
30, 1998. Refunds of any duty paid between May 31,
1997 and August 5, 1997 are provided upon request
of the importer.
Extend unemployment surtax and increase the statutory limit on Federal Unemployment Act (FUTA) trust
fund balances.—The temporary unemployment surtax
of 0.2 percent imposed on employers, which was scheduled to expire with respect to wages paid after December 31, 1998, is extended through December 31, 2007.
In addition, the statutory limit on balances in the Federal Unemployment Account (FUA) of the FUTA trust
fund is increased from .25 percent to .50 percent of
covered wages.
District of Columbia (D.C.) Tax Incentives
Designate D.C. Enterprise Zone.—Certain economically depressed census tracts within D.C. are designated as the ‘‘D.C. Enterprise Zone.’’ The following
tax incentives are available to businesses and individual residents within the zone: (1) a 20-percent wage
credit for the first $15,000 of wages paid to D.C. residents who work in the zone; (2) an additional $20,000
of expensing under section 179 for qualified zone property; and (3) special tax-exempt financing for certain
zone facilities. The D.C. Enterprise Zone designation
will remain in effect for the period from January 1,
1998 through December 31, 2002.
Provide zero-percent capital gains rate on certain Enterprise Zone property.—A zero-percent capital gains
rate is provided for capital gains from the sale of certain qualified assets held for more than five years. To
qualify for the zero-percent rate, the asset must be
within a census tract within the D.C. Enterprise Zone
where the poverty rate is not less than 10 percent.
Provide tax credit to first-time homebuyers.—A tax
credit of up to $5,000 of the purchase price is provided
first-time homebuyers of a principal residence in the
District of Columbia. The credit phases out for single
taxpayers with AGI between $70,000 and $90,000 and
for married couples filing a joint return with AGI between $110,000 and $130,000. The credit is available
with respect to property purchased after August 4, 1997
and before January 1, 2001.
Welfare-to-Work Tax Credit
Provide welfare-to-work tax credit.—Employers are
provided a tax credit on the first $20,000 of eligible
wages paid to qualified recipients of long-term family
assistance (AFDC or its successor program) during the
first two years of employment. The credit is 35 percent
of the first $10,000 of eligible wages in the first year
of employment and 50 percent of the first $10,000 of
eligible wages in the second year of employment. The
credit is effective for wages paid or incurred by the
employer for a qualified employee who begins work on
or after January 1, 1998 and before May 1, 1999.

46

ANALYTICAL PERSPECTIVES

Excise Tax Provisions
Repeal excise tax on diesel fuel used in recreational
motorboats.—The 24.3-cents-per-gallon excise tax on
diesel fuel used in recreational motorboats is repealed.
Under prior law, imposition of this tax had been suspended through December 31, 1997.
Transfer 4.3-cents-per-gallon General Fund highway
fuels tax to the Highway Trust Fund.—Under prior law
4.3-cents-per-gallon of the excise tax on gasoline, diesel
fuel, and special motor fuels used in highway vehicles
was transferred to the General Fund of the Treasury.
Under this Act, collections from these taxes are deposited in the Highway Trust Fund, with 3.45-cents-pergallon allocated to the Highway Account and .85-centsper-gallon allocated to the Mass Transit Account. Conforming amendments ensure that no direct spending
increases will occur as a result of this transfer of funds.
Modify deposit rules for excise taxes on highway motor
fuels.—The excise taxes imposed on highway motor
fuels that would otherwise be required to be deposited
with the Treasury after July 31, 1998 and before September 30, 1998 are not required to be deposited until
October 5, 1998, resulting in a shift of collections from
1998 to 1999.
Modify and expand excise tax on vaccines.—Under
prior law an excise tax was imposed on the following
vaccines: DPT (diphtheria, pertussis, tetanus) at $4.56
per dose; DT (diphtheria, tetanus) at $0.06 per dose;
MMR (measles, mumps, or rubella) at $4.44 per dose;
and polio at $0.29 per dose. Effective for sales after
August 5, 1997, a uniform rate of $0.75 per dose on
any listed vaccine component is imposed on all previously taxed vaccines. In addition, the tax is expanded
to apply to HIB (haemophilus influenza type B), Hepatitis B, and varicella (chickenpox) vaccines
Extend and modify excise taxes deposited in the Airport and Airway Trust Fund.—Under prior law, the
excise taxes deposited in the Airport and Airway Trust
Fund were scheduled to expire after September 30,
1997. These taxes included a 10-percent excise tax on
domestic passenger tickets, a $6-per-person international departure tax, a 6.5-percent domestic air
freight excise tax, and an excise tax on fuels used in
general aviation of 17.5 cents per gallon for jet fuel
and 15 cents per gallon for aviation gasoline. This Act
extends these taxes for 10 years, through September
30, 2007, with the following modifications:
• Tax on domestic passenger tickets.—The 10-percent ad valorem tax on domestic passenger tickets
is replaced with a combination ad valorem and
per-domestic-flight-segment tax. Effective October
1, 1997 the tax is 9 percent of fare plus $1 per
domestic flight segment. The tax changes to 8 percent of fare and $2 per domestic flight segment
effective October 1, 1998; and to 7.5 percent of
fare and $2.25 per domestic flight segment effective October 1, 1999. The ad valorem tax remains
at 7.5 percent, but the per-domestic-flight-segment
tax increases to $2.50 effective January 1, 2000,
$2.75 effective January 1, 2001 and $3 effective

January 1, 2002. The $3 rate is indexed annually
for inflation effective January 1, 2003. The perdomestic-flight-segment tax is not imposed on
flight segments to and from qualified rural airports; the ad valorem tax on such flights is 7.5
percent of fare. The 7.5 percent ad valorem tax
also applies to payments to air carriers (and related parties) for the right to award air travel benefits.
• Tax on international departures and arrivals.—
The $6-per-passenger international departure tax
is increased to $12 per passenger and extended
to apply to international arrivals effective October
1, 1997. A $6-per-passenger rate is applicable to
the international airspace component of flights between the 48 contiguous States and Alaska or Hawaii (or flights between Alaska and Hawaii). Both
the $6 and $12 taxes are indexed annually for
inflation effective January 1, 1999.
• Deposit schedule for certain aviation taxes.—Deposits of air passenger taxes otherwise due after
August 14, 1997 and before October 1, 1997 are
due on October 10, 1997. In addition, deposits of
air passenger taxes otherwise required after August 14, 1998 and before October 1, 1998 are due
on October 5, 1998. Deposits of commercial air
cargo and aviation fuels taxes otherwise required
to be made after July 31, 1998 and before October
1, 1998 are due on October 5, 1998.
• Transfer of General Fund taxes.—The 4.3-centsper-gallon excise tax on aviation fuels that was
deposited in the General Fund of the Treasury
under prior law is deposited in the Airport and
Airway Trust Fund effective October 1, 1997.
Impose excise taxes on kerosene as diesel fuel.—A
24.3-cents-per-gallon excise tax is imposed on diesel fuel
upon removal from a registered terminal storage facility
unless the fuel is indelibly dyed and is destined for
a nontaxable use. Under prior law, undyed kerosene
was not subject to the diesel fuel excise tax when it
was removed from a terminal. Undyed kerosene was
subject to tax, however, when it was blended with previously taxed diesel fuel. Effective July 1, 1998, kerosene is taxed as diesel fuel when it is removed from
a terminal. Exceptions are provided for aviation fuel
and, to the extent provided in regulations, for feedstock
uses. In addition, special refund rules apply in certain
cases of kerosene used for heating purposes.
Reinstate excise taxes deposited in the Leaking Underground Storage Tank (LUST) Trust Fund.—Before January 1, 1996, a 0.1-cent-per-gallon excise tax was levied
on gasoline, other motor fuels, methanol and ethanol
fuels, aviation fuels, and on fuels used in inland waterways and deposited in the LUST Trust Fund. This Act
reinstates those taxes effective October 1, 1997 through
March 31, 2005.
Apply communications excise tax to prepaid telephone
cards.—A 3-percent excise tax is imposed on amounts
paid for local and toll telephone service and teletypewriter exchange service. This Act extends this tax to

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47

FEDERAL RECEIPTS

apply to amounts paid to communications service providers (in cash or in kind) for the right to award or
otherwise distribute free or reduced-rate telephone service. The tax is effective for cards sold after October
31, 1997.
Modify treatment of tires under the heavy highway
vehicle retail excise tax.—A 12-percent retail excise tax
is imposed on certain heavy highway trucks and trailers, and on highway tractors. A separate manufacturer’s excise tax is imposed on tires weighing more than
40 pounds. Under prior law, because tires were taxed
separately, the value of tires installed on highway vehicles was excluded from the 12-percent retail excise tax
on heavy highway vehicles. This Act repeals this exclusion; instead, a credit for the amount of manufacturers’
excise tax paid on the tires is allowed. This change
is effective after December 31, 1997.
Small Business Provisions
Clarify definition of principal place of business for
home office deduction.—The definition of ‘‘principal
place of business’’ is expanded to include a home office
that is used by the taxpayer to conduct administrative
or management activities of the business, provided that
there is no other fixed location where the taxpayer conducts substantial administrative or management activities of the business, regardless of whether such activities are performed by others at other locations. As
under prior law, deductions are allowed only if the office is exclusively used on a regular basis as a place
of business and, in the case of an employee, only if
such exclusive use is for the convenience of the employer. The expanded definition applies to taxable years
beginning after December 31, 1998.
Increase deduction of health insurance costs for selfemployed individuals.—Under prior law self-employed
individuals were allowed a deduction for the cost of
health insurance for themselves and their spouse and
dependents as follows: 40 percent for 1997; 45 percent
for 1998 through 2002; 50 percent for 2003; 60 percent
for 2004; 70 percent for 2005; and 80 percent for 2006
and subsequent years. This Act increases the allowable
deduction to 100 percent as follows: 45 percent for 1998
and 1999; 50 percent for 2000 and 2001; 60 percent
for 2002; 80 percent for 2003 through 2005; 90 percent
for 2006; and 100 percent for 2007 and subsequent
years.
Increase deduction for business meals for certain individuals.—Generally the amount allowable as a deduction for food and beverage is limited to 50 percent of
the otherwise deductible amount. Exceptions to this 50percent rule are provided for food and beverages provided to crew members of certain vessels and offshore
oil or gas platforms or drilling rigs. This Act increases
the deduction for food and beverages consumed while
away from home by an individual during or incident
to a period of duty subject to the hours of service limitations of the Department of Transportation. Such individuals include certain air transportation employees,
interstate truck operators and bus drivers, certain rail-

road employees and certain merchant mariners. The
increase in the deductible percentage is phased in as
follows: 55 percent for 1998 and 1999, 60 percent for
2000 and 2001, 65 percent for 2002 and 2003, 70 percent for 2004 and 2005, 75 percent for 2006 and 2007,
and 80 percent for 2008 and subsequent years.
Increase standard mileage rate for purposes of computing the charitable deduction.—Effective for taxable
years beginning after December 31, 1997, for purposes
of computing the charitable deduction, the standard
mileage rate for the use of a passenger vehicle is increased from 12 cents per mile to 14 cents per mile.
Incentives for Distressed Areas
Provide tax incentive to clean up environmentally contaminated areas known as brownfields.—A current deduction is allowed for certain costs incurred by businesses to remediate environmentally contaminated land
in certain areas. Qualified sites generally are limited
to those properties located in or next to census tracts
with a poverty rate of 20 percent or more, Federal
empowerment zones and enterprise communities, and
areas subject to certain Environmental Protection Agency (EPA) Brownfields Pilots. To claim this incentive,
taxpayers are required to obtain from the appropriate
State or local agency verification that the site satisfies
geographic and contamination requirements. The deduction is available for qualified expenses incurred after
August 5, 1997 and before January 1, 2001.
Expand and modify Empowerment Zone and Enterprise Community program.—Under the Omnibus Budget Reconciliation Act of 1993 (OBRA 93), certain tax
incentives were provided for nine empowerment zones
(6 urban and 3 rural) and 95 enterprise communities.
The tax incentives were a 20-percent employer wage
credit, an additional $20,000 of section 179 expensing,
and a new category of tax-exempt financing. Qualifying
businesses in empowerment zones were eligible for all
three incentives, while businesses in enterprise communities were eligible only for the tax-exempt financing.
This Act authorizes the designation of two additional
urban empowerment zones within 180 days of enactment; however, the designations, which generally will
remain in effect for 10 years, will not take effect before
January 1, 2000. These two additional zones are subject
to the same eligibility criteria as the original 6 urban
empowerment zones, and, except for a modification of
the wage credit, generally enjoy the same tax incentives
as the original zones. For these two additional zones
the wage credit is modified slightly to provide that the
percentage of wages taken into account for purposes
of determining the wage credit is 20 percent for 2000
through 2004, 15 percent for 2005, 10 percent for 2006,
and 5 percent for 2007; the credit is not available for
subsequent years. The Act also authorizes the designation of an additional 20 empowerment zones before
1999. Businesses in these 20 additional zones are not
eligible for the wage credit, but are eligible to receive
up to $20,000 of additional section 179 expensing, and
special tax-exempt financing benefits. The ‘‘brownfields

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ANALYTICAL PERSPECTIVES

tax incentive’’ provided in this Act (see discussion
above) is available within all designated empowerment
zones.
Financial Product Provisions
Require recognition of gain on certain appreciated positions in personal property.—Gains and losses generally are taken into account for tax purposes when
realized. Gains or losses are usually realized with respect to a capital asset at the time the asset is sold
or exchanged. However, because of special rules under
prior law, many transactions designed to reduce or
eliminate risk of loss and opportunity for gain on financial assets generally did not cause realization. For example, taxpayers could lock in gain on securities without recognizing gain for tax purposes by entering into
a ‘‘short sale against the box,’’ that is, the taxpayer
could own securities the same as or substantially identical to the securities borrowed and sold short. This
Act requires in some circumstances recognition of gain
(but not loss) upon entering into a constructive sale
of any appreciated financial position in stock, a debt
instrument, or a partnership interest. A constructive
sale occurs when the taxpayer enters into one of the
following transactions with respect to the same or substantially identical property: (1) a short sale, (2) an
offsetting notional principal contract, (3) a futures or
forward contract, or (4) to the extent provided in regulations, one or more transactions that have substantially
the same effect as one of the described transactions.
This provision generally is effective for constructive
sales entered into after June 8, 1997.
Permit dealers in commodities and traders in securities and commodities to elect mark-to-market.—This Act
permits securities traders and commodities traders and
dealers to elect mark-to-market accounting similar to
that currently required for securities dealers. All securities held by an electing taxpayer in connection with
a trade or business as a securities trader, and all commodities held by an electing taxpayer in connection
with a trade or business as a commodities dealer or
trader, are subject to mark-to-market treatment. Property not held in connection with an electing taxpayer’s
trading activity is not subject to the election provided
that it is identified by the taxpayer, under rules similar
to the present law rules for securities dealers, and the
electing taxpayer can demonstrate by clear and convincing evidence that the property bears no relation to its
activities as a trader. Gain or loss recognized by an
electing taxpayer under the provision is ordinary gain
or loss. This provision applies to taxable years ending
after August 5, 1997.
Change the treatment of gains and losses on extinguishment.—The tax law distinguishes between the sale
of a right or obligation to a third party and the extinguishment or retirement of the right or obligation. A
sale to a third party can give rise to capital treatment
while an extinguishment produces ordinary income.
Under prior law extinguishment treatment was eliminated for all debt instruments except those issued by

natural persons and for most options and other positions in actively traded property. This Act eliminates
the remaining portions of the extinguishment doctrine
so that gain or loss attributable to the cancellation,
lapse, expiration, or other termination of any right or
obligation which is (or on acquisition would be) a capital asset in the hands of the taxpayer is treated as
gain or loss from the sale or exchange of a capital
asset. This change applies to property acquired or positions established 30 days after the date of enactment.
In addition, redemptions of debt issued by natural persons and debt issued before July 2, 1982 are treated
as an exchange and, accordingly, any gain or loss on
that redemption is capital gain or loss effective for debt
issued or purchased after June 8, 1997.
Deny interest deduction on certain debt instruments.—
If an instrument qualifies as equity, the issuer generally does not receive a deduction for dividends paid.
If an instrument qualifies as debt, the issuer may deduct accrued interest, including original issue discount
(OID). The Act eliminates the deduction for interest
and OID on a debt instrument that is issued by a
corporation and that is payable in stock of the issuer
or a related party. The Act applies to debt instruments
that are mandatorily convertible or convertible at the
issuer’s option into stock of the issuer or of a related
party. The Act does not apply to debt instruments that
are convertible at the holder’s option unless, at the
time the instrument is issued, it is substantially certain
that the holder’s option will be exercised. This provision
generally is effective for instruments issued after June
8, 1997.
Require reasonable payment assumptions for interest
accruals on certain debt instruments.— A taxpayer that
holds a debt instrument generally accrues interest income over the life of the instrument. Certain debt instruments, such as credit card receivables, do not require the debtors to pay interest if they pay their balances in full by a specified date. The operation of the
interest accrual rules of prior law provided that, in
such instances, the holder could assume that each debtor would pay its balance by the specified date and,
thereby, avoid accruing interest over the life of the
debt instrument. In these cases, the holder would not
accrue any interest income until the specified date had
passed. In the case of a large pool of such debt instruments, the assumption that each debtor will prepay
(and thereby avoid a finance charge) is unrealistic and
results in the mismeasurement of income. Under the
Act, taxpayers that hold large pools of prepayable debt
instruments must accrue interest on the pool by making
a reasonable assumption regarding the timing of payments on the instruments that make up the pool. The
provision is effective for taxable years beginning after
August 5, 1997.
Corporate Organizations and Reorganizations
Require gain recognition for certain extraordinary
dividends.—A corporate shareholder generally is allowed to deduct a percentage of dividends received from

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49

FEDERAL RECEIPTS

another domestic corporation. A distribution in redemption of stock may be treated as a dividend if the shareholder’s proportionate interest in the distributing corporation has not been meaningfully reduced. In determining if a shareholder’s interest has been meaningfully reduced, the ownership of options to purchase
stock may be treated as actual stock ownership, rather
than as a sale of the stock, if it is essentially equivalent
to a dividend. Certain dividends and dividend equivalent transactions are treated as ‘‘extraordinary’’ dividends. Whether a dividend is ‘‘extraordinary’’ is determined, among other things, by reference to the size
of the dividend in relation to the adjusted basis of the
shareholder’s stock. If a corporate shareholder receives
an extraordinary dividend, the corporate shareholder
must reduce the basis of the stock to which the distribution relates by the amount of the nontaxed portion
of the dividend (generally the amount of the dividend
that was deducted). Under prior law, if the nontaxed
portion of the dividend exceeded the basis of the stock,
the excess was deferred and not taxed as gain until
the sale or disposition of the stock. Under this Act
a corporate shareholder generally is required to recognize gain immediately with respect to any redemption
treated as a dividend when the nontaxed portion of
the dividend exceeds the basis of the shares surrendered, if the redemption is treated as a dividend due
to options being counted as stock ownership. In addition, immediate gain recognition is required whenever
the basis of stock with respect to which any extraordinary dividend is received is reduced below zero. These
changes generally are effective for distributions after
May 3, 1995, unless made pursuant to the terms of
a written binding contract in effect on May 3, 1995
or a tender offer outstanding on May 3, 1995.
Require gain recognition on certain distributions of
controlled corporation stock.—A corporation generally is
required to recognize gain on a distribution of property
(including stock of a controlled corporation) unless the
distribution meets certain requirements. Under prior
law, if various requirements were met, including restrictions relating to acquisitions and dispositions of
stock of the distributing corporation or the controlled
corporation, a distribution of the stock of a controlled
corporation generally was tax-free to the distributing
corporation. This Act adopts additional restrictions on
acquisitions and dispositions of the stock of a distributing corporation or controlled corporation. Under this
Act, the distributing corporation is required to recognize
gain on the distribution of the stock of the controlled
corporation if the shareholders of the distributing corporation do not retain 50-percent or more of the stock
interest in either the distributing or controlled corporation during the four-year period commencing two years
prior to the distribution. In addition, distributions within an affiliated group of corporations, in connection with
such a distribution or acquisition transaction, are no
longer tax free. These changes generally are effective
for distributions after April 16, 1997.

Reform the tax treatment of certain stock transfers.—
Certain sales of stock to a related corporation are treated as the payment of a dividend by the purchaser.
Such dividends may qualify for the dividends received
deduction; in addition, such dividends may bring with
them foreign tax credits. For example, if a foreign-controlled domestic corporation sells the stock of a subsidiary to a foreign sister corporation, the domestic corporation may take the position that it is entitled to credit
foreign taxes that were paid by the foreign sister corporation. This Act limits the amount treated as a dividend (and the associated foreign tax credits) from the
purchaser to the amount of the purchaser’s earnings
and profits attributable to stock owned by U.S. persons
related to the seller. The Act also clarifies that a
deemed dividend from a purchaser that is a domestic
corporation generally should be treated as an extraordinary dividend requiring a basis reduction and gain
recognition to the extent that the nontaxed portion exceeds the basis of the shares transferred. These changes
generally are effective for distributions or acquisitions
after June 8, 1997, but do not apply to such distributions or acquisitions made pursuant to a written agreement that was binding on that date.
Modify holding period for dividends-received deduction.—The dividends-received deduction is allowed to
a corporate shareholder only if the shareholder satisfies
a 46-day holding period for the dividend-paying stock
or a 91-day period for certain dividends on preferred
stock. The 46- or 91-day holding period generally does
not include any time in which the shareholder is protected from the risk of loss otherwise inherent in the
ownership of an equity interest. However, under prior
law, the holding period requirement did not have to
be proximate to the time the dividend distribution was
made. This Act requires that in order to qualify for
the dividends-received deduction, the holding period requirement must be satisfied with respect to that dividend over a period immediately before or immediately
after the taxpayer becomes entitled to receive the dividend. This change generally is effective for dividends
paid or accrued more than 30 days after August 5,
1997.
Pension and Employee Benefit Provisions
The Act makes a number of changes affecting pension
plans and other employee benefits, including the following:
Change rule relating to involuntary distributions from
retirement plans.—In the case of a participant who separates from service with the employer, a qualified retirement plan may cash out the participant’s benefits
without the participant’s consent if the present value
of the benefits does not exceed a dollar limit. The Act
increases this limit from $3,500 to $5,000 effective for
plan years beginning after August 5, 1997.
Repeal excess distribution and excess retirement accumulation taxes.—Under prior law, an individual’s distributions from qualified retirement plans, tax-sheltered
annuities and IRAs, that, in the aggregate, exceeded

50
$160,000 in a calendar year (or, if made as a lump
sum distribution, five times that amount) were subject
to a 15-percent excise tax on ‘‘excess’’ distributions. This
excise tax was suspended for distributions received in
1997, 1998, or 1999. An individual’s balance in retirement plans was subject to an additional 15-percent estate tax on excess distributions to the extent that the
balance exceeded the present value of a benefit that
would not be subject to the 15-percent excise tax on
excess distributions. The Act repeals both the excise
tax on excess distributions (effective for distributions
received after 1996) and the estate tax on excess retirement accumulations (effective for decedents dying after
1996).
Treat matching contributions of self-employed individuals as not constituting elective deferrals.—Employees
may elect to make tax-deferred elective contributions
(‘‘elective deferrals’’) to a 401(k) plan up to an indexed
dollar limit ($10,000 for 1998). Employers may make
matching contributions based on the employees’ elective
deferrals. Similarly, under a SIMPLE retirement plan,
employees may make elective deferrals (of up to $6,000
per year), and employers may make matching contributions. Under prior law, matching contributions that
were made for a self-employed individual generally
were treated as elective deferrals and were counted
against the dollar limit on elective deferrals, as well
as in the nondiscrimination test applicable to elective
deferrals under a 401(k) plan (the ADP test). The Act
changes this treatment of matching contributions for
self-employed individuals. Instead of subjecting those
contributions to the limits on elective deferrals and to
the ADP test, the Act generally treats them like matching contributions made for employees. This change is
effective for years beginning after 1997 in the case of
401(k) plans and for years beginning after 1996 in the
case of SIMPLE plans.
Change rules affecting State and local government
and church plans.—The Act makes a number of
changes affecting retirement plans maintained by State
and local governments and churches, including permanently exempting governmental plans from the nondiscrimination and minimum participation rules that
otherwise apply to qualified plans. Those rules generally prohibit plans from discriminating in favor of
highly compensated employees with respect to contributions or benefits, participation, coverage and compensation counted under the plan. The exemption generally
is effective for taxable years beginning on or after August 5, 1997.
Increase pension plan full funding limit.—Contributions to a defined benefit pension plan are subject to
a maximum ‘‘full funding’’ limit. Under prior law, the
full funding limit generally was the lesser of the plan’s
accrued liability (based on projected benefits) or 150
percent of its current liability (based on benefits accrued to date). The Act increases the 150-percent-ofcurrent-liability component of the full funding limit to
155 percent for plan years beginning in 1999 or 2000,
160 percent for plan years beginning in 2001 or 2002,

ANALYTICAL PERSPECTIVES

165 percent for plan years beginning in 2003 or 2004,
and 170 percent for plan years beginning thereafter.
The Act also extends the amortization period, from ten
to twenty years, for amounts that could not be contributed because of the 150-percent-of-current-liability
limit. This change is effective for plan years beginning
after December 31, 1998.
Require increased diversification of 401(k) investments.—The Employee Retirement Income Security Act
of 1974, as amended (ERISA), generally permits only
up to 10 percent of the fair market value of the assets
of a retirement plan to be invested in employer securities or real property leased to the employer that sponsors the plan. Prior law contained an exception to this
rule permitting defined contribution plans, including
section 401(k) plans, to invest more than 10 percent
of their assets in employer securities or employer real
property if the plan authorized such investments. The
Act generally provides that a plan is not permitted
to require that an employee’s elective deferrals be invested in employer securities or employer real property
if the employee’s elective deferrals are in excess of one
percent of the employee’s eligible compensation and if
employer securities and employer real property exceed
10 percent of the plan’s assets. The provision does not
apply to employee stock ownership plans or if the value
of assets of all defined contribution plans of the employer does not exceed 10 percent of the value of assets
of all pension plans maintained by the employer. The
provision is effective for elective deferrals for plan years
beginning after December 31, 1998.
Tax Exempt Organization Provisions
Repeal grandfather rule with respect to pension business of certain insurers.—Under prior law, that portion
of the business of the Teachers Insurance Annuity Association-College Retirement Equities Fund (TIAA-CREF)
or of Mutual of America that was attributable to pension business was exempt from tax. Effective for taxable
years beginning after December 31, 1997, TIAA-CREF
and Mutual of America are treated for Federal tax purposes as life insurance companies; that portion of their
business attributable to pension business is no longer
exempt from tax.
Foreign Provisions
Place further restrictions on like-kind exchanges involving personal property.—An exchange of property,
like a sale, is generally a taxable transaction. However,
no gain or loss is recognized if property held for productive use in a trade or business or for investment is
exchanged for property of a like kind that is to be
held for productive use in a trade or business or for
investment. In general, any kind of real estate is treated as of a like kind with other real property; however,
real property located in the United States and real
property located outside the United States are not of
a like kind. Under prior law, for personal property,
property of a ‘‘like class’’ was treated as being of a
like kind; no restrictions applied with regard to location

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51

FEDERAL RECEIPTS

in or outside the United States. To conform the limitations on exchanges of personal property to the limitations on exchanges of real property, this Act provides
that personal property predominantly used within the
United States and personal property predominantly
used outside the United States are not ‘‘like-kind’’ properties. This change generally is effective for exchanges
after June 8, 1997, unless the exchange is pursuant
to a binding contract in effect on such date.
Impose holding period requirement for claiming foreign tax credits with respect to dividends.—Under prior
law, U.S. persons that received dividends from a regulated investment company (RIC), generally were entitled to an indirect credit for foreign taxes paid by the
RIC, regardless of the shareholder’s holding period for
the RIC stock. A U.S. corporation that received a dividend from a foreign corporation in which it had a 10percent or greater voting interest generally was entitled
to an indirect credit for foreign taxes paid by the foreign corporation, also regardless of the shareholder’s
holding period. This Act generally disallows the foreign
tax credits available with respect to a dividend from
a corporation or RIC if the shareholder holds the stock
for less than 16 days in the case of common stock
and 46 days in the case of preferred stock. This provision is effective for dividends paid or accrued more
than 30 days after August 5, 1997.
Allow Foreign Sales Corporation (FSC) benefits for
computer software licenses.—The FSC provisions provide a limited exemption from U.S. tax for income arising in certain export transactions; under prior law, the
exemption was not available for most exports of intangible property, including computer software copyrights.
This Act extends FSC benefits to licenses of computer
software for reproduction abroad. The provision applies
to gross receipts from computer software licenses attributable to periods after December 31, 1997. In the case
of a multi-year license, the provision applies to gross
receipts attributable to the period of such license that
is after December 31, 1997.
Increase dollar limitation on exclusion for foreign
earned income.—U.S. citizens generally are subject to
U.S. income tax on all their income, whether derived
in the United States or elsewhere. U.S. citizens living
abroad may be eligible to exclude from their income
for U.S. tax purposes certain foreign earned income.
In order to qualify for this exclusion, a U.S. citizen
must be either (1) a bona fide resident of a foreign
country for an uninterrupted period that includes an
entire taxable year, or (2) present overseas for 330 days
out of any 12 consecutive month period. In addition,
the taxpayer must have his or her tax home in a foreign
country. Under prior law, the maximum exclusion for
foreign earned income for a taxable year was $70,000.
This Act increases the maximum exclusion to $80,000
in increments of $2,000 each year beginning in 1998.
The limitation on the exclusion is indexed for inflation
beginning in 2008.

Other Corporate Provisions
Require registration of certain corporate tax shelters.—Under prior law promoters of a corporate tax
shelter were required to register such shelters with the
Internal Revenue Service (IRS). This Act generally requires a promoter of a corporate tax shelter to register
the shelter with the Secretary of the Treasury no later
than the next business day after the day when the
shelter is first offered to potential users. This Act also
increases the penalty for failing to register in a timely
manner a corporate tax shelter and modifies the substantial understatement penalty. The tax shelter registration provision applies to any tax shelter offered
to potential participants after the date the Treasury
Department issues guidance with respect to the filing
requirements. The modifications to the substantial understatement penalty apply to items with respect to
transactions entered into after August 5, 1997.
Treat certain preferred stock as ‘‘boot.’’—Under prior
law, in reorganization transactions, no gain or loss was
recognized except to the extent ‘‘other property’’ (boot)
was received; that is, property other than certain stock,
including preferred stock. Upon the receipt of ‘‘other
property,’’ gain but not loss was recognized. This Act
requires certain preferred stock that is received in otherwise tax-free transactions to be treated as ‘‘other
property.’’ This change generally is effective for transactions after June 8, 1997 but does not apply to such
transactions made pursuant to a written agreement
that was binding on that date.
Administrative Provisions
Require tax reporting for payments to attorneys.—
Treasury regulations require a payor to report payments of attorney’s fees if the payments are made in
the course of a trade or business. However, under prior
law a payor generally was not required to report payments made to corporations. In addition, if a payment
to an attorney was a gross amount and it could not
be determined what portion was the attorney’s fee (as
in the case of lump-sum judgments or settlements made
jointly payable to a lawyer and a plaintiff), then no
reporting was required. This Act requires the reporting
of gross proceeds on all payments made to attorneys
by a trade or business in the course of the trade or
business. In addition, the prior law exception for reporting payments to corporations no longer applies to payments made to attorneys. The provision is effective for
payments made after December 31, 1997.
Require reporting of payments to corporations rendering services to Federal agencies.—All persons engaged
in a trade or business and making payments of $600
or more to another person in remuneration for services
generally must report those payments to the IRS and
to the recipient. No reporting is required if the recipient
is a corporation, unless the payment is made to an
attorney (see previous provision). To ensure that corporations that do business with the Federal Government appropriately report as income their payments
from the Federal Government, this Act requires execu-

52
tive agencies to report payments of $600 or more made
to corporations for services rendered. An exception is
provided for certain classified or confidential contracts.
The provision is effective for returns the due date of
which is more than 90 days after August 5, 1997.
Establish IRS continuous levy and improve debt collection.—Under this Act a continuous levy is applicable
to non-means-tested recurring Federal payments, such
as Federal salaries and pensions, received by individuals who owe delinquent tax debt. In addition, this
Act provides that the levy attach up to 15 percent of
any specified payment due the taxpayer. A continuous
levy of up to 15 percent also applies to unemployment
benefits and means-tested public assistance. The Act
also permits the disclosure of otherwise confidential tax
return information to the Treasury Department’s Financial Management Service only for the purpose of,
and to the extent necessary, in implementing these levies. The provision is effective for levies issued after
August 5, 1997.
Earned Income Tax Credit (EITC) Compliance
Provisions
Deny EITC eligibility for prior acts of recklessness
or fraud.—A taxpayer who fraudulently claims the
EITC is denied eligibility for the subsequent 10 years.
A taxpayer who erroneously claims the EITC due to
reckless or intentional disregard of rules or regulations
is denied eligibility for the subsequent 2 years. These
sanctions are in additional to any other penalties imposed by current law and are effective for taxable years
beginning after December 31, 1996.
Require recertification for eligibility if past eligibility
was denied as a result of deficiency procedures.—A taxpayer who has been denied the EITC as a result of
deficiency procedures is denied eligibility in subsequent
years unless evidence of eligibility for the credit is provided. To demonstrate current eligibility the taxpayer
is required to meet evidentiary requirements established by the Secretary of the Treasury. Failure to provide this information is treated as a mathematical or
clerical error. A taxpayer who has been recertified as
eligible for the EITC does not have to resubmit this
information in the future unless the IRS again denies
the EITC as a result of a deficiency procedure. The
provision is effective for taxable years beginning after
December 31, 1996.
Require tax preparers to fulfill certain due diligence
requirements.—Effective for taxable years beginning
after December 31, 1996, tax return preparers are required to fulfill certain due diligence requirements with
respect to returns they prepare claiming the EITC. The
penalty for failure to meet these requirements, which
is in addition to any other penalties assessed under
current law, is $100 for each failure.
Modify the definition of AGI used to phaseout the
EITC.—The EITC is phased out for individuals with
earned income (or AGI, if greater) in excess of certain
amounts. Under prior law, the definition of AGI used
for the phase out of the earned income credit dis-

ANALYTICAL PERSPECTIVES

regarded the following losses: (1) net capital losses (if
greater than zero); (2) net losses from trusts or estates;
(3) net losses from nonbusiness rents and royalties; and
(4) 50 percent of the net losses from business, computed
separately with respect to sole proprietorships (other
than in farming), sole proprietorships in farming, and
other businesses. This Act modifies the definition of
AGI used for phasing out the credit by adding two
sources of nontaxable income: (1) tax-exempt interest
and (2) nontaxable distributions from pensions, annuities, and individual retirement arrangements. The Act
also increases to 75 percent the percentage of net losses
from business disregarded from the definition of AGI
used for the phase out of the EITC. These changes
are effective for taxable years beginning after December
31, 1997.
Use Federal case registry of child support orders for
tax enforcement purposes.—The Personal Responsibility
and Work Opportunity Reconciliation Act of 1997 mandated the creation of a Federal Case Registry of Child
Support Orders (the FCR) by October 1, 1998. The FCR
is required to include the names, and the State case
identification numbers of individuals who are owed or
who owe child support or for whom paternity is being
established. It may also include the social security numbers (SSNs) of these individuals. Under the Taxpayer
Relief Act, the Secretary of the Treasury is provided
access to the FCR not later than October 1, 1998. Also,
by October 1, 1999, the data elements on the State
Case Registry will include the SSNs of children covered
by cases in the Registry, and the States will provide
the SSNs of these children to the FCR.
Expand Social Security Administration (SSA) records
for tax enforcement.—Effective February 1, 1998, SSA
is required to obtain SSNs of both parents on minor
children’s applications for SSNs. The SSA will provide
this information to the IRS as part of the Data Master
File. This information will enable the IRS to identify
questionable claims for the earned income credit, the
dependent exemption, and other tax benefits before tax
refunds are paid.
Other Revenue-Increase Provisions
Phase out preferential tax deferral for certain large
farm corporations required to use accrual accounting.—
Under the Revenue Act of 1987, family farm corporations were required to change to the accrual method
of accounting if their gross receipts exceeded $25 million in any taxable year beginning after 1985. However,
in lieu of including in gross income the entire amount
of the adjustment attributable to the change in accounting method, a family farm corporation could establish
a suspense account. The amount of the suspense account was to be included in gross income if the corporation ceased to be a family corporation or to the extent
the gross receipts of the corporation from farming declined. This Act repeals the ability of family farm corporations to establish such a suspense account and also
repeals the requirement to include a portion of a suspense account in income based on a decrease in the

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53

FEDERAL RECEIPTS

gross receipts of the corporation. Any taxpayer required
to change to the accrual method of accounting may
take the adjustment attributable to the change in accounting method into account ratably over a ten-year
period, beginning with the year of change. Any existing
suspense accounts are to be restored to income ratably
over a twenty-year period, subject to the existing law
requirement to restore such accounts more rapidly. This
provision is effective for taxable years ending after June
8, 1997, except that the first year in the twenty-year
period for restoring existing suspense accounts to income is the first taxable year beginning after June 8,
1997.
Modify loss carryback and carryforward rules.—
Under prior law, net operating losses (NOLs) generally
could be used to offset taxable income from the prior
three taxable years (carrybacks) and the succeeding 15
taxable years (carryforwards). This Act generally limits
carrybacks of NOLs to 2 years and extends
carryforwards to 20 years, effective for NOLs arising
in taxable years beginning after the date of enactment.
The 3-year carryback for NOLs of farmers and small
businesses attributable to losses incurred in Presidentially declared disaster areas is preserved.
Modify general business credit carryback and
carryforward rules.—A qualified taxpayer is allowed to
claim a number of tax credits (collectively, known as
general business credits) provided under current law
(rehabilitation credit, energy credit, alcohol fuels credit,
orphan drug credit, etc.), subject to certain limitations
based on tax liability for the year. Under prior law,
unused general business credits generally could be carried back three years and carried forward 15 years
to offset tax liability of such years. This Act limits
the carryback period for general business credits to one
year and extends the carryforward period to 20 years.
The change is effective for taxable years beginning after
December 31, 1997.
Expand the limitations on deductibility of premiums
and interest with respect to life insurance, endowment
and annuity contracts.—The prior law premium deduction limitation is expanded to provide that no deduction
is permitted for premiums paid on any life insurance,
endowment or annuity contract, if the taxpayer is directly or indirectly a beneficiary under the contract.
In addition, generally no deduction is allowed for interest paid or accrued on any indebtedness with respect
to a life insurance policy or endowment or annuity contract covering the life of any individual. In the case
of a taxpayer other than a natural person, no deduction
is allowed for the portion of the taxpayer’s interest
expense that is allocable to unborrowed policy cash surrender values with respect to any life insurance policy
or annuity or endowment contract issued after June
8, 1997. These limitations apply to contracts issued
after June 8, 1997. For this purpose, a material increase in the death benefit or other material change
in the contract generally causes the contract to be treated as a new contract.

Expand requirement that involuntarily converted
property be replaced with property acquired from an
unrelated party.—Gain realized by taxpayers from certain involuntary conversions is deferred to the extent
the taxpayer purchases property similar or related in
service or use to the converted property within a specified period of time. C corporations (and partnerships
with one or more corporate partners that own more
than 50 percent of the capital or profits interest in
the partnership) generally are not entitled to defer gain
if the replacement property is purchased from a related
person. This Act extends the denial of deferral to any
other taxpayer, including an individual, that acquires
replacement property from a related person, unless the
taxpayer has an aggregate realized gain of $100,000
or less during the year as a result of involuntary conversions. In the case of a partnership or S corporation,
the $100,000 annual limitation applies to the entity
and each partner or shareholder. The provision applies
to involuntary conversions occurring after June 8, 1997.
Miscellaneous Tax Provisions
Provide income-averaging for farmers.—Effective for
taxable years beginning after December 31, 1997 and
before January 1, 2001, an individual taxpayer generally is allowed to elect to compute his or her current
year regular tax liability by averaging, over the threeyear period, all or a portion of his or her taxable income
from farming.
Allow carryback of existing net operating losses of
the National Railroad Passenger Corporation (Amtrak).—Amtrak is allowed to carryback its net operating
losses against the aggregate of the net tax liability of
Amtrak’s railroad predecessors. The maximum allowable refund payable to Amtrak, which is to be divided
equally between the first two taxable years ending after
the date of enactment, is $2.323 billion. The availability
of the refund was conditioned on enactment of Federal
legislation authorizing reform; such legislation has been
enacted.
Modify estimated tax requirements of individuals.—
An individual taxpayer generally is subject to an addition to tax for any underpayment of estimated tax.
An individual generally does not have an underpayment
of estimated tax if timely estimated tax payments are
made at least equal to: (1) 100 percent of the tax shown
on the return of the individual for the preceding tax
year (the ‘‘100 percent of last year’s liability safe harbor’’) or (2) 90 percent of the tax shown on the return
for the current year. Under prior law the 100 percent
of last year’s safe harbor was modified to be a 110
percent of last year’s liability safe harbor for any individual with an AGI of more than $150,000 as shown
on the return for the preceding taxable year. This Act
modifies the safe harbor for individuals with AGI of
more than $150,000 as follows: for taxable years beginning in 1998, the safe harbor is 100 percent; for taxable
years beginning in 1999, 2000, and 2001 the safe harbor is 105 percent; for taxable years beginning in 2002,
the safe harbor is 112 percent. In addition, for any

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ANALYTICAL PERSPECTIVES

period before January 1, 1998, for any estimated payment due before January 16, 1998, no estimated tax
penalties will be imposed on an underpayment created
or increased by a provision of the Taxpayer Relief Act
of 1997.
Balanced Budget Act of 1997. —This Act, together
with the Taxpayer Relief Act of 1997, implements the
historic bipartisan budget agreement that will benefit
generations of Americans. While this Act is primarily
a balanced package of spending provisions that includes
targeted program cuts while it invests in America’s future, it also includes several revenue provisions. The
major provisions of the Act affecting receipts are described below.
Increase excise taxes on tobacco products.—The excise
tax on small cigarettes is increased from 24 cents per
pack to 34 cents per pack effective January 1, 2000
and to 39 cents per pack effective January 1, 2002.
The taxes on other tobacco products (large cigarettes,
cigars, cigarette papers, cigarette tubes, chewing tobacco, snuff, and pipe tobacco) are increased proportionately. In addition, the tax on roll-your-own tobacco is
imposed at the same rate as pipe tobacco.
Increase employee contributions to the Civil Service
Retirement System (CSRS) and the Federal Employees

Retirement System (FERS).—Employee contributions to
CSRS and FERS are increased by 0.5 percent of base
pay in three steps. Contributions increase by 0.25 percent of base pay on January 1, 1999, another 0.15 percent on January 1, 2000 and a final 0.10 percent on
January 1, 2001. These higher contribution rates are
effective through 2002; on January 1, 2003, contribution
rates return to the levels in effect on December 31,
1998.
Authorize appropriation of funds for enforcement initiatives related to the EITC—In addition to any other
funds available for this purpose, the following amounts
are authorized to be appropriated to the Secretary of
the Treasury for improved application of the earned
income tax credit: not more than $138 million for 1998,
$143 million for 1999, $144 million for 2000, $145 million for 2001 and $146 million for 2002.
Adjust payments to the Universal Service Fund—Payments to the Universal Service Fund by telecommunications carriers and other providers of interstate telecommunications are adjusted so that $3 million in payments otherwise due in fiscal year 2001 are deferred
until October 1, 2001. This shift in payments was subsequently repealed during the FY 1998 appropriations
process.

ADMINISTRATION PROPOSALS
PROVIDE TAX RELIEF AND EXTEND
EXPIRING PROVISIONS

indexed. The proposal would be effective for taxable
years beginning after December 31, 1998.

The President’s plan targets tax relief to provide
child-care assistance to working families. It also includes new initiatives to promote energy efficiency and
environmental objectives and new incentives to promote
retirement savings, as well as education incentives and
extensions of certain expiring tax provisions. In addition, the President’s plan contains provisions to simplify
the tax laws and to enhance taxpayers’ rights.

Establish tax credit for employer-provided child
care.—The Administration proposes to provide taxpayers a credit equal to 25 percent of expenses incurred
to build or acquire a child care facility for employee
use, or to provide child care services to children of
employees directly or through a third party. Taxpayers
also would be entitled to a credit equal to 10 percent
of expenses incurred to provide employees with child
care resource and referral services. A taxpayer’s credit
could not exceed $150,000 in a single year. Any deduction the taxpayer would otherwise be entitled to take
for the expenses would be reduced by the amount of
the credit. Similarly, the taxpayer’s basis in a facility
would be reduced to the extent that a credit is claimed
for expenses of constructing or acquiring the facility.
The credit would be effective for taxable years beginning after December 31, 1998.

Make Child Care More Affordable
Increase and simplify child and dependent care
tax credit.—Under current law, taxpayers may receive
a nonrefundable tax credit for a percentage of certain
child care expenses they pay in order to work. The
credit rate is phased down from 30 percent of expenses
(for taxpayers with adjusted gross incomes of $10,000
or less) to 20 percent (for taxpayers with adjusted gross
incomes above $28,000). The Administration proposes
to increase the maximum credit rate from 30 percent
to 50 percent and to extend eligibility for the maximum
credit rate to taxpayers with adjusted gross incomes
of $30,000 or less. The credit rate would be phased
down gradually for taxpayers with adjusted gross incomes between $30,000 and $59,000. The credit rate
would be 20 percent for taxpayers with adjusted gross
incomes over $59,000. Eligibility for the credit would
be simplified by elimination of a complicated household
maintenance test. Certain credit parameters would be

Promote Energy Efficiency and Improve the
Environment
Buildings
Provide tax credit for energy-efficient building
equipment.—No income tax credit is provided currently for investment in energy-efficient building equipment. The Administration proposes to provide a new
tax credit for the purchase of certain highly efficient
building equipment technologies, including fuel cells,
electric heat pump water heaters, natural gas heat

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FEDERAL RECEIPTS

pumps, residential size electric heat pumps, natural gas
water heaters, and advanced central air conditioners.
The credit would equal 20 percent of the amount of
qualified investment, subject to a cap. The credit generally would be available for equipment purchased over
the five-year period beginning January 1, 1999 and ending December 31, 2003.
Provide tax credit for the purchase of new energy-efficient homes.— No income tax credit is provided currently for investment in energy-efficient
homes. The Administration proposes to provide a tax
credit to taxpayers who purchase, as a principal residence, certain newly constructed homes that are highly
energy efficient. The credit would equal one percent
of the purchase price of the home, up to a maximum
of $2,000. The full credit would be available for homes
purchased between January 1, 1999 and December 31,
2003. A credit of up to $1,000 would be available for
homes purchased between January 1, 2004 and December 31, 2005.
Transportation
Provide tax credit for high-fuel-economy vehicles.—No income tax credit is provided currently for
purchases of highly fuel-efficient vehicles. The Administration proposes to provide a credit of $4,000 for each
vehicle that gets three times the base fuel economy
for its class. The $4,000 credit would be available for
purchases of qualifying vehicles after December 31,
2002. This credit would phase down beginning in 2007
and phase out in 2010. A $3,000 credit would also be
provided for purchases of vehicles achieving two times
the base fuel economy for their class. The $3,000 credit
would be available for purchases of qualifying vehicles
after December 31, 1999. This credit would phase down
beginning in 2004 and phase out in 2006.
Equalize treatment of parking and transit benefits.—Under current law, employer-provided transit
and vanpool benefits are only excluded from income
if such benefits are in addition to, not in lieu of, other
compensation. Under the Taxpayer Relief Act of 1997,
however, parking benefits are excluded from income
even if offered in lieu of other compensation. The Administration proposes to allow employers to offer their
employees transit and vanpool benefits in lieu of compensation, beginning January 1, 1999, thus granting
transit and vanpool benefits the same treatment as
parking benefits. Also under current law, up to $155
per month (in 1993 dollars) in employer-provided parking benefits and $60 per month (in 1993 dollars) in
employer-provided transit and vanpool benefits are excludable from income. The Administration proposes to
raise the monthly limit on employer-provided transit
and vanpool benefits excludable from income to be the
same as the limit on parking.

Industry
Provide investment tax credit for combined heat
and power (CHP) systems.— Combined heat and
power (CHP) assets are used in the production of electricity and process heat and/or mechanical power from
the same primary energy source. No tax credits are
currently available for investment in CHP property.
The Administration proposes to establish a 10-percent
investment credit for CHP systems in order to encourage and accelerate investment in such equipment. The
credit would apply to property placed in service in the
United States after December 31, 1998, and before January 1, 2004.
Provide tax credit for replacement of certain
circuitbreaker equipment.—The chlorofluorocarbon
substitute sulfur hexafluoride (SF6), an extremely
harmful greenhouse gas, is used in some large power
circuit breakers used in the transmission and distribution of electric power. The Administration proposes to
make a tax credit available for the installation of new
power circuit breaker equipment to replace certain circuit breakers that are prone to leak SF6. The credit
would be equal to 10 percent of qualified investment.
To be eligible for the credit, the replaced power circuit
breakers must be dual pressure circuit breakers with
a capacity of at least 115kV, contain SF6, and have
been installed prior to December 31, 1985. The replaced
equipment must be destroyed so as to prevent further
use. The credit would apply only to new equipment
placed in service in the five-year period beginning January 1, 1999 and ending December 31, 2003.
Provide
tax
credit
for
certain
perfluorocompound (PFC) and hydrofluorocompound (HFC) recycling equipment.—Under current
law, semiconductor manufacturers who install equipment to recover or recycle PFC and HFC gases used
in the production of semiconductors may depreciate the
cost of that equipment, but no tax credit is provided
for the purchase of such equipment. PFCs and certain
HFCs are among the most potent greenhouse gases because of their extreme stability in the atmosphere and
strong absorption of radiation, and they are used extensively in the semiconductor manufacturing industry.
The Administration proposes to provide a 10 percent
tax credit for the installation of qualified PFC/HFC recovery or recycling equipment to recover gases used
in the production of semiconductors. Equipment would
qualify for the credit only if it recovers at least 99
percent of the PFCs and HFCs and the equipment is
placed in service in the five-year period beginning January 1, 1999 and ending December 31, 2003.
Renewables
Provide tax credit for rooftop solar equipment.—
Current law provides a 10 percent business energy investment tax credit for qualifying equipment that uses

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ANALYTICAL PERSPECTIVES

solar energy to generate electricity, to heat or cool,
to provide hot water for use in a structure, or to provide
solar process heat. The Administration proposes to
make a new tax credit available for purchasers of rooftop photovoltaic systems and solar water heating systems located on or adjacent to the building for uses
other than heating swimming pools. (Taxpayers would
have to choose between the proposed credit and the
current-law tax credit for each investment.) The proposed credit would be equal to 15 percent of qualified
investment up to a maximum of $1,000 for solar water
heating systems and $2,000 for rooftop photovoltaic systems. It would apply only to equipment placed in service after December 31, 1998 and before January 1, 2004
for solar water heating systems and after December
31, 1998 and before January 1, 2006 for rooftop photovoltaic systems.
Extend wind and biomass tax credit.—Current
law provides taxpayers a 1.5-cent-per-kilowatt-hour tax
credit, adjusted for inflation after 1992, for electricity
produced from wind or ‘‘closed-loop’’ biomass. The electricity must be sold to an unrelated third party and
the credit applies to the first 10 years of production.
The current credit applies only to facilities placed in
service before July 1, 1999, after which it expires. The
Administration proposes to extend the current credit
for five years, to facilities placed in service before July
1, 2004.
Promote Expanded Retirement Savings
Building on recent legislation, the Administration
proposes further expansions of retirement savings incentives, including three new initiatives that would expand the availability of retirement plans and other
workplace-based savings opportunities, particularly for
moderate- and lower-income workers not currently covered by employer-sponsored plans. Two of the proposals
are designed to expand pension coverage for employees
of small businesses, a group that currently has low
pension coverage. The Administration also seeks to improve existing retirement plans for employers of all
sizes by promoting portability, expanding workers’ and
spouses’ rights to know about their retirement benefits,
and simplifying the pension rules. These provisions generally are effective beginning in 1999.
Promote Individual Retirement Account (IRA)
contributions through payroll deduction.—Employers could offer employees the opportunity to make IRA
contributions on a pre-tax basis through payroll deduction. Providing employees an exclusion from income (in
lieu of a deduction) is designed to increase savings
among workers in businesses that do not offer a retirement plan. Signing up for payroll deduction is easy
for an employee. In addition, saving is facilitated because it becomes automatic as salary reduction contributions continue each paycheck after an employee’s
initial election. Peer-group participation may also encourage employees to save more. Finally, the favorable

tax treatment of payroll deductions would encourage
participation.
Provide tax credit for new plans.—Effective in the
year of enactment, the Administration proposes a new
three-year tax credit for the administrative and retirement-education expenses of any small business that
sets up a new qualified defined benefit or defined contribution plan (including a 401(k) plan), savings incentive match plan for employees (SIMPLE), simplified employee pension (SEP), or payroll deduction IRA arrangement. The credit would cover 50 percent of the first
$2,000 in administrative and retirement-education expenses for the plan or arrangement for the first year
of the plan and 50 percent of the first $1,000 of such
expenses for each of the second and third years. The
tax credit would help promote new plan sponsorship
by targeting a tax benefit to employers adopting new
plans or payroll deduction IRA arrangements, providing
a marketing tool to financial institutions and advisors
promoting new plan adoption, and increasing awareness
of retirement savings options.
Establish new small business pension plan.—The
Administration is proposing a new small business defined benefit-type plan that combines certain key features of defined benefit plans and defined contribution
plans: guaranteed minimum retirement benefits, an option for payments over the course of an employee’s retirement years, and Pension Benefit Guaranty Corporation insurance, together with individual account balances that can benefit from favorable investment returns and have enhanced portability.
Enhance portability and disclosure; simplify
pensions.—The Administration is also proposing accelerated vesting of employer matching contributions
under 401(k) plans (and other qualified plans). This
would increase pension portability, which is important
given the mobility of today’s workforce, particularly of
working women. Matching contributions would be required to be fully vested after an employee has completed three years of service (or would vest in annual
20 percent increments beginning after two years of
service). The Administration’s proposal also would enhance workers’ and spouses’ rights to know about their
pension benefits—among other things, requiring that
the same explanation of a pension plan’s survivor benefits that is provided to a participant be provided to
the participant’s spouse, and that participants in 401(k)
safe harbor plans receive timely notification of plan
rules governing contributions and employer matching.
Improved benefits for nonhighly compensated employees under the 401(k) safe harbors, a simplified definition of highly compensated employee, and simplification
of rules for multiemployer plans are also being proposed.
Expand Education Incentives
Provide incentives for public school construction.—The Taxpayer Relief Act of 1997 enacted a provi-

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FEDERAL RECEIPTS

sion that allows certain public schools to issue ‘‘qualified zone academy bonds,’’ the interest on which is effectively paid by the Federal government in the form
of an annual income tax credit. The proceeds of the
bonds can be used for a number of purposes, including
teacher training, purchases of equipment, curricular development, and rehabilitation and repair of the school
facilities. The Administration proposes to institute a
new program of Federal tax assistance for public school
construction. Under the proposal, State and local governments would be able to issue up to $9.7 billion of
‘‘qualified school construction bonds’’ in each of 1999
and 2000. Holders of these bonds would receive annual
federal income tax credits, set according to market interest rates by the Treasury Department, in lieu of
interest. At least 95 percent of the bond proceeds of
a qualified school construction bond must be used to
finance public school construction or rehabilitation. The
Administration also proposes to expand the amount of
qualified zone academy bonds that can be issued in
1999 from $400 million to $1.4 billion and to authorize
an additional $1.4 billion of qualified zone academy
bonds in 2000, and to allow the proceeds of these bonds
to be used for school construction.
Extend and expand exclusion for employer-provided educational assistance.—Certain amounts
paid by an employer for educational assistance provided
to an employee currently are excluded from the employee’s gross income for income and payroll tax purposes.
The exclusion is limited to $5,250 of educational assistance with respect to an individual during a calendar
year and applies whether or not the education is jobrelated. The exclusion currently is limited to undergraduate courses beginning before June 1, 2000. The
Administration proposes to extend the current law exclusion by one year to apply to undergraduate courses
beginning before June 1, 2001. In addition, the exclusion would be expanded to cover graduate courses beginning after June 30, 1998 and before June 1, 2001.

units to households with incomes significantly below
area medians. The amount of first-year credits that
can be awarded in each State is currently limited by
annual allocations of $1.25 per capita. The $1.25 per
capita limitation was established in 1986. The Administration proposes to increase the annual State housing
credit limitation to $1.75 per capita effective for calendar years beginning after 1998. The proposed increase in this cap will permit additional new and rehabilitated low-income housing to be provided while still
encouraging State housing agencies to award the credits to projects that meet specific needs.
Extend Expiring Provisions
Extend the work opportunity tax credit.—The
work opportunity tax credit provides an incentive for
employers to hire individuals from certain targeted
groups. The credit equals a percentage of qualified
wages paid during the first year of the individual’s
employment with the employer. The credit percentage
is 25 percent for employment of at least 120 hours
but less than 400 hours and 40 percent for employment
of 400 or more hours. The credit expires with respect
to employees who begin work after June 30, 1998. The
Administration proposes to extend the work opportunity
tax credit so that the credit would be effective for individuals who begin work before May 1, 2000.
Extend the welfare-to-work tax credit.—The welfare-to-work tax credit enables employers to claim a
tax credit on the first $20,000 of eligible wages paid
to certain long-term family assistance recipients. The
credit is 35 percent of the first $10,000 of eligible wages
in the first year of employment and 50 percent of the
first $10,000 of eligible wages in the second year of
employment. The credit is effective for individuals who
begin work before May 1, 1999. The Administration
proposes to extend the welfare-to-work tax credit for
one year, so that the credit would be effective for individuals who begin work before May 1, 2000.

Eliminate tax when forgiving student loans subject to income contingent repayment.—Students who
borrow money to pay for postsecondary education
through the Federal government’s Direct Loan program
may elect income contingent repayment of the loan.
If they elect this option, their loan repayments are adjusted in accordance with their income. If after the
borrower makes repayments for a twenty-five year period any loan balance remains, it is forgiven. The Administration proposes to eliminate any Federal income
tax the borrower may otherwise owe as a result of
the forgiveness of the loan balance. The proposal would
be effective for loan cancellations after December 31,
1998.

Extend the R&E tax credit.—The Administration
proposes to extend the tax credit provided for certain
research and experimentation expenditures, which is
scheduled to expire after June 30, 1998, for one year
through June 30, 1999.

Increase Low-Income Housing Tax Credit

Make permanent the expensing of brownfields
remediation costs.—Under the Taxpayer Relief Act of
1997, taxpayers can elect to treat certain environmental
remediation expenditures that would otherwise be
chargeable to capital account as deductible in the year

Increase low-income housing tax credit per capita cap.—Low-income housing tax credits provide an
incentive to build and make available rental housing

Extend the deduction provided for contributions
of appreciated stock to private foundations.—The
special rule that allows a taxpayer to deduct the full
fair market value of qualified stock donated to a private
foundation expires with respect to contributions made
after June 30, 1998. The Administration proposes to
extend the provision to apply to contributions made
during the period July 1, 1998 through June 30, 1999.

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ANALYTICAL PERSPECTIVES

paid or incurred. The provision does not apply to expenditures paid or incurred after December 31, 2000.
The Administration proposes that the provision be
made permanent.
Modify International Trade Provisions
Extend the Generalized System of Preferences
(GSP) and modify other trade provisions.—Under
GSP, duty-free access is provided to over 4,000 items
from eligible developing countries that meet certain
worker rights, intellectual property protection, and
other criteria. The Administration proposes to extend
the program, which expires after June 30, 1998,
through September 30, 2001. The Administration is proposing new enhanced trade benefits for Subsaharan African countries undertaking strong economic reforms.
The Administration also proposes to provide, through
September 30, 2001, expanded trade benefits mainly
on textiles and apparel to Caribbean Basin countries
that meet new eligibility criteria to prepare for a future
free trade agreement with the United States. The Administration also proposes to implement the OECD
Shipbuilding Agreement.
Extend and modify Puerto Rico economic-activity tax credit (section 30A).—Although the Puerto
Rico and possessions tax credit generally was repealed
in 1996, both the income-based option and the economic-activity option under the credit remain available
for existing business operations through 2005, subject
to base-period caps. To provide a more efficient and
effective tax incentive for the economic development of
Puerto Rico and to continue the shift from an incomebased credit to an economic-activity credit that was
begun in the Omnibus Budget Reconciliation Act of
1993 (OBRA 93), the Administration proposes to modify
the economic-activity credit for Puerto Rico by (1) extending it indefinitely, (2) making newly established
business operations eligible for the credit, effective for
taxable years beginning after December 31, 1998, and
(3) removing the base-period cap.
Levy tariff on certain textiles and apparel products produced in the Commonwealth of the Northern Mariana Islands (CNMI).—The Administration
has proposed a tariff on textile and apparel products
produced in the CNMI without certain percentages of
workers who are U.S. citizens, nationals or permanent
residents or citizens of the Pacific island nations freely
associated with the U.S.
Expand Virgin Island tariff credits.—The Administration proposes the expansion of authorized but currently unused tariff credits for wages paid in the production of watches in the Virgin Islands to be available
for the production of fine jewelry.
Provide Other Tax Incentives
Expand tax incentives for specialized small business investment companies (SSBICs).—Current law

provides certain tax incentives for investment in
SSBICs. The Administration proposes to enhance the
tax incentives for SSBICs. First, the existing provision
allowing a tax-free rollover of the proceeds of a sale
of publicly-traded securities into an investment in a
SSBIC would be modified to extend the rollover period
to 180 days, to allow investment in the preferred stock
of a SSBIC, to eliminate the annual caps on the SSBIC
rollover gain exclusion, and to increase the lifetime caps
to $750,000 per individual and $2,000,000 per corporation. Second, the proposal would allow a SSBIC to convert from a corporation to a partnership within 180
days of enactment without giving rise to tax at either
the corporate or shareholder level, but the partnership
would remain subject to an entity-level tax at any time
that it later disposed of assets that it holds at the
time of conversion on the amount of ‘‘built-in’’ gains
inherent in such assets at the time of conversion. Finally, in the case of a direct or indirect sale of SSBIC
stock that qualifies for treatment under section 1202,
the proposal would raise the exclusion of gain from
50 percent to 60 percent. The tax-free rollover and section 1202 provisions would be effective for sales occurring after the date of enactment.
Accelerate and expand incentives available to
two new Empowerment Zones (EZs).—OBRA 93 authorized a Federal demonstration project in which nine
EZs and 95 empowerment communities would be designated in a competitive application process. Among
other benefits, businesses located in the nine original
EZs are eligible for three Federal tax incentives: an
employment and training credit; an additional $20,000
per year of section 179 expensing; and a new category
of tax-exempt private activity bonds. The Taxpayer Relief Act of 1997 authorized the designation of two additional EZs located in urban areas, which generally are
eligible for the same tax incentives as are available
within the EZs authorized by OBRA 93. The two additional EZs will be designated in early 1998, but the
tax incentives provided for them do not take effect until
January 1, 2000. The incentives generally remain in
effect for 10 years. The wage credit, however, is phased
down beginning in 2005 and expires after 2007. The
Administration proposes to accelerate the start-up date
of the incentives for the two additional EZs to January
1, 1999. In addition, the proposal would provide that
the wage credit would remain in effect for 10 years
from that date and would be phased down using the
same percentages that apply to the original
empowerment zones designated under OBRA 93.
Make first $2,000 of severance pay exempt from
income tax.—Under current law, payments made to
a terminated employee are taxable as compensation.
The Administration proposes to allow an individual to
exclude up to $2,000 of severance pay from income
when certain conditions are met. First, the severance
must result from a reduction in force by the employer.
Second, the individual must not obtain a job within
six months of separation with compensation at least

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FEDERAL RECEIPTS

equal to 95 percent of his or her prior compensation.
Third, the total severance payments received by the
employee must not exceed $125,000. The exclusion
would be effective for severance pay received in taxable
years beginning after December 31, 1998 and before
January 1, 2004.
Simplify The Tax Laws
Provide for optional Self-employment Contributions Act (SECA) computations.—Self-employed individuals currently may elect to increase their self-employment income for purposes of obtaining social security coverage. Current law provides more liberal treatment for farmers as compared to other self-employed
individuals. The Administration proposes to extend the
favorable treatment currently accorded to farmers to
other self-employed individuals. The proposal would be
effective for taxable years beginning after December
31, 1998.
Provide statutory hedging and other rules to ensure business property is treated as ordinary property.—Under current law, there is a significant issue
of whether income from hedging transactions is capital
or ordinary. The rules under which assets are treated
as ordinary assets and under which hedging transactions are accounted for need to be modernized. In
addition, the current-law rules that allow taxpayers to
defer loss when a taxpayer holds a position or positions
that reduce the risk of loss on certain capital assets,
the so-called straddle rules, are punitive and sometimes
result in a total disallowance of losses. The proposal
would generally codify the hedging rules previously promulgated by Treasury Department and make some
modifications to help clarify the rules. The proposal
would clarify that certain assets are ordinary assets
for Federal income tax purposes, provide more equitable
timing of losses under the straddle rules, and eliminate
an exception to the straddle rules for positions in corporate stock. The proposal generally would be effective
after the date of enactment, and would give the Treasury Department authority to issue regulations similar
to the hedging provisions governing hedging transactions entered into prior to the effective date.
Clarify rules relating to certain disclaimers.—
Under current law, if a person refuses to accept (i.e.,
disclaims) a gift or bequest prior to accepting the transfer (or any of its benefits), the transfer to the disclaiming person generally is ignored for Federal transfer tax
purposes. Current law is unclear as to whether certain
transfer-type disclaimers benefit from rules applicable
to other disclaimers under the estate and gift tax. Current law is also silent as to the income tax consequences of a disclaimer. The Administration proposes
to extend to transfer-type disclaimers the rule permitting disclaimer of an undivided interest in property as
well as the rule permitting a spouse to disclaim an
interest that will pass to a trust for the spouse’s benefit. The proposal also clarifies that disclaimers are effec-

tive for income tax purposes. The proposal would apply
to disclaimers made after the date of enactment.
Simplify the foreign tax credit limitation for
dividends from 10/50 companies.—The Taxpayer Relief Act of 1997 modified the regime applicable to indirect foreign tax credits generated by dividends from
so-called 10/50 companies. Specifically, the Act retained
the prior law ‘‘separate basket’’ approach with respect
to pre-2003 distributions by such companies, adopted
a ‘‘single basket’’ approach with respect to post-2002
distributions by such companies of their pre-2003 earnings, and adopted a ‘‘look-through’’ approach with respect to post-2002 distributions by such companies of
their post-2002 earnings. The application of the three
approaches results in significant additional complexity.
The proposal would simplify significantly the application of the foreign tax credit limitation by applying
a look-through approach immediately to dividends paid
by 10/50 companies, regardless of the year in which
the earnings and profits out of which the dividends
are paid were accumulated (including pre-2003 years).
The proposal would be effective for taxable years beginning after December 31, 1997.
Provide interest treatment for certain payments
from regulated investment companies to foreign
persons.—Under current law, foreign investors in U.S.
bond and money-market mutual funds are effectively
subject to withholding tax on interest income and short
term capital gains derived through such funds. Foreign
investors that hold U.S. debt obligations directly generally are not subject to U.S. taxation on such interest
income and gains. This proposal would eliminate the
discrepancy between these two classes of foreign investors by eliminating the U.S. withholding tax on distributions from U.S. mutual funds that hold substantially all of their assets in cash or U.S. debt securities
(or foreign debt securities that are not subject to withholding tax under foreign law). The proposal is designed
to enhance the ability of U.S. mutual funds to attract
foreign investors and to eliminate needless complications now associated with the structuring of vehicles
for foreign investment in U.S. debt securities. The proposal would be effective for mutual fund taxable years
beginning after the date of enactment.
Enhance Taxpayers’ Rights
Collection
Suspend collection by levy during refund suit.—
Generally, full payment of the tax at issue is a prerequisite to a refund suit (Flora v. United States), but
this rule does not apply in the case of ‘‘divisible’’ taxes
(such as employment taxes or the ‘‘100 percent penalty’’
under section 6672). The Administration proposes to
require the IRS to suspend collection by levy of liabilities that are the subject of a refund suit during the
pendency of the litigation. This would only apply where
refund suits can be brought without the full payment
of the tax, i.e., divisible taxes. Collection by levy would

60
be suspended unless jeopardy exists or the taxpayer
waives the suspension of collection in writing. This proposal would not affect the IRS’s ability to collect other
assessments that are not the subject of the refund suit,
to offset refunds or to file a notice of federal tax lien.
The statute of limitations on collection would be stayed
for the period during which collection by levy is prohibited. The proposal would be effective for refund suits
brought with respect to taxable years beginning after
December 31, 1998.
Suspend collection by levy while offer in compromise is pending.—The Administration proposes to
bar the IRS from collecting a tax liability by levy during
any period that a taxpayer’s offer in compromise of
that liability is being processed, during the 30 days
following rejection of an offer, and for any period during
which an appeal of a rejected offer is being considered.
Levy would not be precluded if the IRS determines
that collection is in jeopardy or that the offer is submitted solely to delay collection. This proposal would not
affect liabilities or assessments that are not the subject
of the offer in compromise, the IRS’s ability to offset
refund, or its ability to file a notice of Federal tax
lien. The proposal would not require the IRS to stop
any levy action that was initiated, or withdraw any
lien that was filed, prior to the taxpayer’s making an
offer in compromise. The statute of limitations on collection would be stayed for the period during which collection by levy is barred. The proposal would be effective
with respect to taxes assessed 60 days after the date
of enactment.
Suspend collection to permit resolution of disputes as to liability.—The Administration proposes
to permit an individual taxpayer to request that collection be suspended temporarily with regard to an income
tax liability that is assessed based upon a statutory
notice of deficiency that the taxpayer failed to receive
or to which the taxpayer failed to respond. The IRS
would suspend collection for a 60-day period, during
which the taxpayer may dispute the merits of the underlying assessment. The 60-day period would be extended in appropriate cases where progress is being
made in resolving the liability. Collection by refund
offset and jeopardy levies would be exempted. The proposal would not affect the IRS’s ability to file a notice
of Federal tax lien. The statutory collection period
would be stayed while the taxpayer’s claim is pending.
The proposal would be effective for taxes assessed with
respect to taxable years beginning after December 31,
1998.
Require District Counsel approval of certain
third party collection activities.—The Administration proposes to require IRS District Counsel approval
before a notice of Federal tax lien can be filed or levy
is made in connection with property held by a nominee,
transferee, or alter ego of the taxpayer. Counsel approval would also be required before the IRS seizes
property encumbered by a Federal tax lien if the prop-

ANALYTICAL PERSPECTIVES

erty is presently neither owned nor titled in the name
of the taxpayer. The only exception would be in jeopardy situations. If District Counsel’s approval was not
obtained, the property-owner would be entitled to obtain release of the lien or levy, and, if the IRS failed
to make such release, to appeal first to the Collections
Appeals process and then to the U.S. District Court.
The proposal would be effective with respect to taxes
assessed after the date of enactment.
Require management approval of levies on certain assets.—The Administration proposes to require
the personal approval of an IRS District Director or
Assistant District Director of any levy made against
non-Federal pensions or the cash value of life insurance
policies. The proposal would thus place these assets
in the same class as principal residences pursuant to
section 6334(e). The only exception would be in jeopardy
situations. If the District Director’s approval was not
obtained, the taxpayer would be entitled to obtain release of the levy, and, if the IRS failed to make such
release, to appeal first to the Collections Appeals process and then to the U.S. District Court. The proposal
would be effective with respect to taxes assessed after
the date of enactment.
Require District Counsel review and approval
of jeopardy and termination assessments and jeopardy levies.—Current law provides special procedures
allowing the IRS to make jeopardy assessments or termination assessments in certain extraordinary circumstances, for instance, if the taxpayer is leaving or
removing property from the United States or if assessment or collection would be jeopardized by delay. In
jeopardy situations, a levy may also be made without
the 30-day notice of intent to levy that is ordinarily
required. Jeopardy and termination assessments and
jeopardy levies often involve difficult legal issues, and
the government bears the burden of proof with respect
to the reasonableness of a jeopardy or termination assessment or a jeopardy levy. The Administration proposes to require IRS District Counsel review and approval before the IRS could make a jeopardy assessment, a termination assessment, or a jeopardy levy.
If District Counsel’s approval was not obtained, the
taxpayer would be entitled to obtain abatement of the
assessment or release of the levy, and, if the IRS failed
to offer such relief, to appeal first to the Collections
Appeals process and then to the U.S. District Court.
The proposal would be effective with respect to taxes
assessed after the date of enactment.
Require management approval of sales of perishable goods.—Because of the nature of the property
at issue, special accelerated procedures apply to the
sale of perishable property that has been seized to satisfy a tax liability. The Administration proposes to require approval by an IRS District Director or Assistant
District Director before perishable goods are sold. The
proposal would also clarify what a ‘‘perishable’’ item
is for these purposes. The proposal would be effective

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FEDERAL RECEIPTS

with respect to taxes assessed after the date of enactment.
Codify certain Fair Debt Collection procedures.—Government agencies, including the IRS, are
generally exempt from the Fair Debt Collection Practices Act (FDCPA). In the past, appropriations legislation funding the IRS has required IRS officers and employees to comply with certain provisions of the
FDCPA. Placing these requirements in the Internal
Revenue Code would ensure that both taxpayers and
employees of the IRS are fully aware of these requirements. Therefore, the Administration proposes to add
to the Internal Revenue Code two provisions of the
FDCPA concerning communications in connection with
debt collection and the prohibition on harassment or
abuse. The proposal would be effective on the date of
enactment.
Modify payment of taxes.—The Secretary of the
Treasury is authorized to accept payments by stamps,
check, or money orders, as provided in regulations.
Checks or money orders currently are made payable
to the ‘‘Internal Revenue Service.’’ The proposal would
require amending the rules, regulations, and procedures
to allow payment of taxes by check or money order
to be made payable to the order of ‘‘United States
Treasury.’’ This would make it clearer to taxpayers that
their tax payments support the entire Federal Government, not just the IRS. The proposal would be effective
on the date of enactment.
Require disclosures relating to extension of statutes of limitation by agreement.—Taxpayers and the
IRS may agree in writing to extend the statutory period
of limitations on assessment or collection, either for
a specified period or for an indefinite period. The Administration proposes to require that, on each occasion
that the taxpayer is requested by the IRS to extend
the statute of limitations, the IRS must notify the taxpayer of the taxpayer’s right to refuse to extend the
statute of limitations or to limit the extension to particular issues. The proposal would apply to requests
to extend the statute of limitations made after the date
of enactment.
Publish living allowance schedules relating to
offers in compromise.—The IRS is authorized to compromise a taxpayer’s tax liability for less than the full
amount due. In general, there are two grounds on
which an offer in compromise can be made: doubt as
to the taxpayer’s liability for the full amount, or doubt
as to the taxpayer’s ability to pay in full the amount
owed. The proposal would require the IRS to develop
and publish schedules of national and local living allowances, taking into account variations in the cost of living in different areas. The IRS would use this information in evaluating the sufficiency of offers in compromise. The schedules would be required to be published no later than 180 days after the date of enactment.

Ensure availability of installment agreements.—
The IRS is authorized to enter agreements permitting
taxpayers to pay taxes in installments if such an agreement will ‘‘facilitate collection’’ of the liability. The IRS
has discretion to determine when an installment agreement is appropriate. The Administration proposes to
codify the IRS’s current practice of requiring an installment agreement (at the taxpayer’s option) for liabilities
of $10,000 or less, provided certain conditions are met.
The proposal would be effective on the date of enactment.
Increase ‘‘superpriority’’ dollar limits.—Current
law provides protection to certain property interests
even though a Notice of Federal Tax Lien has been
properly filed before the interests arise. Such ‘‘superpriorities’’ are subject to certain dollar limitations, however. The proposal would increase the current dollar
limit for purchasers at a casual sale from $250 to
$1,000, and it would increase the current dollar limit
from $1,000 to $5,000 for mechanics lienors who provide
home improvement work for residential real property.
The proposal would also clarify current law to reflect
current banking practices, where a ‘‘passbook’’-type loan
may be made even though an actual ‘‘passbook’’ is not
used. The proposal would be effective on the date of
enactment.
Permit personal delivery of 100 percent penalty
notices.—The proposal would permit personal delivery,
in addition to the Internal Revenue Code’s current requirement of mail delivery, of a preliminary notice that
the IRS intends to assess a 100 percent penalty under
section 6672 against the taxpayer. The proposal would
be effective on the date of enactment.
Examination
Allow taxpayers to quash all third party summonses.—Summonses issued to ‘‘third party recordkeepers’’ are subject to different procedures than other
summonses: notice of the summons must be given to
the taxpayer, and the taxpayer has an opportunity to
bring a court proceeding to quash the summons, during
which time collection action is stayed and the third
party recordkeeper is prohibited from complying with
the summons. The Administration proposes generally
to expand the ‘‘third party recordkeeper’’ procedures
to apply to all summonses issued to third parties other
than the taxpayer. This would have the beneficial effect
of giving taxpayers notice and an opportunity to contest
any summons issued to a third party in connection
with the determination of their liability. The provision
would be effective for summonses served after the date
of enactment.
Require disclosure of criteria for examination
selection.—The IRS examines Federal tax returns to
determine the correct liability of taxpayers. Returns are
selected for examination in a number of ways, such
as through ‘‘matching’’ of returns and information returns or through the use of a computerized classifica-

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ANALYTICAL PERSPECTIVES

tion system (the discriminant function (DIF) system).
Taxpayers should better understand the reasons why
they may be selected for examination. Therefore, the
Administration proposes to require that within 180
days the IRS add to Publication 1 (Your Rights as a
Taxpayer) a statement setting forth, in simple and nontechnical terms, the criteria and procedures for selecting taxpayers for examination. The statement would
not include any information that would be detrimental
to law enforcement, and drafts of the statement would
be required to be submitted to the congressional taxwriting committees prior to publication.
Prohibit threat of audit to coerce tip reporting
alternative commitment agreements.—Restaurants
may enter into Tip Reporting Alternative Commitment
(TRAC) agreements. A restaurant entering into a TRAC
agreement is obligated to educate its employees on their
tip reporting obligations, to institute formal tip reporting procedures, to fulfill all filing and record keeping
requirements, and to pay and deposit taxes. In return,
the IRS agrees to base the restaurant’s liability for
employment taxes solely on reported tips and any unreported tips discovered during an IRS audit of an employee. The proposal would require the IRS to instruct
its employees that they may not threaten to audit any
taxpayer in an attempt to coerce the taxpayer to enter
into a TRAC agreement. The provision would be effective on the date of enactment.
Permit service of summonses by mail.—This proposal would permit the IRS to serve summonses by
mail, in addition to the present law requirement that
all summonses be personally served. Most summonses
are served on financial institutions, where personal
service can disrupt the working environment. Further,
notice to the taxpayer that a summons has been served
on a third party recordkeeper can already be given
by mail, and the proposal would thus bring the service
of the actual summons into line with the notice requirements. The provision would be effective for summonses
served after the date of enactment.
New Remedies
Allow suits for damages if IRS violates certain
bankruptcy procedures.—No remedy exists under the
Internal Revenue Code if the IRS willfully violates the
automatic stay or discharge provisions of the Bankruptcy Code. The Administration proposes to provide
for payment of damages, plus attorneys fees’ and costs,
for willful violations by officers or employees of the
IRS of either the automatic stay provision or the discharge injunction under the Bankruptcy Code. Jurisdiction over such cases would lie with the Bankruptcy
Court, but the claimant would be required to exhaust
administrative remedies to the same extent as for other
damage claims. The provision would be effective with
respect to violations occurring after the date of enactment.

Increase Tax Court’s ‘‘small case’’ limit.—Taxpayers may choose to contest many tax disputes in
the Tax Court. Under current law, special ‘‘small case
procedures’’ apply to disputes involving $10,000 or less,
if the taxpayer chooses to utilize these procedures (and
the Tax Court concurs). The Administration proposes
to increase the cap for small case treatment in the
Tax Court from $10,000 to $25,000. The proposal would
apply to proceedings commenced after the date of enactment.
Provide equitable tolling.—A refund claim that is
not filed within certain specified time periods is rejected
as untimely. The Supreme Court recently held (United
States v. Brockamp) that these limitations periods cannot be extended, or ‘‘tolled,’’ for equitable reasons. This
may lead to harsh results for some taxpayers, particularly when they fail to seek a refund because of a
well-documented disability or similar compelling circumstance that prevents them from doing so. Consequently, the Administration proposes to permit ‘‘equitable tolling’’ of the limitation period on claims for refund for the period of time during which an individual
taxpayer is under a sufficient medically determined
physical or mental disability as to be unable to manage
his or her financial affairs. Tolling would not apply
during periods in which the taxpayer’s spouse or another person is authorized to act on the taxpayer’s behalf in financial matters. The proposal would apply
with respect to taxable years ending after the date of
enactment.
Require notice of deficiency to specify Tax Court
filing deadlines.—Under current law, taxpayers must
file a petition with the Tax Court within 90 days after
the notice of deficiency is mailed (150 days if the person
is outside the United States). Because timely filing in
Tax Court is a jurisdictional prerequisite, the IRS cannot extend the filing period, nor can the Tax Court
hear the case of a taxpayer who relies on erroneous
information from the IRS and files too late. The Administration proposes to require the IRS to include on each
notice of deficiency the date it determines is the last
day on which the taxpayer may file a Tax Court petition (including the last day for a taxpayer who is outside the United States). Any petition filed by the later
of the statutory date or the date shown on the notice
would be timely. The provision would apply to notices
mailed after December 31, 1998.
Allow actions for refund with respect to certain
estates that have elected the installment method
of payment.—Under the Internal Revenue Code, a taxpayer may bring a refund suit only if full payment
of the assessed tax liability has been made. However,
under certain conditions, the executor of an estate may
pay the estate tax attributable to certain closely-held
businesses over a 14-year period. These two rules can
be in conflict, preventing electing estates from obtaining
full relief in a refund jurisdiction. The Administration
proposes to grant courts refund jurisdiction to deter-

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63

FEDERAL RECEIPTS

mine the correct liability of such an estate, so long
as the estate had properly elected to pay in installments and was current on all payments. The proposal
also would make a number of technical and conforming
amendments to implement this change. The proposal
would be effective for claims for refunds filed after the
date of enactment.
Expand authority to award costs and fees.—Any
person who substantially prevails in a dispute related
to taxes, interest, or penalties may be awarded reasonable administrative costs incurred before the IRS and
reasonable litigation costs incurred in connection with
any court proceeding. Individuals can receive an award
of litigation and administrative costs only if their net
worth does not exceed $2 million. Awards cannot exceed
amounts actually paid or incurred, and cannot exceed
a statutorily limited rate ($110 per hour, indexed for
inflation). Taxpayers who are represented pro bono, and
thus bear no actual attorney’s fees and costs, cannot
recover such amounts. The Administration proposes to
allow the award of attorney’s fees (in amounts up to
the statutory limit) to persons who represent such taxpayers for no more than a nominal fee. The proposal
would be effective with respect to costs incurred and
services performed after the date of enactment.
Expand authority to issue taxpayer assistance
orders.—Under current law, taxpayers can request
that the Taxpayer Advocate issue a taxpayer assistance
order (TAO) to require the IRS to release property of
the taxpayer that has been levied upon, or to cease
any action, take any action as permitted by law, or
refrain from taking any action with respect to the taxpayer. A TAO may be issued if the taxpayer is suffering
or about to suffer a significant hardship as a result
of the manner in which the laws are being administered
by IRS. The Administration proposes to provide that,
in determining whether to issue a TAO, the Taxpayer
Advocate will also be authorized to consider, among
other factors, the following: unreasonable delays in resolving the taxpayer’s account problems; immediate
threats of substantial adverse action (such as the seizure of a residence to pay overdue taxes); the likelihood
of irreparable harm if relief is not granted; whether
the taxpayer will have to pay significant professional
fees if relief is not granted; and the possibility of longterm adverse impact on the taxpayer. The proposal
would be effective on the date of enactment.
Provide new remedy for third parties who claim
that the IRS has filed an erroneous lien.—The Supreme Court held (Williams v. United States) that a
third party who paid another person’s tax under protest
to remove a lien on the third party’s property could
bring a refund suit, because she had no other adequate
administrative or judicial remedy. However, the Court
left many important questions unresolved. The Administration proposes to create administrative and judicial
remedies for a third party in that situation. Under this
procedure, the owner of property (other than the tax-

payer) could obtain a certificate discharging property
from the Federal tax lien as a matter of right, provided
certain conditions were met. The certificate of discharge
would enable the property owner to sell the property
free and clear of the Federal tax lien in all circumstances. The proposal would also establish a judicial cause of action for persons challenging a Federal
tax lien that is similar to the wrongful levy remedy
already in the Internal Revenue Code. The proposal
would be effective on the date of enactment.
Allow damage suits by persons other than the
taxpayer.—Under current law, taxpayers have a right
to sue for damages if, in connection with any collection
of Federal tax, any officer or employee of the IRS recklessly or intentionally disregards any provision of the
Internal Revenue Code or any regulation thereunder.
Recoverable damages are the lesser of actual, direct
economic damages sustained, plus attorneys’ fees, or
$1 million. Actions under this provision may only be
brought by an injured taxpayer, however, and not by
an injured third party. The Administration proposes
that persons other than the taxpayer from whom collection is sought be granted a right to sue for damages.
The current law limitations on awards for damages
would apply to third party plaintiffs, as well. The proposal would be effective with respect to collection actions taken after the date of enactment.
Joint Returns
Suspend collection in certain joint liability
cases.—When a married couple’s joint return is the
subject of a Tax Court proceeding, the Administration
proposes to require the IRS to withhold collection by
levy against a nonpetitioning spouse while a Tax Court
proceeding involving the other spouse is pending. This
would treat the nonpetitioning spouse the same as the
petitioning spouse in most situations. Certain exceptions would be provided, including in jeopardy situations; when the taxpayer waives this protection (i.e.,
agrees to the collection action); other, limited but automatic kinds of collection activity, such as automatic
refund offset; filing of protective notices of Federal tax
lien, etc.; or certain other situations. The statute of
limitations on assessment and collection would be
stayed for the period during which collection by levy
is barred. If there is a final decision that reduces the
proposed assessment against the petitioning spouse, the
assessment against the nonpetitioning spouse would
likewise be reduced. The proposal would not affect the
IRS’s ability to collect other liabilities or assessments
that are not the subject of the Tax Court proceeding.
The proposal would be effective for taxes assessed with
respect to taxable years beginning after December 31,
1998.
Require explanation of joint and several liability.—In general, spouses who file a joint tax return
are jointly and severally liable for the tax due. Thus
each is fully responsible for the accuracy of the return

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ANALYTICAL PERSPECTIVES

and the full amount of the liability, even if only one
spouse earned the wages or income that is shown on
the return. Married taxpayers need to better understand the legal implications of signing a joint return.
Therefore, the Administration proposes to require the
IRS to establish procedures to alert married taxpayers
clearly of their joint and several liability on appropriate
tax publications and instructions. The proposal would
require that such procedures be established no later
than 180 days after the date of enactment.
Relieve innocent spouse of liability in certain
cases.—Spouses who file a joint tax return are each
fully responsible for the accuracy of the return and
for the full tax liability, even if only one spouse earned
the wages or income shown on the return. Relief from
liability is available for ‘‘innocent spouses’’ in certain
circumstances, but the conditions are frequently hard
to meet and the Tax Court may not have jurisdiction
to review all denials of innocent spouse relief. The Administration proposes to generally make innocent
spouse status easier to obtain. It would first eliminate
certain applicable dollar thresholds for understatements
of tax. Second, the proposal would specifically provide
the Tax Court with jurisdiction to review the IRS’s
denial of innocent spouse relief and to order appropriate
relief. Except in limited cases, the IRS could not collect
the tax until the Tax Court case is final (although
the statute of limitations would be extended while the
Tax Court case is pending). Finally, the proposal would
require the IRS to develop a separate form with instructions for taxpayers to use in applying for innocent
spouse relief within 180 days from the date of enactment. The proposal would be effective for understatements in years beginning after the date of enactment
and for overpayments assessed within the previous two
years.
Miscellaneous
Allow ‘‘global’’ interest netting of under- and
over-payments.—The rate of interest charged taxpayers on their tax underpayments differs from the
rate paid to taxpayers on overpayments. Although the
IRS ameliorates the effect of this interest rate differential by ‘‘netting’’ offsetting underpayments and overpayments in some situations, there is no authority to net
when either the overpayment or the underpayment has
been satisfied already (‘‘global’’ netting). Global interest
netting for income taxes would be implemented under
this proposal. The proposal would be effective for calendar quarters with periods of overlapping mutual indebtedness after the date of enactment.
Facilitate archiving of IRS records.—The IRS,
like all other Federal agencies, must create, maintain,
and preserve agency records, and must transfer significant and historical records to the National Archives
and Records Administration (NARA) for retention or
disposal. However, tax returns and return information
are confidential and can be disclosed only pursuant to

limited exceptions. There is no exception authorizing
the disclosure of return information to NARA. The Administration proposes to provide an exception to the
disclosure rules, authorizing the IRS to disclose tax
returns and return information to officers or employees
of NARA, upon written request from the Archivist, for
purposes of the appraisal of such records for destruction
or retention. The prohibitions on, and penalties for, unauthorized re-disclosure of such information would
apply. The proposal would be effective for requests
made by the Archivist after the date of enactment.
Clarify authority to prescribe manner of making
elections.—Except as otherwise provided by statute,
elections under the Internal Revenue Code must be
made in such manner as the Secretary of the Treasury
‘‘shall by regulations or forms prescribe.’’ The question
has arisen whether the Secretary can prescribe the
manner of required elections other than by regulations
or forms, for instance in revenue rulings or revenue
procedures. The proposal would clarify that, except as
otherwise provided, the Secretary may prescribe the
manner of making any election by any reasonable
means. The proposal would be effective on the date
of enactment.
Grant IRS broad authority to enter into cooperative agreements with State taxing agencies.—Taxpayers currently must file returns with both their State
taxing agency and the IRS, and frequently must resolve
issues with the agencies at different times. If appropriate statutory authority were enacted, taxpayers
could file only one return for both State and Federal
taxes. Then, pursuant to a cooperative agreement between the IRS and the State, the information could
be processed by one tax administrator and shared between the two, substantially simplifying filing requirements and reducing taxpayer burden. The Administration proposes to allow the IRS to enter such agreements
with the States to provide for joint filing and processing
of returns, joint collection of taxes (other than Federal
income taxes), and such other provisions as may enhance joint tax administration. It would further amend
the Internal Revenue Code’s confidentiality provisions
to permit sharing of common tax data, would address
the effect of joint agreements in a number of situations,
and would include a thorough list of conforming amendments. The provision would be effective on the date
of enactment.
Provide clinics for low-income taxpayers.—Lowincome individuals frequently have difficulty complying
with their tax obligations or resolving disputes over
their tax liabilities. Providing tax services to such individuals through clinics that offer such services for a
nominal fee would improve compliance with the tax
laws and should be encouraged. The Administration
proposes that the Legal Services Corporation be authorized to make up to $3,000,000 in grants for the development, expansion, or continuation of certain low-income

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FEDERAL RECEIPTS

taxpayer clinics. The provision would be effective on
the date of enactment.
Provide procedures for release of field service
memoranda.—The Administration proposes to clarify
that Field Service Advice Memoranda (FSAs) are return
information that is protected under the Internal Revenue Code and cannot be disclosed without authorization. It would also, however, make the non-confidential
information in such documents public, subject to a redaction process in which the taxpayer whose liability
is the subject of the FSA would be allowed to participate. The proposal would be effective on the date of
enactment, but it would include a schedule of time over
which the IRS would make past FSAs available under
the redaction procedure.
ELIMINATE UNWARRANTED BENEFITS AND
ADOPT OTHER REVENUE MEASURES
The President’s plan curtails unwarranted corporate
tax subsidies, closes tax loopholes, improves tax compliance and adopts other revenue measures.
Defer deduction for interest and original issue
discount (OID) on convertible debt.— The accrued
but unpaid interest and OID on a convertible debt instrument generally is deductible, even if the instrument
is converted into the stock of the issuer or a related
party before the issuer pays any interest or OID. The
Administration proposes to defer the deduction for all
interest, including OID, on convertible debt until payment. The proposal would be effective for convertible
debt issued on or after the date of first committee action.
Eliminate dividends-received deduction for certain preferred stock.—A corporate holder of stock
generally is entitled to a deduction for dividends received on stock in the following amounts: 70 percent
if the recipient owns less than 20 percent of the stock
of the payor, 80 percent if the recipient owns 20 percent
or more of the stock, and 100 percent of qualifying
dividends received from members of the same affiliated
group. The Administration proposes to eliminate the
70- and 80-percent dividends-received deduction for
dividends on certain limited-term preferred stock, effective for stock issued after the date of enactment.
Repeal percentage depletion for non-fuel minerals mined on Federal and formerly Federal
lands.—Taxpayers are allowed to deduct a reasonable
allowance for depletion relating to certain mineral deposits. The depletion deduction for any taxable year
is calculated under either the cost depletion method
or the percentage depletion method, whichever results
in the greater allowance for depletion for the year. The
percentage depletion method is viewed as an incentive
for mineral production rather than as a normative rule
for recovering the taxpayer’s investment in the property. This incentive is excessive with respect to minerals mined on Federal and formerly Federal lands

65
under the 1872 mining act, in light of the minimal
costs of acquiring the mining rights ($5.00 or less per
acre). The Administration proposes to repeal percentage
depletion for non-fuel minerals mined on Federal lands
where the mining rights were originally acquired under
the 1872 law, and on private lands acquired under the
1872 law. The proposal would be effective for taxable
years beginning after the date of enactment.
Repeal tax-free conversions of large C corporations to S corporations (section 1374).—A corporation can avoid the existing two-tier tax by electing to
be treated as an S corporation or by converting to a
partnership. Converting to a partnership is a taxable
event that generally requires the corporation to recognize any built-in gain on its assets and requires the
shareholders to recognize any built-in gain on their
stock. By contrast, the conversion to an S corporation
is generally tax-free, except that the S corporation generally must recognize the built-in gain on assets held
at the time of conversion if the assets are sold within
ten years. The Administration proposes that the conversion of a C corporation with a value of more than $5
million into an S corporation would be treated as a
liquidation of the C corporation, followed by a contribution of the assets to an S corporation by the recipient
shareholders. Thus, the proposal would require immediate gain recognition by both the corporation (with
respect to its appreciated assets) and its shareholders
(with respect to their stock). This proposal would make
the tax treatment of conversions to an S corporation
generally consistent with conversions to a partnership.
The proposal would apply to elections that are first
effective for a taxable year beginning after January
1, 1999 and to acquisitions of a C corporation by an
S corporation made after December 31, 1998.
Replace sales-source rules with activity-based
rules.—The foreign tax credit generally reduces U.S.
tax on foreign source income, but does not reduce U.S.
tax on U.S. source income. When products are manufactured in the United States and sold abroad, Treasury
regulations provide that 50 percent of such income generally is treated as earned in production activities, and
sourced on the basis of the location of assets held or
used to produce income from the sale. The remaining
50 percent of the income is treated as earned in sales
activities and sourced based on where title to the inventory transfers. Thus, if a U.S. manufacturer sells inventory abroad, half of the income generally is treated
as derived from domestic sources, and half of the income generally is treated as derived from foreign
sources. However, the taxpayer may use a more favorable method if it can establish to the satisfaction of
the IRS that more than half of its economic activity
occurred in a foreign country. This 50/50 rule provides
a benefit to U.S. exporters that operate in high-tax
foreign countries. Thus, U.S. multinational exporters
have a competitive advantage over U.S. exporters that
conduct all their business activities in the U.S. Because
export benefits should be targeted equally to all export-

66
ers, the Administration proposes to reduce the amount
of export sales income that such corporations may treat
as derived from foreign sources by requiring that the
allocation be based on actual economic activity. The
proposal would be effective for taxable years beginning
after the date of enactment.
Modify rules relating to foreign oil and gas extraction income.—To be eligible for the U.S. foreign
tax credit, a foreign levy must be the substantial equivalent of an income tax in the U.S. sense, regardless
of the label the foreign government attaches to it.
Under regulations, a foreign levy is a tax if it is a
compulsory payment under the authority of a foreign
government to levy taxes and is not compensation for
a specific economic benefit provided by the foreign country. Taxpayers that are subject to a foreign levy and
that also receive (directly or indirectly) a specific economic benefit from the levying country are referred to
as ‘‘dual capacity’’ taxpayers and may not claim a credit
for that portion of the foreign levy paid as compensation
for the specific economic benefit received. The Administration proposes to treat as taxes payments by a dualcapacity taxpayer to a foreign country that would otherwise qualify as income taxes or ‘‘in lieu of’’ taxes, only
if there is a ‘‘generally applicable income tax’’ in that
country. For this purpose, a generally applicable income
tax is an income tax (or a series of income taxes) that
applies to trade or business income from sources in
that country, so long as the levy has substantial application both to non-dual-capacity taxpayers and to persons who are citizens or residents of that country.
Where the foreign country does generally impose an
income tax, as under present law, credits would be
allowed up to the level of taxation that would be imposed under that general tax, so long as the tax satisfies the new statutory definition of a ‘‘generally applicable income tax.’’ The proposal also would create a new
foreign tax credit basket within section 904 for foreign
oil and gas income. The proposal would be effective
for taxable years beginning after the date of enactment.
The proposal would yield to U.S. treaty obligations that
allow a credit for taxes paid or accrued on certain oil
or gas income.
Repeal lower-of-cost-or-market inventory accounting method.—Taxpayers required to maintain
inventories are permitted to use a variety of methods
to determine the cost of their ending inventories, including the last-in, first-out (LIFO) method, the firstin, first-out (FIFO) method, and the retail method. Taxpayers not using a LIFO method may determine the
carrying values of their inventories by applying the
lower-of-cost-or-market (LCM) method and by writing
down the cost of goods that are unsalable at normal
prices or unusable in the normal way because of damage, imperfection or other causes (subnormal goods
method). The allowance of write-downs under the LCM
and subnormal goods methods is essentially a one-way
mark-to-market method that understates taxable income. The Administration proposes to repeal the LCM

ANALYTICAL PERSPECTIVES

and subnormal goods methods effective for taxable
years beginning after the date of enactment.
Increase penalties for failure to file correct information returns.—Any person who fails to file required information returns in a timely manner or incorrectly reports such information is subject to penalties.
For taxpayers filing large volumes of information returns or reporting significant payments, existing penalties ($15 per return, not to exceed $75,000 if corrected
within 30 days; $30 per return, not to exceed $150,000
if corrected by August 1; and $50 per return, not to
exceed $250,000 if not corrected at all) may not be
sufficient to encourage timely and accurate reporting.
The Administration proposes to increase the general
penalty amount, subject to the overall dollar limitations, to the greater of $50 per return or 5 percent
of the total amount required to be reported. The increased penalty would not apply if the aggregate
amount actually reported by the taxpayer on all returns
filed for that calendar year was at least 97 percent
of the amount required to be reported. The increased
penalty would be effective for returns the due date for
which is more than 90 days after the date of enactment.
Tighten the substantial understatement penalty
for large corporations.—Currently taxpayers may be
penalized for erroneous, but non-negligent, return positions if the amount of the understatement is ‘‘substantial’’ and the taxpayer did not disclose the position in
a statement with the return. ‘‘Substantial’’ is defined
as 10 percent of the taxpayer’s total current tax liability, but this can be a very large amount. This has
led some large corporations to take aggressive reporting
positions where huge amounts of potential tax liability
are at stake—in effect playing the audit lottery—without any downside risk of penalties if they are caught,
because the potential tax still would not exceed 10 percent of the company’s total tax liability. To discourage
such aggressive tax planning, the Administration proposes that any deficiency greater than $10 million be
considered ‘‘substantial’’ for purposes of the substantial
understatement penalty, whether or not it exceeds 10
percent of the taxpayer’s liability. The proposal, which
would be effective for taxable years beginning after the
date of enactment, would affect only taxpayers that
have tax liabilities greater than or equal to $100 million.
Repeal exemption for withholding on gambling
winnings from bingo and keno in excess of
$5,000.—Proceeds of most wagers with odds of less
than 300 to 1 are exempt from withholding, as are
all bingo and keno winnings. The Administration proposes to impose withholding on proceeds of bingo or
keno in excess of $5,000 at a rate of 28 percent, regardless of the odds of the wager, effective for payments
made after the start of the first calendar quarter that
is at least 30 days after the date of enactment.

3.

FEDERAL RECEIPTS

Reinstate oil spill excise tax.—Before January 1,
1995, a five-cents-per-barrel excise tax was imposed on
domestic crude oil and imported oil and petroleum products. The tax was dedicated to the Oil Spill Liability
Trust Fund to finance the cleanup of oil spills and
was not imposed for a calendar quarter if the unobligated balance in the Trust Fund exceeded $1 billion
at the close of the preceding quarter. The Administration proposes to reinstate this tax for the period after
the date of enactment and before October 1, 2008. The
tax would be suspended for a given calendar quarter
if the unobligated Trust Fund balance at the end of
the preceding quarter exceeded $5 billion.
Modify Federal Unemployment Act (FUTA) provisions.—Beginning in 2004, the Administration proposes
to require an employer to pay Federal and State unemployment taxes monthly (instead of quarterly) in a
given year, if the employer’s FUTA tax liability in the
immediately preceding year was $1,100 or more.
Extend pro rata disallowance of tax-exempt interest expense that applies to banks to all financial intermediaries.—No income tax deduction is allowed for interest on debt used directly or indirectly
to acquire or hold investments that produce tax-exempt
income. The determination of whether debt is used to
acquire or hold tax-exempt investments differs depending on the holder of the instrument. For banks and
a limited class of other financial institutions, debt generally is treated as financing all of the taxpayer’s assets
proportionately. Securities dealers are not included in
the definition of ‘‘financial institution,’’ and under a
special rule are subject to a disallowance of a much
smaller portion of their interest deduction. For other
financial intermediaries, such as finance companies,
that are also not included in the narrow definition of
‘‘financial institutions,’’ deductions are disallowed only
when indebtedness is incurred or continued for the purpose of purchasing or carrying tax-exempt investments.
These taxpayers are therefore able to reduce their tax
liabilities inappropriately through the double Federal
tax benefits of interest expense deductions and taxexempt interest income, notwithstanding that they operate similarly to banks. Effective for taxable years beginning after the date of enactment, with respect to
obligations acquired on or after the date of first committee action, the Administration proposes that all financial intermediaries, other than insurance companies
(which are subject to a separate regime), be treated
the same as banks are treated under current law with
regard to deductions for interest on debt used directly
or indirectly to acquire or hold tax-exempt obligations.
Increase the proration percentage for property
casualty (P&C) insurance companies.—In computing their underwriting income, P&C insurance companies deduct reserves for losses and loss expenses incurred. These loss reserves are funded in part with
the company’s investment income. In 1986, Congress
reduced the reserve deductions of P&C insurance com-

67
panies by 15 percent of the tax-exempt interest or the
deductible portion of certain dividends received. In
1997, Congress expanded the 15-percent proration rule
to apply to the inside buildup on certain insurance contracts. The existing 15-percent proration rule still enables P&C insurance companies to fund a substantial
portion of their deductible reserves with tax-exempt or
tax-deferred income. Other financial intermediaries,
such as life insurance companies and banks, are subject
to more stringent proration rules that substantially reduce or eliminate their ability to use tax-exempt or
tax-deferred investments to fund currently deductible
reserves or to deduct interest expense. Effective for taxable years beginning after the date of enactment, with
respect to investments acquired on or after the date
of first committee action, the Administration proposes
to increase the proration percentage to 30 percent.
Preclude certain taxpayers from prematurely
claiming losses from receivables.—An accrual method taxpayer generally must recognize income when all
events have occurred that fix the right to its receipt
and its amount can be determined with reasonable accuracy. In the event that a receivable arising in the
ordinary course of the taxpayer’s trade or business becomes uncollectible, the accrual method taxpayer may
deduct the account receivable as a business bad debt
in the year in which it becomes wholly or partially
worthless. Accrual method service providers, however,
are provided a special exception to these general rules.
Under the exception, a taxpayer using an accrual method with respect to amounts to be received for the performance of services is not required to accrue any portion of such amounts that (on the basis of experience)
will not be collected. This special exception permits an
accrual method service provider to reduce current taxable income by an estimate of its future bad debt losses.
This method of estimation results in a mismeasurement
of a taxpayer’s economic income and, because this tax
benefit only applies to amounts to be received for the
performance of services, promotes controversy over
whether a taxpayer’s receivables represent amounts to
be received for the performance of services or for the
provision of goods. The Administration proposes to repeal the special exception for accrual method service
providers effective for taxable years ending after the
date of enactment.
In general, dealers in securities are required to use
a mark-to-market method of accounting. Under this
method, securities that are inventory in the hands of
the dealer must be included in inventory at fair market
value. A taxpayer that is otherwise not a dealer in
securities may elect to be treated as such for this purpose if the taxpayer purchases and sells debt instruments that, at the time of purchase or sale, are customer paper with respect to either the taxpayer or a
corporation that is a member of the same consolidated
group as the taxpayer (the ‘‘customer paper election’’).
Significant numbers of taxpayers whose principal activities are selling nonfinancial goods or providing nonfinancial services are making the customer paper elec-

68
tion as a means of restoring bad debt reserves. The
customer paper election is also being used inappropriately to mark-to-market trade receivables that bear little or no interest in order to recognize loss. Under the
proposal, certain customer receivables would not be allowed to be marked to market. The proposal would
be effective for taxable years ending after the date of
enactment.
Restrict special net operating loss carryback
rules for specified liability losses.—Under current
law, the portion of a net operating loss that qualifies
as a specified liability loss may be carried back 10
years rather than being limited to the general twoyear carryback period. A specified liability loss includes
amounts allowable as a deduction with respect to product liability, and also certain liabilities that arise under
Federal or State law or out of any tort of the taxpayer.
The proper interpretation of the specified liability loss
provisions as they apply to liabilities arising under Federal or State law or out of any tort of the taxpayer
has been the subject of manipulation and significant
controversy. Accordingly, the Administration proposes
to modify the specified liability loss provisions to provide that only a limited class of liabilities qualifies as
a specified liability loss. Under the proposal, specified
liability losses would include (in addition to product
liability losses) any amount allowable as a deduction
that is attributable to a liability under Federal or State
law for reclamation of land, decommissioning of a nuclear power plant (or any unit thereof), dismantlement
of an offshore oil drilling platform, remediation of environmental contamination, or payments under a workers’ compensation statute. The proposal would be effective for taxable years beginning after the date of enactment.
Freeze grandfather status of stapled (or ‘‘pairedshare’’) Real Estate Investment Trusts (REITs).—
REITs generally are limited to owning passive investments in real estate and certain securities. Prior to
1984, certain ‘‘stapled’’ REITs were paired with subchapter C corporations and traded in tandem as a single unit. This effectively allowed these stapled REITs
to circumvent the restrictions on operating active businesses. In the Deficit Reduction Act of 1984, Congress
restricted REITs’ ability to avoid these investment limitations by providing that stapled entities must be treated as one entity for purposes of determining qualification under the REIT rules. However, Congress grandfathered the existing stapled REITs indefinitely. The
Administration proposes to limit the grandfather status
of the existing stapled REITs. Under the proposal, for
purposes of determining whether any grandfathered entity is a REIT, the stapled entities would be treated
as one entity with respect to properties acquired on
or after the date of the first committee action and with
respect to activities or services relating to such properties (i.e., properties acquired after the effective date)
that are undertaken or performed by one of the stapled
entities on or after such date.

ANALYTICAL PERSPECTIVES

Restrict impermissible business indirectly conducted by REITs.—REITs generally are restricted to
owning passive investments in real estate and certain
securities. To prevent indirect ownership of impermissible businesses, current law restricts a REIT from
owning more than 10 percent of the outstanding voting
securities of any issuer. Nonetheless, a REIT can essentially conduct an impermissible business through a subsidiary by holding a significant amount of non-voting
stock in a corporation. Through the retention of nonvoting stock and debt, the REIT is able to retain most,
if not all, of the income generated by the impermissible
business and to circumvent the restrictions on operating active businesses. The Administration proposes to
restrict this ability by prohibiting REITs from holding
stock possessing more than 10 percent of the vote or
value of all classes of stock of a corporation. In general,
the proposal would be effective with respect to stock
acquired on or after the date of first committee action.
Modify treatment of closely held REITs.—When
originally enacted, the REIT legislation was intended
to provide a tax-favored vehicle through which small
investors could invest in a professionally managed real
estate portfolio. REITs are intended to be widely held
entities, and certain requirements of the REIT rules
are designed to ensure this result. Among other requirements, in order for an entity to qualify for REIT
status, the beneficial ownership of the entity must be
held by 100 or more persons. In addition, a REIT cannot be closely held, which generally means that no more
than 50 percent of the value of the REIT’s stock can
be owned by five or fewer individuals during the last
half of the taxable year. Certain attribution rules apply
in making this determination. The Administration has
become aware of a number of tax avoidance transactions involving the use of closely held REITs. In order
to meet the 100 or more shareholder requirement, the
REIT generally issues common stock, which is held by
one shareholder, and a separate class of non-voting preferred stock with a relatively nominal value, which is
held by 99 ‘‘friendly’’ shareholders. The closely held limitation does not disqualify the REITs that are utilizing
this ownership structure because the majority shareholders of these REITs are not individuals. The Administration proposes to impose as an additional requirement for REIT qualification that no person can own
stock of a REIT possessing more than 50 percent of
the total combined voting power of all classes of voting
stock or more than 50 percent of the total value of
shares of all classes of stock. For purposes of determining a person’s stock ownership, rules similar to the
attribution rules contained in section 856(d)(5) would
apply. The proposal would be effective for entities electing REIT status for taxable years beginning on or after
the date of first committee action.
Modify depreciation method for tax-exempt use
property.—Current law requires tax-exempt use property (property owned by a U.S. person but leased to
a foreign or tax-exempt person) to be depreciated using

3.

FEDERAL RECEIPTS

the straight-line method over a period equal to the
greater of (1) the property’s class life; or (2) 125 percent
of the lease term. This rule has led to manipulations
designed to create a shortened recovery period. The
Administration proposes to lengthen the recovery period
for ‘‘tax-exempt use property’’ to 150 percent of its class
life. This will prevent the U.S. tax system from providing tax benefits in the form of accelerated depreciation
for the use of property that is not connected with U.S.
business activities. The proposal generally would be effective for property placed in service after December
31, 1998.
Impose excise tax on purchase of structured settlements.—Current law facilitates the use of structured
personal injury settlements because recipients of annuities under these settlements are less likely than recipients of lump sum awards to consume their awards too
quickly and require public assistance. Consistent with
that policy, this favorable treatment is conditional upon
a requirement that the periodic payments cannot be
accelerated, deferred, increased or decreased by the injured person. Nonetheless, certain factoring companies
are able to purchase a portion of the annuities from
the recipients for heavily discounted lump sums. These
purchases are inconsistent with the policy underlying
favorable tax treatment of structured settlements. Accordingly, the Administration proposes to impose on
any person who purchases (or otherwise acquires for
consideration) a structured settlement payment stream,
a 20-percent excise tax on the purchase price unless
such purchase is pursuant to a court order finding that
the extraordinary and unanticipated needs of the original intended recipient render such a transaction desirable. The proposal would apply to purchases occurring
after the date of enactment. No inference is intended
as to the contractual validity of the purchase or the
effect of the purchase transaction on the tax treatment
of any party other than the purchaser.
Clarify and expand math error procedures.—If
the IRS determines that a taxpayer has failed to provide a correct taxpayer identification number (TIN) that
is required by statute, the IRS may, in certain cases,
use the streamlined procedures for mathematical and
clerical errors (‘‘math error procedures’’) to expedite the
assessment of tax. The Administration proposes the following clarifications to the math error procedures applicable to the child tax credit, the child and dependent
care tax credit, the personal exemption for dependents,
the Hope and Lifetime Learning tax credits, and the
earned income tax credit. First, the term ‘‘correct taxpayer identification number’’ used on a tax return
would be defined as the TIN assigned to such individual
by the Social Security Administration (SSA), or in certain limited cases, the IRS. Second, the IRS would be
authorized to use data obtained from SSA to verify
that the TIN provided on the return corresponds to
the individual for whom the TIN was assigned. Such
data would include the individual’s name, age or date
of birth, and Social Security number. Third, the IRS

69
would be authorized to use math error procedures to
deny eligibility for those tax benefits subject to the
math error procedures that impose a statutory age restriction (i.e., the child tax credit, the child and dependent care tax credit and the earned income tax credit)
if the taxpayer provides a TIN for either the taxpayer
or qualifying child that the IRS determines, using data
from SSA, does not meet the statutory age restrictions.
The proposal would be effective for taxable years ending
after the date of enactment.
Clarify the meaning of ‘‘subject to’’ liabilities
under section 357(c).—A transferor generally is required to recognize gain on a transfer of property in
an otherwise tax-free section 351 exchange to the extent
the sum of the liabilities assumed, plus those to which
the transferred property is subject, exceeds the basis
in the property. If a recourse liability is secured by
multiple assets, it is unclear under present law whether
a transfer of one asset where the transferor remains
liable is a transfer of property ‘‘subject to the liability.’’
Similar issues exist with respect to nonrecourse liabilities. Under the Administration’s proposal, the distinction between the assumption of a liability and the acquisition of an asset subject to a liability would be
eliminated. Instead, the extent to which a liability (including a nonrecourse liability) is treated as assumed
for Federal income tax purposes in connection with a
transfer of property would be determined on the basis
of all the facts and circumstances. In general, if nonrecourse indebtedness is secured by more than one
asset, and any assets securing the indebtedness are
transferred subject to the indebtedness without any indemnity agreements, then for all Federal income tax
purposes the transferee would be treated as assuming
an allocable portion of the liability based upon the relative fair market values (determined without regard
to section 7701(g)) of the assets securing the liability.
The proposal would be effective for transfers after the
date of first committee action. No inference regarding
the tax treatment under current law is intended.
Simplify foster child definition under EITC.—In
order to simplify the EITC rules, the Administration
proposes to clarify the definition of foster child for purposes of claiming the EITC. Under the proposal, the
foster child must be the taxpayer’s sibling (or a descendant of the taxpayer’s sibling), or be placed in the
taxpayer’s home by an agency of a State or one of
its political subdivisions or a tax-exempt child placement agency licensed by a State. The proposal would
be effective for taxable years beginning after December
31, 1998.
Clarify tie-breaker rule under EITC.—The earned
income tax credit tie-breaker rule prevents a lowerincome individual from claiming the credit with respect
to a particular child who could also be a qualifying
child with respect to a higher-income individual. The
Administration proposes to clarify that the requirement
that a taxpayer identify on his or her tax return any

70
child with respect to whom the taxpayer is claiming
the EITC is a requirement for claiming the credit, rather than an element of the definition of ‘‘qualifying
child.’’ Thus, under the EITC tie-breaker rule, the child
would be a qualifying child with respect to the higherincome individual, regardless of whether the higherincome individual actually identifies the child on his
or her return. A similar change would be made to the
definition of ‘‘eligible individual.’’ The proposal is effective with respect to taxable years ending after the date
of enactment. No inference is intended as to the operation of the tie-breaker rule under current law.
Eliminate non-business valuation discounts.—
Under current law, taxpayers are claiming large discounts on the valuation of gifts and bequests of interests in entities holding marketable assets. Because
these discounts are inappropriate, the Administration
proposes to eliminate valuation discounts except as they
apply to active businesses. Interests in entities generally would be required to be valued for gift and estate
tax purposes at a proportional share of the net asset
value of the entity to the extent that the entity holds
readily marketable assets. The proposal would be effective for gifts made after, and decedents dying after,
the date of enactment.
Eliminate ‘‘Crummey’’ rule.—Currently, gifts of
present interests of up to $10,000 (in 1998) per donor
per donee each year are excepted from the gift tax.
The decision in Crummey v. Commissioner held that
a transfer in trust is a transfer of a present interest
if the beneficiary has a right to withdraw the property
from the trust for a limited period of time. The Administration proposes to overrule this decision so that only
outright gifts of present interests would be counted for
purposes of the $10,000 gift exception. The proposal
would be effective for gifts completed after December
31, 1998.
Eliminate gift tax exemption for personal residence trusts.— Current law excepts transfers of personal residences in trust from the special valuation
rules applicable when a grantor retains an interest in
a trust. The Administration proposes to repeal this personal residence exception. Thereafter, if a residence is
to be used to fund a grantor retained interest trust,
the trust would be required to pay out the required
annuity or unitrust amount or else the grantor’s retained interest would be valued at zero for gift tax
purposes. This proposal would be effective for transfers
in trust after the date of enactment.
Include qualified terminable interest property
(QTIP) trust assets in surviving spouse’s estate.—
A marital deduction is allowed for qualified terminable
interest property (QTIP) passing to a qualifying trust
for a spouse either by gift or by bequest. The value
of the recipient spouse’s estate includes the value of
any such property in which the decedent had a qualifying income interest for life and a deduction was allowed

ANALYTICAL PERSPECTIVES

under the gift or estate tax. In some cases, taxpayers
have attempted to whipsaw the government by claiming
the deduction in the first estate and then arguing
against inclusion in the second estate due to some technical flaw in the QTIP election. The Administration
proposes that, if a deduction is allowed under the QTIP
provisions, inclusion is required in the beneficiary
spouse’s estate. The proposal would be effective for decedents dying after the date of enactment.
Apply 7.7 percent capitalization rate to credit
life insurance premiums.—Under current law, a company that issues group credit life insurance contracts
is required to capitalize 2.05 percent of its net premiums for such contracts. However, commissions and
other policy acquisition expenses on credit life insurance contracts generally are higher than policy acquisition expenses for individual life insurance contracts,
to which a 7.7 percent capitalization rate applies. Thus,
the statutory proxy rate for policy acquisition costs on
credit life insurance contracts does not accurately reflect the level of commissions and other policy acquisition expenses for credit life insurance. Under the Administration’s proposal, insurance companies would be
required to capitalize 7.7 percent of their net premiums
for a taxable year with respect to all credit life insurance contracts. The proposal would be effective for taxable years beginning after the date of enactment.
Modify corporate-owned life insurance (COLI)
rules.—In general, interest on policy loans or other
indebtedness with respect to life insurance, endowment
or annuity contracts is not deductible unless the insurance contract insures the life of a ‘‘key person’’ of a
business. In addition, the interest deductions of a business generally are reduced under a proration rule if
the business owns or is a direct or indirect beneficiary
with respect to certain insurance contracts. The COLI
proration rules generally do not apply if the contract
covers an individual who is a 20 percent owner of the
business or is an officer, director, or employee of such
business. These exceptions under current law still permit leveraged businesses to fund significant amounts
of deductible interest and other expenses with tax-exempt or tax-deferred inside buildup. The Administration proposes to repeal the exception under the COLI
proration rules for contracts insuring employees, officers or directors (other than 20 percent owners) of the
business. The proposal also would conform the key person exception for disallowed interest deductions attributable to policy loans and other indebtedness with respect to insurance contracts to the 20 percent owner
exception in the COLI proration rules. The proposal
would be effective for taxable years beginning after date
of enactment.
Modify reserve rules for annuity contracts.—
Under current law, a life insurance company that issues
an annuity contract claims a reserve deduction equal
to the greater of the net surrender value of the contract
and an amount that is based on the Commissioner’s

3.

FEDERAL RECEIPTS

71

Annuities Reserve Valuation Method (CARVM) in effect
on the date that the annuity contract is issued, subject
to a cap equal to the annual statement reserve for
the contract. In 1997, the National Association of Insurance Commissioners adopted new actuarial guidelines
interpreting CARVM. The guidelines generally require
life insurance companies to compute CARVM reserves
by determining the greatest possible present value of
all guaranteed benefits, using a number of worst case
or ‘‘conservative’’ assumptions. The guidelines are effective on December 31, 1998, and apply to all contracts
issued on or after January 1, 1981. Because these new
guidelines would be inappropriate for calculating tax
reserves, the Administration proposes that tax reserves
for all annuity contracts with cash surrender values
would be set at the contract’s net cash surrender value
plus a specified percentage of the contract’s net cash
surrender value that would be phased out over a portion of the contract period. The proposal would be effective for taxable years ending on or after the date of
enactment.

putation of basis under section 72 by subtracting mortality and expense charges. This proposal would apply
to contracts issued after the date of first committee
action.

Tax certain exchanges of insurance contracts
and reallocations of assets within variable insurance contracts.—Generally, investors are taxed upon
the sale or exchange of assets. However, certain exchanges of life insurance, endowment and annuity contracts are not taxed. Also, the holder of a variable contract who liquidates part or all of his investment in
one fund, and reallocates the proceeds to a different
fund within a variable contract, is not taxed. The
Adminstration proposes that all exchanges of an insurance contract for a variable contract would be taxable.
Exchanges of variable contracts for any type of life insurance, endowment or annuity contract would be taxable. Each variable contract investment in a separate
account mutual fund or in the insurance company’s general account would be treated as a separate contract.
In addition, the investment in the contract would be
net of mortality and expense charges. These rules
would apply to contracts issued after the date of first
committee action. A material change in an existing contract would be treated as the issuance of a new contract.

Prescribe regulatory directive to address tax
avoidance involving foreign built-in losses.—Certain taxpayers are engaging in tax avoidance transactions that inappropriately use losses generated outside the United States to offset income that otherwise
would be subject to U.S. tax. The provision would direct
the Secretary of Treasury to prescribe regulations, as
may be necessary or appropriate to prevent the avoidance of tax, to determine (1) the basis of assets held
directly or indirectly by a person other than a United
States person, and (2) the amount of built-in deductions
of a person other than a U.S. person, or an entity
held directly or indirectly by such a person. The proposal would be effective on the date of enactment.

Reduce ‘‘investment in the contract’’ for mortality and expense charges on certain insurance contracts.—For purposes of computing the amount of taxable investment income under section 72 of the Internal
Revenue Code from distributions under cash value life
insurance, endowment, or annuity contracts, the holder’s tax basis includes premiums used to pay mortality
and expense charges. These charges are used to pay
for annual term life insurance coverage, other types
of insurance coverage, and options to buy life annuities
at specified rates guaranteed in a deferred annuity contract. As a result, these rules overstate basis and thus
understate the amount of tax-deferred income under
these contracts when they are surrendered for cash or
the holder receives other distributions under the contract. The Administration proposes to modify the com-

Amend 80/20 company rules.—Dividends paid by
a so-called ‘‘80/20 company’’ generally are partially or
fully exempt from U.S. withholding tax. A U.S. corporation is treated as an 80/20 company if at least 80 percent of the gross income of the corporation for the threeyear period preceding the year of a dividend is foreign
source income attributable to the active conduct of a
foreign trade or business (or the foreign business of
a subsidiary). Certain foreign multinationals improperly
seek to exploit the rules applicable to 80/20 companies
in order to avoid U.S. withholding tax liability on earnings of U.S. subsidiaries that are distributed abroad.
The proposal would prevent taxpayers from avoiding
withholding tax through manipulations of these rules.
The proposal would apply to interest or dividends paid
or accrued after the date of enactment.

Prescribe regulatory directive to address tax
avoidance through use of hybrids.—Certain persons
are entering into tax avoidance transactions that utilize
hybrid entities, securities and transactions to achieve
tax results that are inconsistent with the purposes of
the provisions of U.S. law (including treaties) that are
relied on for such results. Other transactions involving
hybrids do not achieve tax results that are inconsistent
with the purposes of U.S. law. The consequences of
these transactions should be described in the form of
promptly issued administrative guidance both to prevent inappropriate results and to provide taxpayers
with greater certainty. The proposal would direct the
Secretary of Treasury to prescribe regulations to prevent the avoidance of tax through the use of hybrid
entities, securities and transactions that achieve results
inconsistent with the purposes of U.S. law (including
treaties). The proposal would be effective on the date
of enactment.
Modify foreign office material participation exception applicable to inventory sales attributable
to nonresident’s U.S. office.—In the case of a sale
of inventory property that is attributable to a non-

72
resident’s office or other fixed place of business within
the United States, the sales income is generally U.S.
source. The income is foreign source, however, if the
inventory is sold for use, disposition, or consumption
outside the United States and the nonresident’s foreign
office or other fixed place of business materially participates in the sale. The proposal would provide that the
foreign source exception shall apply only if an income
tax equal to at least 10 percent of the income from
the sale is actually paid to a foreign country with respect to such income. The proposal thereby ensures that
the United States does not cede its jurisdiction to tax
such sales unless the income from the sale is actually
taxed by a foreign country at some minimal level. The
proposal would be effective for transactions occurring
on or after the date of enactment.
Stop abuse of controlled foreign corporation
(CFC) exception to ownership requirements.—
Under section 887 of the Internal Revenue Code, a foreign corporation is subject to a four-percent tax on its
United States source gross transportation income. The
tax does not apply, however, if the corporation is organized in a country (an ‘‘exemption country’’) that grants
an equivalent tax exemption to U.S. shipping companies. The exemption from the four-percent tax is subject
to an anti-abuse rule that requires at least 50 percent
of the stock of the corporation be owned by individual
residents of an exemption country. Thus residents of
a non-exemption country cannot secure the exemption
simply by forming their shipping corporation in an exemption country. The anti-abuse rule requiring exemption country ownership does not apply, however, if the
corporation is a controlled foreign corporation (the ‘‘CFC
exception’’). The premise for the CFC exception is that
the U.S. shareholders of a CFC will be subject under
U.S. tax law to current income taxation on their share
of the foreign corporation’s shipping income and thus
the four-percent tax should not apply if the corporation
is organized in an exemption country. However, residents of non-exemption countries can achieve CFC status for their shipping companies simply by owning the
corporations through U.S. partnerships. Non-exemption
country individuals can thereby avoid the anti-abuse
rule requiring exemption country ownership and illegitimately secure the exemption from the U.S. four-percent tax. The proposal would stop that abuse. It would
be effective for taxable years beginning after the date
of enactment.
OTHER PROVISIONS THAT AFFECT RECEIPTS
Reinstate environmental tax imposed on corporate taxable income and deposited in the Hazardous Substance Superfund Trust Fund.—Under
prior law a tax equal to 0.12 percent of alternative
minimum taxable income (with certain modifications)
in excess of $2 million was levied on all corporations
and deposited in the Hazardous Substance Superfund
Trust Fund. The Administration proposes to reinstate
this tax, which expired on December 31, 1995, for tax-

ANALYTICAL PERSPECTIVES

able years beginning after December 31, 1997 and before January 1, 2009.
Reinstate excise taxes deposited in the Hazardous Substance Superfund Trust Fund.—The excise
taxes that were levied on petroleum, chemicals, and
imported substances and deposited in the Hazardous
Substance Superfund Trust Fund, are proposed to be
reinstated for the period after the date of enactment
and before October 1, 2008. These taxes expired on
December 31, 1995.
Extend excise taxes on gasoline, diesel fuel, and
special motor fuels.—Excise taxes are imposed on
gasoline (other than aviation gasoline) at a rate of 18.4
cents per gallon, diesel fuel at a rate of 24.4 cents
per gallon, and special motor fuels at varying rates.
The tax rates are scheduled to fall to 4.4 cents per
gallon (or comparable rates in the case of special motor
fuels) on September 30, 1999. The Administration proposes to extend the current rates of tax on nonaviation
gasoline, diesel fuel and special motor fuels (with a
0.1-cent-per-gallon reduction, reflecting the expiration
of the LUST Trust Fund tax on April 1, 2005).
Convert excise taxes deposited in the Airport and
Airway Trust Fund to cost-based user fees assessed
for Federal Aviation Administration (FAA) services.—Beginning in 2000, the excise taxes that are levied on domestic air passenger tickets and flight segments, international departures and arrivals, domestic
air cargo, and aviation fuels are proposed to be phased
out over a five-year period, and replaced with more
efficient, cost-based user fees charged for FAA services.
As part of a continuing effort to create a more businesslike FAA, the Administration will propose legislation
by which the FAA would be entirely funded by costbased user fees by 2003.
Receipts from tobacco legislation.—The Administration includes receipts from tobacco legislation in the
1999 budget. These receipts, which total approximately
$65 billion for the five years 1999 through 2003, would
support tobacco-related public health and other activities at the State and Federal level.
Assess fees for examination of bank holding companies and State-chartered member banks (receipt
effect).—The Administration proposes to require the
Federal Reserve and the Federal Deposit Insurance
Corporation (FDIC) to assess fees for the examination
of bank holding companies and State-chartered banks.
The Federal Reserve currently funds the costs of such
examinations from earnings; therefore, deposits of earnings by the Federal Reserve, which are classified as
governmental receipts, will increase by the amount of
the fees.
Transfer retirees and certain active employees
of the FDIC and the Board of Governors of the
Federal Reserve to the Federal Employee Health

3.

73

FEDERAL RECEIPTS

Benefits Program (FEHBP) (receipt effect).—The
Administration supports the transfer of health coverage
for retirees and certain active employees of the FDIC
and the Board of Governors of the Federal Reserve,
who are now covered by in-house health care plans,
to the FEHBP administered by the Office of Personnel
Management (OPM). The current plans are becoming
more expensive because of the small size and age of
the insured group. FEHBP coverage would be more cost
effective. This proposal will reduce the administrative
costs of the Federal Reserve, thereby increasing deposits of earnings by the Federal Reserve, which are classified as governmental receipts.
Repeal Federal Employees Retirement System
(FERS) open season (receipt effect).—The Administration proposes, in a supplemental, to repeal section
642 of the Treasury and General Government Appro-

Table 3–3.

priation Act, 1998. That section provides an ‘‘open season’’ from July 1, 1998 through December 31, 1998
during which time Federal and Postal Service employees covered by the Civil Service Retirement System
(CSRS) could switch to FERS. Repealing section 642
would increase employee payments to the Civil Service
Retirement and Disability Fund.
Create solvency incentive for State Unemployment Trust Fund accounts.—The Administration proposes to create an incentive for States to improve the
solvency of their State accounts in the Federal Unemployment Trust Fund. This is intended to improve the
ability of States to continue paying benefits in the event
of a recession. The incentive consists of tying a portion
of the projected distributions to the States under the
Reed Act to demonstrated improvements in solvency.

EFFECT OF PROPOSALS ON RECEIPTS
(In billions of dollars)
Estimate
1998

1999

2000

2001

2002

2003

1999–2003

Provide tax relief and extend expiring provisions:
Make child care more affordable:
Increase and simplify child and dependent care tax credit ............................................................
Establish tax credit for employer-provided child care .....................................................................

..............
..............

–0.3
–*

–1.3
–0.1

–1.1
–0.1

–1.2
–0.1

–1.2
–0.1

–5.1
–0.5

Subtotal, make child care more affordable .................................................................................

..............

–0.3

–1.3

–1.3

–1.3

–1.4

–5.6

Promote energy efficiency and improve the environment:
Provide tax credit for energy-efficient building equipment ..............................................................
Provide tax credit for purchase of new energy-efficient homes .....................................................
Provide tax credit for high-fuel-economy vehicles ..........................................................................
Equalize treatment of parking and transit benefits .........................................................................
Provide investment tax credit for CHP systems .............................................................................
Provide tax credit for replacement of certain circuitbreaker equipment ........................................
Provide tax credit for certain PFC and HFC recycling equipment .................................................
Provide tax credit for rooftop solar equipment ................................................................................
Extend wind and biomass tax credit ...............................................................................................

..............
..............
..............
..............
*
..............
..............
..............
..............

–0.1
–*
..............
–*
–0.3
–*
–*
–*
–*

–0.2
–*
..............
–*
–0.3
–*
–*
–*
–*

–0.3
–*
–0.1
–*
–0.1
–*
–*
–*
–*

–0.3
–0.1
–0.2
–*
–0.1
–*
–*
–*
–0.1

–0.4
–0.1
–0.4
–*
–0.2
–*
–*
–*
–0.1

–1.4
–0.2
–0.7
–0.1
–0.9
–*
–*
–0.1
–0.2

Subtotal, promote energy efficiency and improve the environment ...........................................

*

–0.4

–0.6

–0.6

–0.8

–1.2

–3.6

Promote expanded retirement savings ................................................................................................
Expand education incentives:
Provide incentives for public school construction ...........................................................................
Extend and expand exclusion for employer-provided educational assistance ...............................
Eliminate tax when forgiving student loans subject to income contingent repayment ..................

–*

–0.1

–0.2

–0.2

–0.2

–0.2

–0.9

..............
–*
..............

–0.2
–0.2
..............

–0.9
–0.3
..............

–1.3
–0.4
..............

–1.3
–0.1
..............

–1.3
..............
..............

–5.0
–1.0
..............

Subtotal, expand education incentives ........................................................................................

–*

–0.4

–1.2

–1.7

–1.4

–1.3

–6.0

Increase low-income housing tax credit per capita cap .....................................................................
Extend expiring provisions:
Extend work opportunity tax credit ..................................................................................................
Extend welfare-to-work tax credit ....................................................................................................
Extend R&E tax credit ......................................................................................................................
Extend deduction provided for contributions of appreciated stock to private foundations ............
Make permanent the expensing of brownfields remediation costs ................................................

..............

–*

–0.2

–0.3

–0.4

–0.6

–1.6

–*
..............
–0.4
..............
..............

–0.2
–*
–0.8
–*
..............

–0.3
–0.1
–0.6
–*
..............

–0.2
–0.1
–0.3
..............
–0.1

–0.1
–*
–0.1
..............
–0.2

–*
–*
–*
..............
–0.2

–0.8
–0.2
–1.8
–0.1
–0.5

Subtotal, extend expiring provisions ............................................................................................

–0.4

–1.1

–1.0

–0.6

–0.4

–0.3

–3.4

Modify international trade provisions:
Extend GSP and modify other trade provisions 1 ...........................................................................
Extend and modify Puerto Rico economic-activity tax credit .........................................................
Levy tariff on certain textiles and apparel products produced in the CNMI 1 ...............................
Expand Virgin Island tariff credits 1 .................................................................................................

..............
..............
..............
..............

–0.5
–*
..............
..............

–0.5
–0.1
0.2
–*

–0.5
–0.1
0.2
–*

–*
–0.2
0.2
–*

–*
–0.2
0.2
–*

–1.5
–0.6
0.7
–*

Subtotal, modify international trade provisions 1 .........................................................................

..............

–0.6

–0.4

–0.4

*

–*

–1.4

74

ANALYTICAL PERSPECTIVES

Table 3–3.

EFFECT OF PROPOSALS ON RECEIPTS—Continued
(In billions of dollars)
Estimate
1998

1999

2000

Provide other tax incentives:
Expand tax incentives for SSBICs ..................................................................................................
Accelerate and expand incentives available to two new empowerment zones ............................
Make first $2,000 of severance pay exempt from income tax. ......................................................

–*
..............
..............

–*
–*
–*

2001

2002

2003

1999–2003

–*
–*
–0.2

–*
..............
–0.2

–*
..............
–0.2

–*
..............
–0.2

–*
–0.1
–0.8

Subtotal, provide other tax incentives .........................................................................................

–*

–0.1

–0.2

–0.2

–0.2

–0.2

–0.8

Simplify the tax laws .............................................................................................................................
Enhance taxpayers’ rights ....................................................................................................................

–*
..............

–0.1
–*

–0.1
–*

–0.1
–*

–0.1
–0.1

–0.1
–0.1

–0.6
–0.2

Subtotal, provide tax relief and extend expiring provisions 1 .................................................

–0.5

–3.2

–5.1

–5.5

–5.0

–5.4

–24.2

*
*
..............
..............
..............
..............
*
..............
..............

*
*
0.1
*
0.6
*
0.4
*
..............

*
*
0.1
*
1.4
0.1
0.5
*
*

*
*
0.1
*
1.5
0.1
0.4
*
*

*
*
0.1
*
1.5
0.1
0.2
*
*

0.1
0.1
0.1
0.1
1.6
0.1
0.1
*
*

0.2
0.2
0.5
0.1
6.6
0.4
1.6
0.1
0.1

..............
*
..............

*
0.2
..............

*
0.2
..............

*
0.2
..............

*
0.2
..............

*
0.3
..............

*
1.2
..............

*
–*
..............
..............
*
..............
..............
..............
..............
..............
*
..............
..............
..............
..............
..............
..............
*
0.3
..............

*
*
0.4
*
*
*
*
*
*
*
*
..............
*
..............
..............
–*
..............
*
0.4
1.8

*
0.1
0.1
*
*
*
*
*
*
0.1
*
*
*
0.2
*
–*
*
*
0.4
0.7

*
0.1
0.1
*
*
*
*
*
*
0.1
*
*
*
0.2
*
*
*
*
0.4
0.8

*
0.1
0.1
*
*
*
*
*
*
0.1
*
*
*
0.3
*
*
*
*
0.5
0.6

*
0.1
0.1
*
*
*
*
*
*
0.1
*
*
*
0.3
*
*
*
*
0.5
0.7

0.1
0.4
0.7
0.1
0.1
*
0.1
0.1
0.1
0.3
0.1
*
*
1.0
0.1
*
*
0.1
2.2
4.6

*

*

0.1

0.2

0.3

0.4

0.9

..............
*
..............
..............

*
*
*
*

*
*
0.1
0.1

*
*
0.1
0.1

*
0.1
0.1
*

0.1
0.1
0.1
*

0.1
0.2
0.2
0.2

*
..............

*
*

*
*

*
*

*
*

*
*

*
*

0.3

4.3

4.3

4.7

4.7

5.0

23.0

..............
0.1
..............
..............
..............

1.1
0.7
..............
..............
9.8

0.7
0.7
0.4
1.7
11.8

0.7
0.7
0.4
1.7
13.3

0.7
0.7
0.4
1.7
14.5

0.7
0.7
0.4
0.8
16.1

3.8
3.6
1.5
6.0
65.5

..............

0.1

0.1

0.1

0.1

0.1

0.4

..............

*

*

*

*

*

*

Eliminate unwarranted benefits and adopt other revenue measures:
Defer deduction for interest and OID on convertible debt ..................................................................
Eliminate dividends-received deduction for certain preferred stock ...................................................
Repeal percentage depletion for non-fuel minerals mined on Federal and formerly Federal lands
Repeal tax-free conversions of large C corporations to S corporations ............................................
Replace sales-source rules with activity-based rules ..........................................................................
Modify rules relating to foreign oil and gas extraction income ...........................................................
Repeal lower-of-cost-or-market inventory accounting method ............................................................
Increase penalties for failure to file correct information returns .........................................................
Tighten the substantial understatement penalty for large corporations .............................................
Repeal exemption for withholding on gambling winnings from bingo and keno in excess of
$5,000 ...............................................................................................................................................
Reinstate oil spill excise tax 1 ..............................................................................................................
Modify Federal Unemployment Act provisions ....................................................................................
Extend pro-rata disallowance of tax-exempt interest expense that applies to banks to all financial
intermediaries ...................................................................................................................................
Increase proration percentage for P&C insurance companies ...........................................................
Preclude certain taxpayers from prematurely claiming losses from receivables ...............................
Restrict special net operating loss carryback rules for specified liability losses ...............................
Freeze grandfather status of stapled (or ‘‘paired-share’’) REITs ........................................................
Restrict impermissible business indirectly conducted by REITs .........................................................
Modify treatment of closely held REITs ...............................................................................................
Modify depreciation method for tax-exempt use property ...................................................................
Impose excise tax on purchase of structured settlements 1 ...............................................................
Clarify and expand math-error procedures ..........................................................................................
Clarify the meaning of ‘‘subject to’’ liabilities under section 357(c) ...................................................
Simplify foster child definition under EITC ..........................................................................................
Clarify tie-breaker rule under EITC ......................................................................................................
Eliminate non-business valuation discounts ........................................................................................
Eliminate ‘‘Crummey’’ rule ....................................................................................................................
Eliminate gift tax exemption for personal residence trusts .................................................................
Include QTIP trust assets in surviving spouse’s estate ......................................................................
Apply 7.7% capitalization rate to credit life insurance premiums .......................................................
Modify corporate-owned life insurance (COLI) rules ...........................................................................
Modify reserve rules for annuity contracts ..........................................................................................
Tax certain exchanges of insurance contracts and reallocations of assets within variable insurance contracts ..................................................................................................................................
Reduce ‘‘investment in the contract’’ for mortality and expense charges on certain insurance contracts .................................................................................................................................................
Amend 80/20 company rules ...............................................................................................................
Prescribe regulatory directive to address tax avoidance involving foreign built-in losses .................
Prescribe regulatory directive to address tax avoidance through use of hybrids ..............................
Modify foreign office material participation exception applicable to inventory sales attributable to
nonresident’s U.S. office ..................................................................................................................
Stop abuse of CFC exception to ownership requirements .................................................................
Subtotal, eliminate unwarranted benefits and adopt other revenue measures 1 ..............
Other provisions that affect receipts:
Reinstate environmental tax imposed on corporate taxable income 2 ...............................................
Reinstate Superfund excise taxes 1 .....................................................................................................
Extend excise taxes on gasoline, diesel fuel and special motor fuels 1 ............................................
Convert airport and airway trust fund taxes to a cost-based user fee system 1 ...............................
Receipts from tobacco legislation ........................................................................................................
Assess fees for examination of bank holding companies and State-chartered member banks (receipt effect) 1 .....................................................................................................................................
Transfer retirees and certain active employees of the FDIC and Board of Governors of the Federal Reserve to FEHBP (receipt effect) ..........................................................................................

3.

75

FEDERAL RECEIPTS

Table 3–3.

EFFECT OF PROPOSALS ON RECEIPTS—Continued
(In billions of dollars)
Estimate
1998

1999

2000

Repeal FERS open season (receipt effect) .........................................................................................
Create solvency incentive for State unemployment trust fund accounts 1 .........................................

*
..............

0.2
..............

0.2
..............

0.2
0.4

0.2
0.4

0.2
..............

1.0
0.8

Subtotal, other provisions that affect receipts 1 ....................................................................

0.1

11.8

15.5

17.4

18.8

19.1

82.6

Total effect of proposals 1 .....................................................................................................................

–0.1

12.9

14.7

16.7

18.5

18.7

81.5

* $50 million or less.
1
Net of income offsets.
2
Net of deductibility for income tax purposes.

2001

2002

2003

1999–2003

76

ANALYTICAL PERSPECTIVES

Table 3–4.

RECEIPTS BY SOURCE
(In millions of dollars)

Source

1997
actual

1998
estimate

1999
estimate

2000
estimate

2001
estimate

2002
estimate

2003
estimate

Individual income taxes (Federal funds):
Existing law .............................................................................................................................
737,466
Proposed Legislation (PAYGO) .............................................................................................. ..................

767,874
–106

792,739
–1,285

808,471
–3,907

837,867
–4,503

881,538
–4,485

919,874
–4,341

Total individual income taxes ..................................................................................................

737,466

767,768

791,454

804,564

833,364

877,053

915,533

Corporation income taxes:
Federal funds:
Existing law .........................................................................................................................
182,289
Proposed Legislation (PAYGO) .......................................................................................... ..................

190,944
–102

194,412
2,210

200,388
1,671

206,033
2,255

211,741
2,080

217,427
2,145

190,842

196,622

202,059

208,288

213,821

219,572

Total Federal funds corporation income taxes ......................................................................

182,289

Trust funds:
Hazardous substance superfund ........................................................................................
4 .................. .................. .................. .................. .................. ..................
Proposed Legislation (PAYGO) .......................................................................................... .................. ..................
1,343
870
863
863
864
Total corporation income taxes ..............................................................................................

182,293

190,842

197,965

202,929

209,151

214,684

220,436

336,729
55,261
110,710

358,949
57,042
118,029

374,612
59,516
122,626

388,988
64,915
128,479

404,101
68,630
134,081

422,586
71,756
140,430

441,648
74,995
146,899

1,611
2,440

1,611
2,493

1,619
2,495

1,624
2,507

1,636
2,521

1,648
2,536

1,651
2,548

Total employment and general retirement .............................................................................

506,751

538,124

560,868

586,513

610,969

638,956

667,741

On-budget ...........................................................................................................................
Off-budget ...........................................................................................................................

114,761
391,990

122,133
415,991

126,740
434,128

132,610
453,903

138,238
472,731

144,614
494,342

151,098
516,643

Unemployment insurance:
Deposits by States 1 ..........................................................................................................
22,071
22,658
24,175
25,456
Proposed Legislation (PAYGO) ..................................................................................... .................. .................. .................. ..................
Federal unemployment receipts 1 ......................................................................................
6,103
6,196
6,254
6,345
Railroad unemployment receipts 1 .....................................................................................
28
68
104
97

26,319
450
6,359
78

27,175
28,075
490 ..................
6,449
6,495
78
95

Total unemployment insurance ...............................................................................................

Social insurance and retirement receipts (trust funds):
Employment and general retirement:
Old-age and survivors insurance (Off-budget) ..................................................................
Disability insurance (Off-budget) ........................................................................................
Hospital insurance ..............................................................................................................
Railroad retirement:
Social Security equivalent account ................................................................................
Rail pension and supplemental annuity ........................................................................

28,202

28,922

30,533

31,898

33,206

34,192

34,665

Other retirement:
Federal employees’ retirement—employee share .............................................................
4,344
Proposed Legislation (non-PAYGO) .............................................................................. ..................
Non-Federal employees retirement 2 .................................................................................
74

4,245
6
77

4,247
167
71

4,361
201
65

4,601
212
60

4,382
224
54

3,838
232
44

Total other retirement .............................................................................................................

4,418

4,328

4,485

4,627

4,873

4,660

4,114

Total social insurance and retirement receipts ....................................................................

539,371

571,374

595,886

623,038

649,048

677,808

706,520

On-budget ................................................................................................................................
Off-budget ................................................................................................................................

147,381
391,990

155,383
415,991

161,758
434,128

169,135
453,903

176,317
472,731

183,466
494,342

189,877
516,643

Excise taxes:
Federal funds:
Alcohol taxes ......................................................................................................................
7,257
7,251
Tobacco taxes ....................................................................................................................
5,873
5,926
Transportation fuels tax ......................................................................................................
7,107
442
Telephone and teletype services .......................................................................................
4,543
4,864
Ozone depleting chemicals and products ..........................................................................
130
55
Other Federal fund excise taxes ........................................................................................
2,921
1,529
Proposed Legislation (PAYGO) ..................................................................................... .................. ..................

7,254
5,900
682
5,129
30
1,613
12

7,250
7,236
7,223
7,211
7,495
8,083
8,686
8,895
88
89
90
92
5,394
5,691
6,015
6,356
10 .................. .................. ..................
1,430
1,373
1,338
1,263
515
531
550
568

Total Federal fund excise taxes .............................................................................................

27,831

20,067

20,620

22,182

23,003

23,902

24,385

Trust funds:
Highway ...............................................................................................................................
Airport and airway ..............................................................................................................

23,867
4,007

26,063
7,975

38,614
10,038

33,201
9,273

33,812
9,793

34,448
10,525

35,107
11,095

3.

77

FEDERAL RECEIPTS

Table 3–4.

RECEIPTS BY SOURCE—Continued
(In millions of dollars)

Source

1997
actual

1998
estimate

1999
estimate

2000
estimate

2001
estimate

2002
estimate

2003
estimate

Proposed Legislation (PAYGO) ..................................................................................... .................. .................. ..................
2,267
2,267
2,267
1,133
Aquatic resources ...............................................................................................................
316
281
379
339
345
353
359
Black lung disability insurance ...........................................................................................
614
640
662
684
703
718
733
Inland waterway ..................................................................................................................
96
116
120
123
126
131
135
Hazardous substance superfund ........................................................................................
71 .................. .................. .................. .................. .................. ..................
Proposed Legislation (PAYGO) ..................................................................................... ..................
101
934
949
960
976
990
Oil spill liability ....................................................................................................................
1 .................. .................. .................. .................. .................. ..................
Proposed Legislation (PAYGO) ..................................................................................... ..................
46
317
321
325
330
336
Vaccine injury compensation ..............................................................................................
123
111
111
111
111
111
111
Leaking underground storage tank ....................................................................................
–2
140
214
182
186
189
193
Total trust funds excise taxes ................................................................................................

29,093

35,473

51,389

47,450

48,628

50,048

50,192

Total excise taxes .....................................................................................................................

56,924

55,540

72,009

69,632

71,631

73,950

74,577

Estate and gift taxes:
Existing law .............................................................................................................................
19,845
20,436
Proposed Legislation (PAYGO) .............................................................................................. .................. ..................

20,542
–1

21,389
253

22,353
266

24,156
291

25,300
319

Total estate and gift taxes .......................................................................................................

20,436

20,541

21,642

22,619

24,447

25,619

Customs duties:
Federal funds ..........................................................................................................................
17,131
17,515
Proposed Legislation (PAYGO) .......................................................................................... .................. ..................
Trust funds ..............................................................................................................................
797
848

17,928
–658
905

18,890
–323
964

19,691
–333
1,029

21,053
225
1,097

22,655
224
1,171

Total customs duties ................................................................................................................

18,175

19,531

20,387

22,375

24,050

19,845

17,928

18,363

MISCELLANEOUS RECEIPTS: 3
Miscellaneous taxes ................................................................................................................
107
113
Receipts from tobacco legislation (PAYGO) .......................................................................... .................. ..................
United Mine Workers of America combined benefit fund .....................................................
339
323
Deposit of earnings, Federal Reserve System ......................................................................
19,636
24,991
Proposed Legislation (PAYGO) .......................................................................................... .................. ..................
Defense cooperation ............................................................................................................... ..................
12
Fees for permits and regulatory and judicial services ..........................................................
3,222
5,778
Fines, penalties, and forfeitures .............................................................................................
1,994
2,140
Gifts and contributions ............................................................................................................
184
194
Refunds and recoveries ..........................................................................................................
–17
–16

115
118
120
123
126
9,795
11,787
13,283
14,544
16,085
282
273
266
258
251
24,544
24,950
25,501
26,121
26,786
98
102
106
111
116
6 .................. .................. .................. ..................
9,605
12,888
15,097
15,843
16,074
2,100
1,991
1,899
1,877
1,877
177
147
126
121
123
–16
–16
–16
–16
–16

Total miscellaneous receipts ...................................................................................................

25,465

33,535

46,706

52,240

56,382

58,982

61,422

Total budget receipts ................................................................................................................
On-budget ................................................................................................................................
Off-budget ................................................................................................................................

1,579,292
1,187,302
391,990

1,657,858
1,241,867
415,991

1,742,736
1,308,608
434,128

1,793,576
1,339,673
453,903

1,862,582
1,389,851
472,731

1,949,299
1,454,957
494,342

2,028,157
1,511,514
516,643

MEMORANDUM
Federal funds ..........................................................................................................................
Trust funds ..............................................................................................................................
Interfund transactions ..............................................................................................................

1,010,315
365,248
–188,261

1,050,472
383,120
–191,725

1,093,576
412,247
–197,215

1,121,674
423,654
–205,655

1,163,467
441,874
–215,490

1,219,949
461,621
–226,613

1,269,885
480,193
–238,564

Total on-budget .........................................................................................................................

1,187,302

1,241,867

1,308,608

1,339,673

1,389,851

1,454,957

1,511,514

Off-budget (trust funds) ............................................................................................................

391,990

415,991

434,128

453,903

472,731

494,342

516,643

Total .............................................................................................................................................

1,579,292

1,657,858

1,742,736

1,793,576

1,862,582

1,949,299

2,028,157

1

Deposits by States cover the benefit part of the program. Federal unemployment receipts cover administrative costs at both the Federal and State levels. Railroad unemployment receipts cover both the benefits and administrative costs of the program for the railroads.
2
Represents employer and employee contributions to the civil service retirement and disability fund for covered employees of Government-sponsored, privately owned enterprises and the District of Columbia municipal government.
3
Includes both Federal and trust funds. Trust fund amounts in miscellaneous receipts are 1997: $746 million; 1998: $740 million; 1999: $683 million; 2000: $649 million; 2001:
$639 million; 2002: $647 million; and 2003: $662 million.

4. USER FEES AND OTHER COLLECTIONS
In addition to collecting taxes and other governmental receipts by the exercise of its sovereign powers,
the Federal Government earns income from its various
business-type activities. The term ‘‘user fee’’ is defined
as fees, charges, and assessments levied on a class directly benefiting from, or subject to regulation by, a
government program or activity, to be utilized solely
to support the program or activity. In addition, the
payers of the fee must be limited in the authorizing
legislation to those benefiting from, or subject to regulation by, the program or activity, and may not include
the general public or a broad segment of the public.
The user fee must be authorized for use only to fund
the specified programs or activities for which they are
charged, including directly associated agency functions,
not for unrelated programs or activities and not for
the broad purposes of the Government or an agency.
User fees include: collections from non-Federal
sources for goods and services provided (such as the
sale of postage stamps and electricity); voluntary payments to social insurance programs (such as Medicare
Part B premiums); miscellaneous customs fees (such
as United States Customs Service merchandise processing fees); and certain specific taxes and duties (such
as Harbor Maintenance and Inland Waterways taxes).
The term ‘‘user fee’’ is not a separate budget category
for collections. Depending primarily on whether the
user charge is based on the Government’s sovereign

power or business-type activity, it may be classified
as a governmental receipt, or as an offsetting collection.
User fees classified as governmental receipts are included along with the taxes and other governmental
receipts discussed in the previous chapter. Those fees
classified as offsetting collections are subtracted from
gross outlays. The purpose of this treatment is to
produce budget totals for receipts, outlays, and budget
authority in terms of the amount of resources allocated
governmentally, through collective political choice rather than through the market.
Offsetting collections are classified into two major
categories: offsetting receipts, which are deposited in
receipt accounts; and offsetting collections credited to
appropriations (expenditure) accounts, which are deposited directly in these accounts and usually can be spent
without further action by the Congress. While most
offsetting receipts and collections result from businesslike activity or are collected from other Government
accounts, some result from the Government’s sovereign
or governmental powers and would be classified as
governmental receipts but are required by law to be
treated as offsetting. Chapter 24, ‘‘Budget System and
Concepts,’’ explains the budgetary treatment of these
collections more fully.
Not all offsetting collections are user fees. User fees
do not include collections from other Federal accounts;

Why User Fees?
•

•
•
•
•
•
•
•

The term ‘‘user fee’’ refers to Government charges to those who use a Government good or service or are subject to Government regulation. For example:
—Park entrance fees charged to visitors to national parks
—Meat, poultry, and egg inspection fees
—Tennessee Valley Authority proceeds from power sales
—Proceeds from the lease of Department of Energy buildings and facilities
—Flood insurance premiums
—Sales of commemorative coins
User fees are dedicated to funding part or all of the cost of providing the service or regulation by crediting them to a
program account instead of to the general fund of the Treasury.
User fees are generally designated as offsetting collections or receipts so that they offset the spending they are designated
to fund.
User fees are different from general revenue, because they are not collected from the general public or broad segments of
the public (like income taxes) and they are not used for the general purposes of government (like national defense).
Users are more willing to support and pay fees when they are dedicated to maintaining or improving the quality of the
programs that affect them directly.
Government program managers may be more diligent about collecting and spending fees when funding for their programs
is dependent on fees, instead of guaranteed appropriations of general taxpayer money.
Administration policy is to shift to user fee funding wherever appropriate. However, essential government services will
continue to be supported by general fund appropriations from the Treasury as necessary.
The Administration’s user fee proposals generally require authorizing legislation to authorize the fees first and appropriations action before the fees can actually be collected and spent. This is done to preserve the traditional roles of the
authorizing and appropriations committees in Congress and to conform to the ‘‘scoring’’ conventions of the Budget
Enforcement Act.

79

80

ANALYTICAL PERSPECTIVES

Table 4–1.

USER FEE COLLECTIONS
(In millions of dollars)
Estimates

1997
actual

1998

1999

Governmental receipts:
Harbor maintenance and inland waterway fees ..................................................................................
Agricultural quarantine inspection fees ................................................................................................
Existing FAA user fees 1 ......................................................................................................................
Proposed FAA user fees ......................................................................................................................
Other governmental receipt user fees .................................................................................................

832
115
..............
..............
134

900
141
..............
..............
215

959
144
..............
..............
224

1,021
148
5,815
1,700
224

1,087
153
7,066
1,700
225

1,159
159
7,649
1,700
229

1,235
163
11,056
850
230

Total, governmental receipts .....................................................................................................................

1,081

1,256

1,327

8,908

10,231

10,896

13,534

Offsetting collections:
Offsetting collections deposited in receipt accounts:
Medicare premiums ..........................................................................................................................
Services charges on foreign military sales .....................................................................................
Immigration fees ...............................................................................................................................
U.S. customs user fees ....................................................................................................................
Medical care and National Serviceman’s Life Insurance Premiums and other Veterans fees .....
Nuclear Regulatory Commission fees .............................................................................................
Interior park entrance, concessionaire and other fees ...................................................................
Inspection, grading and other Agriculture fees ...............................................................................
Other collections deposited in receipt accounts .............................................................................

20,421
15,128
992
1,288
234
459
349
148
396

20,672
13,750
994
1,184
915
455
392
170
413

21,511
12,550
1,400
1,272
889
467
420
176
428

23,934
11,790
1,400
1,316
975
469
467
176
448

26,278
11,090
1,412
1,363
1,044
480
454
176
441

28,816
10,570
1,430
1,412
1,117
496
475
176
441

31,731
9,770
1,404
1,464
1,135
510
469
176
465

Subtotal, offsetting collections deposited in receipt accounts .............................................................

39,415

38,945

39,113

40,975

42,738

44,933

47,124

Offsetting collections deposited in appropriations accounts:
Postal Service ...................................................................................................................................
Tennessee Valley Authority and other power marketing ................................................................
Housing and commissary fees paid by military personnel and other defense related fees .........
Federal Employee and Retiree health and life insurance benefits ................................................
Pension Benefit Guaranty Corporation premiums and and other Department of Labor fees ......
Veterans insurance premiums and other fees ................................................................................
National flood insurance fund premiums .........................................................................................
Bureau of Engraving and Printing and U.S. Mint fees ...................................................................
Patent and Trademark and fees ......................................................................................................
Other offsetting collections deposited in appropriations accounts .................................................

57,407
8,135
7,909
4,104
1,576
1,595
1,108
1,086
641
6,580

59,986
8,829
7,378
5,895
1,708
1,594
1,230
1,088
730
6,603

63,349
9,121
7,428
6,188
1,740
1,563
1,353
1,141
836
7,880

64,850
9,389
7,402
6,558
1,615
1,571
1,448
1,165
929
7,520

67,300
9,557
7,402
6,952
1,610
1,538
1,549
1,188
1,098
7,440

69,750
9,623
7,402
7,398
1,652
1,502
1,652
1,209
1,161
7,551

72,200
9,750
7,402
7,880
1,681
1,468
1,761
1,236
1,238
7,666

Subtotal, offsetting collections deposited in appropriations accounts .................................................

90,141

95,041

100,599

102,447

105,634

108,900

112,282

Total, offsetting collections ........................................................................................................................

129,556

133,986

139,712

143,422

148,372

153,833

159,406

Total, user fee collections .....................................................................................................................

130,637

135,242

141,039

152,330

158,603

164,729

172,940

Memorandum:
Existing fees:
Postal Service .......................................................................................................................................
Existing Medicare premiums ................................................................................................................
Service charges on foreign military sales ............................................................................................
Other existing user fees .......................................................................................................................

57,407
20,421
15,128
37,681

59,986
20,672
13,750
40,808

63,349
21,384
12,550
41,417

64,850
23,255
11,790
47,419

67,300
25,464
11,090
49,551

69,750
27,791
10,570
51,146

72,200
30,497
9,770
55,597

Subtotal, existing user fee collections .............................................................................................
User fee proposals ....................................................................................................................................

130,637
..............

135,216
26

138,700
2,339

147,314
5,016

153,405
5,198

159,257
5,472

168,064
4,876

1

2000

2001

2002

2003

Represents proceeds from current law aviation excise taxes which the FAA will convert to cost-based user fees.

collections deposited in general fund receipt accounts;
collections associated with credit programs; realizations
upon loans and investments; interest, dividends, and
other earnings; involuntary payments to social insurance programs; excise taxes; customs duties; fines, penalties, and forfeitures; cost sharing contributions; proceeds from asset sales (property, plant, and equipment);
Outer Continental Shelf receipts; spectrum auction proceeds; and Federal Reserve earnings.
As shown in Table 4–1, total user fee collections (including those proposed in this budget) are estimated
to be $141.0 billion in 1999, rising to $172.9 billion
in 2003. User fee collections by the United States Postal
Service, Medicare premiums, and service charges on

foreign military sales are estimated to be 69 percent
of all user fee collections in 1999. Table 4–3 provides
more detail for offsetting receipts collected from the
public and includes offsetting receipts collected from
other accounts within the Government.
The Budget contains a variety of user fee proposals
that would yield $2.3 billion in 1999 and $22.9 billion
from 1999 through 2003. User fee proposals establish,
increase, or extend fees in order to recover more of
the costs of providing government services. The proposals would make the affected program funding levels
dependent on enactment of the user fee proposals and
subsequently, the actual collections of the fees. Regular
appropriations have only been requested to fund the

4. USER FEES AND OTHER COLLECTIONS

start-up costs associated with these fee proposals. Table
4–2 splits the proposals between discretionary and
mandatory categories for the appropriate scoring under
the Budget Enforcement Act of 1997 (BEA). It includes
user fees classified as offsetting collections and governmental receipts.
Discretionary Proposals
The following proposed fees are classified as discretionary because the Appropriations Committees are
being requested to authorize collection of the fees and
make them available for expenditure. In some cases,
authorizing legislation will be proposed either to establish new fees or increase existing ones. The proposed
authorizing legislation will make both the fee collection
and spending contingent upon appropriations action.
Collections from the following proposals are to be deposited directly in appropriations accounts as offsetting
collections:
DEPARTMENT OF AGRICULTURE
Animal and Plant Health Inspection Service (APHIS):
The budget proposes to establish five APHIS fees to
cover the cost of:
• Providing animal welfare inspections to recipients
of APHIS services such as animal research centers, humane societies, and kennels.
• Issuing biotechnology certificates to firms that
manufacture biotechnologically-derived products.
• Licensing, inspecting, and testing veterinary biologics by veterinary biologic companies.
• Inspecting to ensure the garbage fed to swine is
properly cooked to avoid contamination to establishments regulated under the Swine Health Protection Act.
• Eradicating the pink bollworm.
Grain Inspection, Packers and Stockyards Administration (GIPSA) licensing fees.—The budget proposes to
allow GIPSA to charge the grain shippers and handlers
using the official inspection system its costs to develop,
review and maintain standards and methods of testing
(such as for grain quality and classification) used by
the grain industry. In addition, an annual licensing
fee is proposed to fund GIPSA activities that ensure
the integrity of the livestock, meat and poultry market
and marketplace, such as fostering open competition,
and protecting consumers and businesses from unfair
practices.
Food Safety and Inspection Service meat, poultry and
egg products inspection fee.—The 1999 Budget proposes
a new user fee for USDA’s Food Safety and Inspection
Service (FSIS). Under the proposed fee, the meat, poultry and egg products industries would be required to
reimburse the Federal government for the cost of the
salaries and benefits and other direct costs for all inplant inspection. The proposal would transfer the cost
of Federal inspection services to the industries that
directly benefit, and would ensure that sufficient resources are available to provide the level of in-plant

81
inspection necessary to meet the demands of industry.
The cost of the user fee would amount to less than
one cent per pound of meat inspected.
Natural Resources Conservation Service (NRCS) costshare fee.—The 1999 Budget proposes to impose fees
for a number of NRCS activities, including the sale
of soil survey data, maps, and snow survey data to
private users, engineering designs, soil map interpretations for commercial purposes, and irrigation management activities where water supplies are not very limited. Fees would also be charged to meet requests for
the NRCS to expedite soil surveys, watershed planning,
and other services.
Farm services fee.—The Administration proposes to
allow the Farm Services Administration (FSA) to
charge fees to cover the full cost of collecting, processing, and disseminating information of interest to private individuals and companies (crop insurance companies, appraisers, and agricultural consultants, etc.),
where the provision of information is not required to
fulfill FSA’s mission.
DEPARTMENT OF COMMERCE
National Oceanic and Atmospheric Administration
(NOAA), navigational assistance fees.—The Administration proposes a fee on U.S. and foreign commercial
cargo carriers to recover the cost of navigational assistance services, such as nautical charting, provided by
NOAA. The fee would be administered for NOAA by
the United States Cost Guard as part of the Coast
Guard’s proposed navigational assistance fee program
described below.
NOAA, fisheries management fees.—The Budget proposes a fee of not more than one percent of the exvessel value of fish harvested by commercial fisherman
to provide for fisheries management and enforcement
services.
Patent and Trademark fees.—The surcharge on patent fees, established in the Omnibus Budget Reconciliation Act of 1990 and extended in the Omnibus Budget
Reconciliation Act of 1993, will expire at the end of
1998. The expiration of this authority will reduce Patent and Trademark Office (PTO) revenue by $182 million in 1999. The Budget proposes legislation to extend
and increase statutory fees charged for patent products
and services to ensure that fee revenues continue to
cover the cost of patent processing and related services.
Trade promotion services fees.—The Administration
proposes to charge U.S. businesses for counseling and
other promotional services provided by the International Trade Administration.
DEPARTMENT OF HEALTH AND HUMAN SERVICES
Food and Drug Administration (FDA) fees.—The proposal seeks $128 million in new fees to finance FDA
activities such as medical device reviews, animal drug
approvals, import inspections, food additive petition reviews, generic drug application reviews, and fees for
postmarket surveillance of products.

82

ANALYTICAL PERSPECTIVES

Table 4–2.

PROPOSED USER FEE COLLECTIONS
(In millions of dollars)

Discretionary fee proposals

1998

Offsetting collections deposited in appropriations accounts:
Department of Agriculture:
Animal and Plant Health Inspection Service fees .........................................................................................
Grain Inspection, Packers and Stockyards Administration licensing fees ...................................................
Food Saftey and Inspection Service, meat, poultry, and egg products inspection fee ..............................
Natural Resources Conservation Service (NRCS) cost-share fee ...............................................................
Farm Services Administration, farm service fee ...........................................................................................
Department of Commerce:
National Oceanic and Atmospheric Administration proposals:
Navigational assistance fee .......................................................................................................................
Fisheries management fee ........................................................................................................................
Patent and Trademark Office, patent fees ....................................................................................................
International Trade Administration, trade promotion fees .............................................................................
Department of Health and Human Services:
Food and Drug Administration fees ...............................................................................................................
Health Care Financing Administration Fee Proposals:
Physician, provider, and supplier enrollment registration fees .................................................................
Managed care organization application and renewal fees .......................................................................
Initial provider certification fees .................................................................................................................
Provider recertification fees .......................................................................................................................
Paper claims submission fees ...................................................................................................................
Duplicate and unprocessable claims fees ................................................................................................
Department of the Interior: Bureau of Land Management, hardrock location and maintenance fees ............
Department of Labor: Alien labor certification fee .............................................................................................
Department of Transportation:
Coast Guard—navigational assistance fee ....................................................................................................
Surface Transportation Board fees ................................................................................................................
Army Corps of Engineers, wetlands permit Fee ...............................................................................................
Federal Emergency Management Administration, radiological emergency preparedness fees ......................
National Transportation Safety Board, Aviation accident investigation fee ......................................................
Social Security Administration, claimant representative fees ............................................................................

1999

2000

2001

2002

2003

1999–
2003

............
............
............
............
............

10
17
473
10
10

10
21
573
15
15

10
21
573
15
15

10
21
573
25
25

10
21
573
25
25

50
101
2,765
90
90

............
............
............
............

3
20
182
6

11
20
189
12

11
20
207
12

11
20
219
12

11
20
228
12

47
100
1,025
54

26

128

128

128

128

128

640

............
............
............
............
............
............
............
............

20
37
10
52
110
36
39
............

21
38
10
54
114
37
40
40

21
39
11
56
118
38
41
40

22
41
11
58
122
39
42
40

23
42
12
61
126
41
43
40

107
196
54
282
589
190
205
160

............
............
............
............
............
............

35
16
7
13
6
7

165
16
14
13
6
9

165
16
14
13
6
9

165
16
14
13
6
9

165
16
14
13
6
9

695
80
63
65
30
43

26

1,246

1,571

1,599

1,642

1,663

7,721

............
............

82
48

82
48

82
48

82
48

82
48

410
240

............
............
............
............

16
8
313
12

16
8
314
17

16
8
322
17

16
8
332
17

16
8
342
17

80
40
1,623
80

Subtotal, offsetting collections deposited in receipt accounts ......................................................................
Total, discretionary user fee proposals .............................................................................................................
Mandatory Fee Proposals
Offsetting collections deposited in appropriations accounts:
Department of Health and Human Services:
Medicare cost-based provider audit fees ......................................................................................................
Federal Deposit Insurance Corporation state bank examination fees .............................................................

............
26

479
1,725

485
2,056

493
2,092

503
2,145

513
2,176

2,473
10,194

............
............

395
89

395
94

395
97

395
101

395
106

1,975
487

Subtotal, offsetting collections deposited in appropriations accounts ..........................................................
Offsetting collections deposited in receipt accounts:
Department of Health and Human Services:
Medicare premiums ........................................................................................................................................
Department of the Interior:
Interior/USDA, entrance and recreation fees ................................................................................................
National Park Service, park concession fees ...............................................................................................

............

484

489

492

496

501

2,462

............

127

679

814

1,025

1,234

3,879

............
............

............
3

86
6

88
12

88
18

90
25

352
64

Subtotal, offsetting collections deposited in receipt accounts ......................................................................
Collections deposited in governmental receipt accounts:
Federal Aviation Administration, proposed user fees ........................................................................................

............

130

771

914

1,131

1,349

4,295

............

............

1,700

1,700

1,700

850

5,950

Total, mandatory user fee proposals .................................................................................................................

............

614

2,960

3,106

3,327

2,700

12,707

Total, User Fee Proposals ...................................................................................................................................

26

2,339

5,016

5,198

5,472

4,876

22,901

Subtotal, offsetting collections deposited in appropriations accounts ..........................................................
Offsetting collections deposited in receipt accounts:
Department of Transportation: Federal Railroad Administration—railroad safety inspection fees ..................
Department of the Treasury: Customs merchandise processing fee ...............................................................
Environmental Protection Agency:
Pesticide registration fees ..............................................................................................................................
Chemical pre-manufacturing notification fees ................................................................................................
Nuclear Regulatory Commission, extend NRC fees .........................................................................................
Social Security Administration, claimant representative fees ............................................................................

Health Care Financing Administration (HCFA).—This
proposal would establish fees for a variety of activities
associated with the Medicare Program, including:
Physician, provider, and supplier enrollment registration fees.—The Administration proposes to charge phy-

sicians, providers, and suppliers an initial enrollment
fee and a renewal fee in order to participate in the
Medicare program. Physicians would be required to reenroll every 5 years. Durable medical equipment suppliers, hospitals, skilled nursing facilities, home health

4. USER FEES AND OTHER COLLECTIONS

agencies, and all other providers would be required to
re-enroll every 3 years. Proceeds from the fee would
be used for enrollment costs and other contracting activities.
Managed care organization application and renewal
fees.—The Budget proposes to charge managed care organizations a fee to cover 100% of the cost of reviewing
initial applications and renewing annual contracts with
Medicare. Proceeds from this fee would be used to offset
administrative costs related to managed care organization application and renewals as well as other administrative activities.
Initial provider certification fee.—The Administration
proposes to levy a fee on providers (e.g., home health
agencies (HHA) and skilled nursing facilities (SNF))
who wish to enter the Medicare program. The fee would
vary by type of provider. Proceeds from this fee would
be used to offset survey and certification costs.
Provider recertification fee.—This fee would be levied
on providers who are recertified for the Medicare program. By statute, SNFs must be surveyed every year,
HHAs every three years, and other providers about
once every ten years. The fee would be charged every
year to spread the costs of the certification program
over time. Proceeds from this fee would be used to
offset survey and certification costs.
Paper claims submission fee.—Providers would be
charged $1.00 for every paper claim submitted for payment because of the additional cost of processing paper
rather than electronic claims. Rural providers and very
small providers who may not be able to purchase the
necessary hardware to comply with electronic claims
transmission would be exempt from the fee. Proceeds
from the fee would be used for claims processing and
other contracting activities.
Duplicate and unprocessable claims fees.—The budget proposes to charge Medicare providers $1.00 for each
duplicate and unprocessable claim submitted for payment to the Health Care Financing Administration.
Proceeds from the fee would be used for claims processing and other contracting activities.
DEPARTMENT OF THE INTERIOR
Bureau of Land Management, hardrock mining location and maintenance fees.—This proposal would raise
and extend the hardrock mining location and maintenance fees established in the 1993 Omnibus Budget
Reconciliation Act beyond 1998.
DEPARTMENT OF LABOR
Alien labor certification fee.—The proposal would establish a new fee, charged to businesses, for processing
of alien labor certification and attestation applications
by the Labor Department. Collection of the fee would
begin in 2000 with the proceeds offsetting the costs
of administering the alien labor program. In 2000, regular appropriations are required in addition to regular
user fees to process the backlog of applications that
already have been filed.

83
DEPARTMENT OF TRANSPORTATION
Coast Guard, navigational assistance fees.—The Administration proposes to levy a fee on U.S. and foreign
commercial cargo carriers for the use of Coast Guard
navigational assistance services. Navigational assistance services include the placement and maintenance
of buoys and other short-range aids-to-navigation, radio
navigation, and vessel traffic services. Fishing and recreational vessels would be exempt.
Surface Transportation Board fees.—The Administration proposes to create a fee mechanism to completely
offset the expenses of the Surface Transportation Board
(STB), the successor to the Interstate Commerce Commission (ICC). The fees would be collected from those
who benefit from the continuation of the ICC functions
transferred to the STB, e.g., railroads and shippers.
DEPARTMENT OF THE TREASURY
Customs merchandise processing fee.—The Budget
proposes to allow the U.S. Customs Service to collect
and spend an increase in the Customs Merchandise
Processing Fee that will be proposed in authorizing legislation subsequent to release of the Budget. The Administration will propose to increase the ad valorem
rate of the Merchandise Processing Fee paid by importers from 0.21 percent to up to 0.25 percent of the value
of formal cargo entries into the United States. Collection and use of the proceeds from the fee increase would
be provided for in appropriations action, and would be
statutorily restricted to the modernization of Customs’
automated commercial operations.
ARMY CORPS OF ENGINEERS
Wetlands permit fees.—The Budget proposes to increase fees charged to permit commercial use of wetlands. The proceeds of the fee would be used to fund
wetland regulatory activities.
FEDERAL EMERGENCY MANAGEMENT AGENCY (FEMA)
Radiological emergency preparedness fee.—The budget
includes a proposal to reauthorize FEMA’s assessments
on Nuclear Regulatory Commission (NRC) licensees to
cover 100 percent of the cost of providing site-specific
services that directly contribute to the fulfillment of
emergency preparedness requirements needed for NRC
licensing.
NATIONAL TRANSPORTATION SAFETY BOARD (NTSB)
Aviation accident investigation fees.—To offset a portion of the NTSB’s growing cost of commercial aviation
accident investigations, a new aviation accident recovery and investigation fee is proposed. This fee, which
would be paid by commercial air carriers based on revenue flight hours of operation, would collect an estimated $6 million in 1999.
SOCIAL SECURITY ADMINISTRATION
Administration of claimant representative approval
and direct payment process fees.—The Budget proposes

84
to impose a fee on persons who represent Supplemental
Security Income claimants in administrative or judicial
proceedings. This fee is designed to recover the cost
of processing attorney fee agreements and determining
the allowable charge under the fee petition process.
This assessment would be imposed only if the claimant
is awarded past due benefits and a fee for representation is approved by the Social Security Administration.
Collections from the following proposals would be deposited in receipt accounts as offsetting receipts:
DEPARTMENT OF TRANSPORTATION
Federal Railroad Administration, railroad safety
inspection fee.—The rail safety fee would offset costs
incurred by the Federal Railroad Administration for
inspection, research and development and related activities to ensure the safe operation of passenger and
freight railroads. A similar fee was enacted in the Omnibus Budget Reconciliation Act of 1990, but expired
at the end of 1995.
ENVIRONMENTAL PROTECTION AGENCY
Pesticide registration fees.—The budget proposes to
reinstate pesticide registration fees that are statutorily
suspended through 2001. These fees would be used to
offset the cost of reviewing applications for pesticide
registrations, amendments to registrations, and experimental use permits.
Chemical pre-manufacturing notification (PMN)
fees.—The Administration proposes to eliminate the
statutory cap on PMN fees and to increase fees charged
to chemical producers to recover the cost of reviewing
notifications of new chemicals prior to production.
NUCLEAR REGULATORY COMMISSION (NRC)
Extend Nuclear Regulatory Commission fees.—Under
current law, the NRC must recover approximately 100
percent of its costs from licensing, inspection, and annual fees charged to its applicants and licensees
through 1998. Unless the law is extended, the fee coverage requirement will revert to 33 percent of NRC’s
cost of operations. The Administration proposes to extend fees at approximately 100 percent of NRC’s cost
of operations through 2003.
SOCIAL SECURITY ADMINISTRATION
Administration of claimant representative approval
and direct payment process fees.—The Budget proposes
to impose a fee on persons who represent Social Security claimants in administrative or judicial proceedings.

ANALYTICAL PERSPECTIVES

This fee is designed tor ecover the cost of processing
attorney fee agreements, determining the allowable
charge under the fee petition process, and processing
the direct payment of attorney fees. This assessment
would be imposed only if the claimant is awarded past
due benefits, and a fee for representation is approved
by the Social Security Administration.
Mandatory Proposals
The following new and increased fees are classified
as mandatory because they are proposed to be included
in authorizing legislation and neither the collection or
spending of the fee would be contingent upon appropriations action.
Collections from the following proposals are to be deposited directly in appropriations accounts as offsetting
collections:
DEPARTMENT OF HEALTH AND HUMAN SERVICES
Medicare cost-based provider audit fees.—The Budget
proposes $395 million in 1999 in fees to charge costbased health care providers the full cost associated with
performing annual audits of these providers cost reports. The fee would allow more annual audits to be
conducted and act as a deterrent to inflating reported
costs.
Medicare premiums for retirees under the age of 65
and displaced workers.—The Administration proposes
to charge premiums based on an actuarially fair rate
to people between the ages of 62 and 65 and displaced
workers between 55 and 61 who elect to participate
in the Medicare buy-in premium based program. This
increase in premium collections is partially offset by
the reduction in premium collections due to the Medicare program integrity proposal.
FEDERAL DEPOSIT INSURANCE CORPORATION (FDIC)
State bank examination fee.—The Administration proposes to require the FDIC and the Federal Reserve
to assess fees for examinations of bank holding companies and state-chartered FDIC-insured banks. The costs
of such examinations are currently funded from deposit
insurance premiums and Federal Reserve earnings from
monetary policy activities. The FDIC fee proceeds would
be used to finance the examination operation. The Federal Reserve collections do not meet the technical definition of user fees, but are considered governmental
receipts and are discussed in the preceding chapter on
governmental receipts.

85

4. USER FEES AND OTHER COLLECTIONS

Collections from the following proposals are to be deposited in receipt accounts as offsetting receipts:

posal and administrative reforms to improve management of the park concessions program and increase
competition for concessions contracts.

DEPARTMENT OF THE INTERIOR
Interior and USDA, entrance and recreation fees.—
The Administration proposes to increase entrance,
recreation, and other fees charged by the National Park
Service and other land management agencies, and to
grant those agencies permanent authority to use all
receipts for facility improvements and new repairs.
National Park Service, park concession fees.—The Administration proposes to allow parks to retain all existing and new franchise fees to use for park improvements and concessions related activities. This proposal
would encourage parks to increase returns from concessions contracts, and is part of a set of legislative pro-

Collections from the following proposal are to be deposited in receipt accounts, as governmental receipts.
DEPARTMENT OF TRANSPORTATION
Federal Aviation Administration (FAA), cost based
user fees.—Beginning in 2000, the Budget assumes that
the existing aviation excise taxes will be gradually reduced over a five year period and replaced with a more
efficient system of cost-based user fees charged for FAA
services. As part of a continuing effort to create a more
business-like FAA, the Administration will propose legislation to fund the FAA entirely with cost-based user
fees by 2003.

OFFSETTING RECEIPTS
Table 4–3 itemizes all offsetting collections deposited
in receipt accounts. These include payments from one
part of the Government to another, called intra-governmental transactions, and collections from the public.

These receipts are offset (deducted) from outlays in the
Federal budget. In total, offsetting receipts are estimated at $352.9 billion in 1999.

86

ANALYTICAL PERSPECTIVES

Table 4–3.

OFFSETTING RECEIPTS BY TYPE
(In millions of dollars)

Source

1997
actual

1998
estimate

1999
estimate

2000
estimate

2001
estimate

2002
estimate

2003
estimate

INTRAGOVERNMENTAL TRANSACTIONS
On-budget receipts:
Federal intrafund transactions:
Distributed by agency:
Interest from the Federal Financing Bank ....................................................................
Interest on Government capital in enterprises ..............................................................
Other ...............................................................................................................................

4,171
1,570
1,969

3,142
1,543
1,610

2,758
1,321
1,632

2,518
1,257
1,741

2,344
1,153
1,842

2,113
1,033
1,960

1,853
926
2,078

Total Federal intrafunds .................................................................................................

7,710

6,295

5,711

5,516

5,339

5,106

4,857

Trust intrafund transactions:
Distributed by agency:
Payments to railroad retirement ....................................................................................
Other ...............................................................................................................................

3,747
1

3,784
1

3,785
1

3,806
1

3,692
1

3,797
1

3,796
1

Total trust intrafunds ......................................................................................................

3,748

3,785

3,786

3,807

3,693

3,798

3,797

Total intrafund transactions ................................................................................................

11,458

10,080

9,497

9,323

9,032

8,904

8,654

Interfund transactions:
Distributed by agency:
Federal fund payments to trust funds:
Contributions to insurance programs:
Military retirement fund ..........................................................................................
15,151
15,119
Supplementary medical insurance ........................................................................
59,471
59,773
Proposed Legislation (PAYGO) ........................................................................ .................. ..................
Hospital insurance .................................................................................................
4,202
5,414
Railroad social security equivalent fund ...............................................................
56
62
Rail industry pension fund ....................................................................................
182
192
Civilian supplementary retirement contributions ...................................................
21,558
21,502
Unemployment insurance ......................................................................................
565
517
Other contributions ................................................................................................
425
372
Proposed Legislation (PAYGO) ........................................................................ .................. ..................
Miscellaneous payments .......................................................................................
585
515
Subtotal ......................................................................................................................

102,195

103,466

15,724
16,353
17,007
17,688
18,395
62,171
67,824
74,738
82,489
91,201
–135
–250
–295
–325
–365
6,021
5,894
6,192
6,556
6,975
57
58
59
60
62
197
199
202
205
209
21,813
22,041
21,918
21,770
21,718
526
551
619
608
598
435
401
415
406
404
5 .................. .................. .................. ..................
476
476
478
480
482
107,290

113,547

Trust fund payments to Federal funds:
Quinquennial adjustment for military service credits ................................................ .................. .................. .................. ..................
Other ...........................................................................................................................
1,049
1,065
1,062
1,085

121,333

129,937

139,679

1,182 .................. ..................
1,108
1,129
1,153

Subtotal ......................................................................................................................

1,049

1,065

1,062

1,085

2,290

1,129

1,153

Total interfunds distributed by agency ..........................................................................

103,244

104,531

108,352

114,632

123,623

131,066

140,832

Undistributed by agency:
Employer share, employee retirement (on-budget):
Civil service retirement and disability insurance .......................................................
CSRDI from Postal Service .......................................................................................
Hospital insurance (contribution as employer) 1 .......................................................
Postal employer contributions to FHI ........................................................................
Military retirement fund ..............................................................................................
Other Federal employees retirement ........................................................................

8,168
5,927
1,860
605
11,102
111

8,676
6,068
1,902
597
10,543
122

8,776
6,014
1,976
620
10,563
128

9,032
6,237
2,063
645
10,535
132

9,400
6,452
2,117
671
10,584
137

9,819
6,715
2,220
698
10,750
143

9,774
6,863
2,317
727
11,000
145

Total employer share, employee retirement (on-budget) .........................................

27,773

27,908

28,077

28,644

29,361

30,345

30,826

Interest received by on-budget trust funds ...............................................................
63,776
Proposed Legislation (non-PAYGO) ..................................................................... ..................

65,852
99

67,206
214

68,804
457

70,083
728

71,648
967

73,309
1,187

Total interfund transactions undistributed by agency ...................................................

91,549

93,859

95,497

97,905

100,172

102,960

105,322

Total interfund transactions ................................................................................................

194,793

198,390

203,849

212,537

223,795

234,026

246,154

Total on-budget receipts .........................................................................................................

206,251

208,470

213,346

221,860

232,827

242,930

254,808

87

4. USER FEES AND OTHER COLLECTIONS

Table 4–3.

OFFSETTING RECEIPTS BY TYPE—Continued
(In millions of dollars)

Source

1997
actual

1998
estimate

1999
estimate

2000
estimate

2001
estimate

2002
estimate

2003
estimate

Off-budget receipts:
Interfund transactions:
Distributed by agency:
Federal fund payments to trust funds:
Old-age, survivors, and disability insurance .............................................................
Undistributed by agency:
Employer share, employee retirement (off-budget) ..................................................
Interest received by off-budget trust funds ...............................................................

6,880

9,650

8,899

9,363

9,913

10,562

11,267

6,483
41,214

7,155
46,730

7,667
51,623

8,317
56,966

8,831
62,889

9,571
69,318

10,304
76,337

Total off-budget receipts: ........................................................................................................

54,577

63,535

68,189

74,646

81,633

89,451

97,908

Total intragovernmental transactions .....................................................................................

260,828

272,005

281,535

296,506

314,460

332,381

352,716

PROPRIETARY RECEIPTS FROM THE PUBLIC
Distributed by agency:
Interest:
Interest on foreign loans and deferred foreign collections ...............................................
Interest on deposits in tax and loan accounts ..................................................................
Other interest (domestic—civil) 2 .......................................................................................

672
948
5,365

633
920
6,098

596
920
6,928

561
908
7,679

545
908
8,428

602
908
9,210

583
908
9,957

Total interest .......................................................................................................................

6,985

7,651

8,444

9,148

9,881

10,720

11,448

Royalties and rents .................................................................................................................
1,298
1,321
1,367
Proposed Legislation (PAYGO) .......................................................................................... .................. .................. ..................
Sale of products:
Sale of timber and other natural land products ................................................................
485
499
519
Sale of minerals and mineral products ..............................................................................
792
440
57
Sale of power and other utilities ........................................................................................
812
739
761
Other ...................................................................................................................................
38
34
51

1,375
–1

1,396
–1

1,417
–1

1,446
–1

500
56
761
54

487
87
786
54

473
146
791
53

471
181
781
53

Total sale of products .........................................................................................................

2,127

1,712

1,388

1,371

1,414

1,463

1,486

Fees and other charges for services and special benefits:
Medicare premiums and other charges (trust funds) ........................................................
20,421
20,672
Proposed Legislation (PAYGO) ..................................................................................... .................. ..................
Nuclear waste disposal revenues ......................................................................................
596
602
Veterans life insurance (trust funds) ..................................................................................
231
224
2
Other ................................................................................................................................
2,095
1,806
Proposed Legislation (non-PAYGO) .............................................................................. .................. ..................
Proposed Legislation (PAYGO) ..................................................................................... .................. ..................

21,384
127
625
210
1,621
12
24

23,255
679
632
192
1,598
17
119

25,464
814
637
174
1,581
17
128

27,791
1,025
641
158
1,596
17
135

30,497
1,234
652
142
1,602
17
144

Total fees and other charges .............................................................................................

23,343

23,304

24,003

26,492

28,815

31,363

34,288

Sale of Government property:
Sale of land and other real property .................................................................................
Military assistance program sales (trust funds) .................................................................
Other ...................................................................................................................................

96
15,128
111

102
13,750
95

63
12,550
82

67
11,790
82

70
11,090
82

613
10,570
82

74
9,770
63

Total sale of Government property ....................................................................................

15,335

13,947

12,695

11,939

11,242

11,265

9,907

Realization upon loans and investments:
Foreign military credit sales ...............................................................................................
653
553
391
261
186
134
85
Negative subsidies and downward estimates ....................................................................
2,395
2,565
6,576
2,530
2,319
2,270
2,436
Proposed Legislation (non-PAYGO) .............................................................................. .................. ..................
50 .................. .................. .................. ..................
Proposed Legislation (PAYGO) ..................................................................................... .................. .................. ..................
241
234
233
237
Repayment of loans to United Kingdom ...........................................................................
108
110
112
115
117
50
57
Other ...................................................................................................................................
131
73
38
40
44
29
30
Total realization upon loans and investments ...................................................................

3,287

3,301

7,167

3,187

2,900

2,716

2,845

Recoveries and refunds .......................................................................................................
2,831
3,361
3,863
3,996
4,204
5,325
Proposed Legislation (non-PAYGO) .................................................................................. .................. .................. .................. .................. .................. ..................
Proposed Legislation (PAYGO) .......................................................................................... .................. ..................
40
323
332
333
Miscellaneous receipt accounts 2 ...........................................................................................
1,621
2,518
2,070
2,117
2,148
2,186
Proposed Legislation (PAYGO) .......................................................................................... .................. ..................
–21
–22
–23
–24

4,078
285
331
2,231
–24

2

Total proprietary receipts from the public distributed by agency ..........................................

56,827

57,115

61,016

59,925

62,308

66,763

68,320

88

ANALYTICAL PERSPECTIVES

Table 4–3.

OFFSETTING RECEIPTS BY TYPE—Continued
(In millions of dollars)

Source

1997
actual

1998
estimate

Undistributed by agency:
Other interest: Interest received from Outer Continental Shelf escrow account ..................
6
Rents and royalties on the Outer Continental Shelf:
Rents and bonuses ............................................................................................................
1,259
Royalties ..............................................................................................................................
3,452
Sale of major assets ............................................................................................................... ..................

1999
estimate

2000
estimate

2001
estimate

2002
estimate

2003
estimate

1,120

30 .................. .................. .................. ..................

1,652
3,011
4,424

983
908
877
789
725
3,204
3,044
3,257
3,488
3,161
728 .................. .................. .................. ..................

Total proprietary receipts from the public undistributed by agency ......................................

4,717

10,207

4,945

3,952

4,134

4,277

3,886

Total proprietary receipts from the public 3 .........................................................................

61,544

67,322

65,961

63,877

66,442

71,040

72,206

OFFSETTING GOVERNMENTAL RECEIPTS
Distributed by agency:
Regulatory fees .......................................................................................................................
3,057
2,927
Proposed Legislation (non-PAYGO) .................................................................................. .................. ..................
Other ........................................................................................................................................
76
70
Undistributed by agency:
Spectrum auction proceeds ....................................................................................................
11,006
2,216

3,127
385
70

3,184
386
70

3,237
394
70

3,311
404
70

3,365
414
8

1,833

4,889

4,841

11,354

3,300

Total offsetting governmental receipts ...................................................................................

14,139

5,213

5,415

8,529

8,542

15,139

7,087

Total offsetting receipts ...........................................................................................................

336,511

344,540

352,911

368,912

389,444

418,560

432,009

2000
estimate

2001
estimate

2002
estimate

2003
estimate

1
2
3

Includes provision for covered Federal civilian employees and military personnel.
Includes both Federal funds and trust funds.
Consists of:
1997
actual
On budget:
Federal funds ..................................................................................................................................
Trust funds ......................................................................................................................................
Off-budget ................................................................................................................................................

24,524
37,002
18

1998
estimate
31,163
36,139
20

1999
estimate
30,238
35,691
32

26,430
37,410
37

27,370
39,035
37

29,932
41,071
37

28,978
43,191
37

5. TAX EXPENDITURES
Tax expenditures are revenue losses due to preferential provisions of the Federal tax laws, such as
special exclusions, exemptions, deductions, credits, deferrals, or tax rates. They are alternatives to other policy instruments, such as spending or regulatory programs, as means of achieving Federal policy goals. Tax
expenditures are created for a variety of reasons, including to encourage certain activities, to improve fairness, to ease compliance with and administration of
the tax system, and to reduce certain tax-induced distortions. The Congressional Budget Act of 1974 (Public
Law 93–344) requires that a list of tax expenditures
be included in the budget.
The largest tax expenditures tend to be associated
with the individual income tax. For example, tax preferences are provided for employer contributions for
medical insurance, pension contributions and earnings,
mortgage interest payments on owner-occupied homes,
capital gains, and payments of State and local individual income taxes. Tax expenditures under the corporate
income tax tend to be related to the rate of cost recovery for various investments; as is discussed below, the
extent to which these provisions are classified as tax
expenditures varies according to the conceptual baseline
used. Charitable contributions and credits for State
taxes on bequests are the largest tax expenditures
under the unified transfer (i.e., estate and gift) tax.
Because of potential interactions among provisions,
this chapter does not present a grand total revenue
loss estimate for tax expenditures. Moreover, past tax
changes entailing broad elimination of tax expenditures

were generally accompanied by changes in tax rates
or other basic provisions, so that the net effects on
Federal revenues were considerably (if not totally) offset. Nevertheless, in aggregate, tax expenditures have
revenue impacts of hundreds of billions of dollars, and
are some of the most important ways in which the
Federal Government affects economic decisions and social welfare.
Tax expenditures relating to the individual and corporate income taxes are considered first in this chapter.
They are estimated for fiscal years 1997–2003 using
three methods of accounting: revenue loss, outlay equivalent, and present value. The present value approach
provides estimates of the revenue losses for tax expenditures that involve deferrals of tax payments into the
future or have similar long-term effects. Tax expenditures relating to the unified transfer tax are considered
in a section at the end of the chapter.
The section in this chapter on Performance Measures
and the Economic Effects of Tax Expenditures presents
information related to assessment of the effect of tax
expenditures on the achievement of program performance goals. This section was prepared under the Government Performance and Results Act of 1993 and is
a part of the government-wide performance plan required by this Act (see also Sections III, IV, and VI
of the Budget volume). Tax expenditures are also discussed in Section VI of the Budget, which considers
the Federal Government’s spending, regulatory, and tax
policies across functional areas.

TAX EXPENDITURES IN THE INCOME TAX
Tax Expenditure Estimates
The Treasury Department prepared all tax expenditure estimates presented here based upon tax law enacted as of December 31, 1997. The analysis includes
new tax expenditures which were enacted this year in
the Taxpayer Relief Act of 1997. Expired or repealed
provisions are not listed if their revenue effects result
only from taxpayer activity occurring before fiscal year
1997. Due to the time required to estimate the large
number of tax expenditures, the estimates are based
on mid-session economic assumptions; exceptions are
the earned income tax credit and child credit provisions,
which involve outlay components and hence are updated to reflect the economic assumptions used elsewhere in the budget.
The total revenue loss estimates for tax expenditures
for fiscal years 1997–2003 are displayed by the budget’s
functional categories in table 5–1. Descriptions of the
specific tax expenditure provisions follow the tables of

estimates and discussion of general features of the tax
expenditure concept.
As in prior years, two baseline concepts—the normal
tax baseline and the reference tax law baseline—are
used to identify tax expenditures. 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 losses for these items are zero using the reference tax rules. The alternative baseline concepts are
discussed in detail following the estimates.
Table 5–2 reports the respective portions of the total
revenue losses that arise under the individual and corporate income taxes. Listing revenue loss 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 break-

89

90

ANALYTICAL PERSPECTIVES

downs show the specific tax accounts through which
the various provisions are cleared. The ultimate beneficiaries of corporate tax expenditures, for example,
could be stockholders, employees, customers, or others,
depending on the circumstances.
Table 5–3 ranks the major tax expenditures by fiscal
year 1999 revenue loss. This table merges several individual entries provided in table 5–1; for example, table
5–3 contains one merged entry for charitable contributions instead of the three separate entries found in
table 5–1.
Interpreting Tax Expenditure Estimates
Tax expenditure revenue loss estimates do not necessarily equal the increase in Federal revenues (or the
change in the budget balance) that would result from
repealing the special provisions, for the following reasons:
• Eliminating a tax expenditure may have incentive
effects that alter economic behavior. These incentives can affect the resulting magnitudes of the
formerly subsidized activity or of other tax preferences or Government programs. For example,
if deductibility of mortgage interest were limited,
some taxpayers would hold smaller mortgages,
with a concomitantly smaller effect on the budget
than if no such limits were in force.
• Tax expenditures are interdependent even without
incentive effects. Repeal of a tax expenditure provision can increase or decrease the revenue losses
associated with other provisions. For example,
even if behavior does not change, repeal of an
itemized deduction could increase the revenue
losses from other deductions because some taxpayers would be moved into higher tax brackets.
Alternatively, repeal of an itemized deduction
could lower the revenue loss 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, since
each is estimated assuming that the other remains
in force. In addition, the estimates reported in
Table 5–1 are the totals of individual and corporate income tax revenue losses reported in Table
5–2 and do not reflect any possible interactions
between the individual and corporate income tax
receipts. For this reason, the figures in Table 5–1
(as well as those in Table 5–5, which are also
based on summing individual and corporate estimates) should be regarded as approximations.
• Revenues raised by changes to tax expenditures
are sensitive to timing effects and effective dates.
Changes in some provisions would yield their full
potential revenue gains relatively quickly, whereas

changes to other provisions would only gradually
yield their full revenue potential, as certain deductions or exemptions would likely be grandfathered.
• The annual value of tax expenditures for tax deferrals is reported on a cash basis in all tables
except Table 5–4. 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. While such
estimates are useful as a measure of cash flows
into the Government, they do not accurately reflect the true economic cost of these provisions.
For example, for a provision where activity levels
have changed, so that incoming tax receipts from
past deferrals are greater than deferred receipts
from new activity, the cash-basis tax expenditure
estimate can be negative, despite the fact that
in present-value terms current deferrals do have
a real cost to the Government. Alternatively, in
the case of a newly enacted deferral provision,
a cash-based estimate can overstate the real cost
to the Government because the newly deferred
taxes will ultimately be received. Present-value estimates, which are a useful supplement to the
cash-basis estimates for provisions involving deferrals, are discussed below.
• Repeal of some provisions could affect overall levels of income and rates of economic growth. In
principle, repeal of major tax provisions may have
some impact on the budget economic assumptions.
In general, however, most changes in particular
provisions are unlikely to have significant macroeconomic effects.
Present-Value Estimates
Discounted present-value estimates of revenue losses
are presented in Table 5–4 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
losses, net of future tax payments, that follow from
activities undertaken during calendar year 1998 which
cause the deferrals or other long-term revenue effects.
For instance, a pension contribution in 1998 would
cause a deferral of tax payments on wages in 1998
and on pension earnings on this contribution (e.g., interest) in later years. In some future year, however,
the 1998 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.

91

5. TAX EXPENDITURES

Table 5–1.

TOTAL REVENUE LOSS ESTIMATES FOR TAX EXPENDITURES IN THE INCOME TAX
(In millions of dollars)
Total revenue loss from corporate and individual Income taxes
1997

1998

1999

2000

2001

2002

2003

1999–
2003

1

National defense:
Exclusion of benefits and allowances to armed forces personnel ...............................................................

2,080

2,095

2,120

2,140

2,160

2,180

2,200

10,800

2
3
4
5

International affairs:
Exclusion of income earned abroad by U.S. citizens ..................................................................................
Exclusion of income of foreign sales corporations .......................................................................................
Inventory property sales source rules exception ..........................................................................................
Deferral of income from controlled foreign corporations (normal tax method) ............................................

1,790
1,600
1,500
2,200

1,985
1,700
1,600
2,400

2,205
1,800
1,700
2,600

2,450
1,900
1,800
2,800

2,725
2,000
1,900
3,000

3,035
2,100
2,000
3,200

3,345
2,200
2,100
3,400

13,760
10,000
9,500
15,000

6
7

General science, space, and technology:
Expensing of research and experimentation expenditures (normal tax method) ........................................
Credit for increasing research activities ........................................................................................................

195
880

430
2,125

580
860

685
370

740
165

765
55

785
10

3,555
1,460

8
9
10
11
12
13
14
15
16
17
18

Energy:
Expensing of exploration and development costs, fuels ..............................................................................
Excess of percentage over cost depletion, fuels ..........................................................................................
Alternative fuel production credit ...................................................................................................................
Exception from passive loss limitation for working interests in oil and gas properties ..............................
Capital gains treatment of royalties on coal .................................................................................................
Exclusion of interest on energy facility bonds ..............................................................................................
Enhanced oil recovery credit .........................................................................................................................
New technology credit ....................................................................................................................................
Alcohol fuel credit 1 ........................................................................................................................................
Tax credit and deduction for clean-fuel burning vehicles and properties ....................................................
Exclusion from income of conservation subsidies provided by public utilities ............................................

–160
830
710
45
50
175
95
60
20
65
70

–95
835
670
50
50
175
100
65
20
75
20

–50
840
630
50
50
170
100
70
20
80
30

10
855
600
50
55
165
110
80
20
85
40

–10
865
560
55
60
155
115
80
20
100
45

..............
880
530
55
60
150
120
80
20
95
50

20
890
350
60
60
140
130
80
20
70
60

–30
4,330
2,670
270
285
780
575
390
100
430
225

19
20
21
22
23
24
25
26
27

Natural resources and environment:
Expensing of exploration and development costs, nonfuel minerals ...........................................................
Excess of percentage over cost depletion, nonfuel minerals ......................................................................
Capital gains treatment of iron ore ...............................................................................................................
Special rules for mining reclamation reserves ..............................................................................................
Exclusion of interest on bonds for water, sewage, and hazardous waste facilities ...................................
Capital gains treatment of certain timber income .........................................................................................
Expensing of multiperiod timber growing costs ............................................................................................
Investment credit and seven-year amortization for reforestation expenditures ...........................................
Tax incentives for preservation of historic structures ...................................................................................

45
335
..............
20
625
50
460
45
120

55
340
..............
20
605
50
480
45
115

55
355
..............
20
590
50
505
50
115

55
360
..............
20
565
55
525
50
110

55
365
..............
20
540
60
540
50
105

55
380
..............
20
500
60
555
50
105

55
385
..............
20
455
60
575
55
105

275
1,845
..............
100
2,650
285
2,700
255
540

28
29
30
31
32

Agriculture:
Expensing of certain capital outlays ..............................................................................................................
Expensing of certain multiperiod production costs .......................................................................................
Treatment of loans for solvent farmers .........................................................................................................
Capital gains treatment of certain income ....................................................................................................
Income averaging for farmers ........................................................................................................................

65
80
10
505
..............

65
80
10
520
5

70
85
10
535
30

70
85
10
550
35

70
85
10
570
25

70
85
10
585
..............

70
85
10
600
..............

350
425
50
2,840
90

800
70
12,765
5
200
110

880
45
13,465
5
215
115

960
20
14,200
5
230
120

1,050
10
14,990
5
245
125

1,150
5
15,810
5
260
130

1,260
5
16,680
5
280
135

1,380
..............
17,585
5
300
140

5,800
40
79,265
25
1,315
650

1,750
810
49,060
16,915
960
12,245
3,740
8,750
4,175
2,300
1,365

1,670
750
51,245
17,700
975
5,770
1,110
9,100
3,910
2,420
1,585

1,595
695
53,695
18,440
995
..............
..............
9,465
3,680
2,365
1,845

1,520
615
56,515
19,220
1,015
..............
..............
9,845
3,465
2,340
2,100

1,440
530
59,505
20,045
1,035
..............
..............
10,235
3,270
2,385
2,235

1,365
450
62,730
20,920
1,055
..............
..............
10,645
3,080
2,415
2,560

1,290
320
66,245
21,855
1,075
..............
..............
11,070
2,900
2,490
2,880

7,210
2,610
298,690
100,480
5,175
..............
..............
51,260
16,395
11,995
11,620

40
155
24,620
35
8,750

15
155
25,360
35
9,100

..............
160
26,120
35
9,465

–10
160
26,900
35
9,845

–5
160
27,710
40
10,235

–5
165
28,540
40
10,645

..............
165
29,395
40
11,070

–20
810
138,665
190
51,260

33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48
49
50
51
52
53
54

Commerce and housing:
Financial institutions and insurance:
Exemption of credit union income ............................................................................................................
Excess bad debt reserves of financial institutions ...................................................................................
Exclusion of interest on life insurance savings ........................................................................................
Special alternative tax on small property and casualty insurance companies .......................................
Tax exemption of insurance companies owned by tax-exempt organizations ........................................
Small life insurance company deduction ..................................................................................................
Housing:
Exclusion of interest on owner-occupied mortgage subsidy bonds .........................................................
Exclusion of interest on rental housing bonds .........................................................................................
Deductibility of mortgage interest on owner-occupied homes .................................................................
Deductibility of State and local property tax on owner-occupied homes ................................................
Deferral of income from post 1987 installment sales ..............................................................................
Deferral of capital gains on home sales ...................................................................................................
Exclusion of capital gains on home sales for persons age 55 and over ...............................................
Capital gains exclusion on home sales ....................................................................................................
Exception from passive loss rules for $25,000 of rental loss .................................................................
Credit for low-income housing investment ................................................................................................
Accelerated depreciation on rental housing (normal tax method) ...........................................................
Commerce:
Cancellation of indebtedness ....................................................................................................................
Exceptions from imputed interest rules ....................................................................................................
Capital gains (other than agriculture, timber, iron ore, and coal) (normal tax method) .........................
Capital gains exclusion of small corporation stock ..................................................................................
Step-up basis of capital gains at death ....................................................................................................

92

ANALYTICAL PERSPECTIVES

Table 5–1.

TOTAL REVENUE LOSS ESTIMATES FOR TAX EXPENDITURES IN THE INCOME TAX—Continued
(In millions of dollars)
Total revenue loss from corporate and individual Income taxes
1997

1998

1999

2000

2001

2002

2003

1999–
2003

55
56
57
58
59
60
61
62

Carryover basis of capital gains on gifts ..................................................................................................
Ordinary income treatment of loss from small business corporation stock sale ....................................
Accelerated depreciation of buildings other than rental housing (normal tax method) ..........................
Accelerated depreciation of machinery and equipment (normal tax method) .........................................
Expensing of certain small investments (normal tax method) .................................................................
Amortization of start-up costs (normal tax method) .................................................................................
Graduated corporation income tax rate (normal tax method) ..................................................................
Exclusion of interest on small-issue bonds ..............................................................................................

155
..............
5,830
24,970
1,050
200
4,695
350

165
..............
4,690
26,655
970
205
4,950
295

180
5
3,470
28,535
880
210
5,085
275

190
20
2,530
29,410
815
215
5,280
255

200
40
1,705
30,620
1,360
220
5,525
245

210
70
1,070
31,620
1,285
225
5,820
230

220
95
350
31,935
930
230
6,130
225

1,000
230
9,125
152,120
5,270
1,100
27,840
1,230

63
64
65

Transportation:
Deferral of tax on shipping companies .........................................................................................................
Exclusion of reimbursed employee parking expenses .................................................................................
Exclusion for employer-provided transit passes ...........................................................................................

20
1,280
60

20
1,315
70

20
1,340
80

20
1,370
95

20
1,405
110

20
1,440
125

20
1,475
145

100
7,030
555

66
67
68
69
70

Community and regional development:
Investment credit for rehabilitation of structures (other than historic) .........................................................
Exclusion of interest for airport, dock, and similar bonds ............................................................................
Exemption of certain mutuals’ and cooperatives’ income ............................................................................
Empowerment zones and enterprise communities .......................................................................................
Expensing of environmental remediation costs ............................................................................................

80
970
60
255
..............

70
1,020
65
460
100

70
1,060
65
555
120

70
1,095
65
640
160

65
1,125
65
670
65

65
1,140
70
620
–10

65
1,160
70
465
–30

335
5,580
335
2,950
305

71
72
73
74
75
76
77
78
79
80
81
82
83
84

Education, training, employment, and social services:
Education:
Exclusion of scholarship and fellowship income (normal tax method) ....................................................
HOPE tax credit .........................................................................................................................................
Lifetime Learning tax credit .......................................................................................................................
Education Individual Retirement Accounts ................................................................................................
Deductibility of student-loan interest .........................................................................................................
Deferral of state prepaid tuition plans ......................................................................................................
Exclusion of interest on student loan bonds ............................................................................................
Exclusion of interest on bonds for private nonprofit educational facilities ..............................................
Credit for holders of zone academy bonds ..............................................................................................
Exclusion of interest on savings bonds transferred to educational institutions ......................................
Parental personal exemption for students age 19 or over ......................................................................
Child credit 2 ...............................................................................................................................................
Deductibility of charitable contributions (education) .................................................................................
Exclusion of employer provided educational assistance ..........................................................................

875
..............
..............
..............
..............
..............
290
835
..............
10
845
..............
2,670
320

910
205
115
15
65
65
275
860
5
10
875
3,590
2,890
215

955
4,160
2,550
85
235
110
255
885
35
10
925
19,175
3,010
215

995
4,870
2,590
190
285
120
240
910
45
15
970
19,240
3,145
210

1,040
5,225
2,805
295
345
130
230
920
45
15
1,025
19,015
3,295
15

1,085
5,525
2,840
405
410
145
215
935
45
15
1,070
18,845
3,460
..............

1,135
5,625
3,160
520
430
155
210
940
45
15
1,125
18,580
3,640
..............

5,210
25,405
13,945
1,495
1,705
660
1,150
4,590
215
70
5,115
94,855
16,550
440

85
86
87
88
89
90
91
92
93
94
95

Training, employment, and social services:
Work opportunity tax credit .......................................................................................................................
Welfare-to-work tax credit ..........................................................................................................................
Exclusion of employer provided child care ...............................................................................................
Adoption assistance ...................................................................................................................................
Exclusion of employee meals and lodging (other than military) ..............................................................
Credit for child and dependent care expenses ........................................................................................
Credit for disabled access expenditures ...................................................................................................
Expensing of costs of removing certain architectural barriers to the handicapped ................................
Deductibility of charitable contributions, other than education and health ..............................................
Exclusion of certain foster care payments ...............................................................................................
Exclusion of parsonage allowances ..........................................................................................................

110
..............
860
10
595
2,515
65
20
17,080
35
295

275
10
910
200
620
2,510
65
20
18,700
35
315

200
30
950
320
650
2,510
65
20
19,565
40
340

100
30
995
355
680
2,505
70
20
20,530
40
360

30
15
1,040
370
710
2,500
70
20
21,555
45
385

10
10
1,085
365
740
2,500
70
20
22,655
45
410

..............
5
1,135
225
775
2,495
70
20
23,830
50
440

340
90
5,205
1,635
3,555
12,510
345
100
108,135
220
1,935

96
97
98
99
100
101
102

Health:
Exclusion of employer contributions for medical insurance premiums and medical care ..........................
Medical savings accounts ..............................................................................................................................
Deductibility of medical expenses .................................................................................................................
Exclusion of interest on hospital construction bonds ...................................................................................
Deductibility of charitable contributions (health) ...........................................................................................
Tax credit for orphan drug research .............................................................................................................
Special Blue Cross/Blue Shield deduction ....................................................................................................

67,050
..............
4,175
1,675
2,365
15
225

71,465
30
4,550
1,740
2,570
40
185

76,230
110
4,815
1,795
2,685
50
240

81,295
115
5,110
1,845
2,805
55
255

86,875
115
5,425
1,880
2,940
60
290

93,045
120
5,775
1,910
3,095
70
340

100,245
125
6,150
1,930
3,250
80
330

437,690
585
27,275
9,360
14,775
315
1,455

445
4,410
545
85
125

455
4,950
580
85
130

460
5,210
605
80
135

465
5,480
630
75
140

465
5,775
655
70
145

470
6,090
685
70
150

480
6,420
710
65
155

2,340
28,975
3,285
360
725

71,145
9,770
3,520

72,135
10,275
3,655

72,375
10,780
3,755

73,500
11,085
3,895

73,285
11,485
4,070

73,225
11,865
4,260

73,480
12,160
4,450

365,865
57,375
20,430

103
104
105
106
107
108
109
110

Income security:
Exclusion of railroad retirement system benefits ..........................................................................................
Exclusion of workmen’s compensation benefits ...........................................................................................
Exclusion of public assistance benefits (normal tax method) ......................................................................
Exclusion of special benefits for disabled coal miners ................................................................................
Exclusion of military disability pensions ........................................................................................................
Net exclusion of pension contributions and earnings:
Employer plans ..........................................................................................................................................
Individual Retirement Accounts .................................................................................................................
Keogh plans ...............................................................................................................................................

93

5. TAX EXPENDITURES

Table 5–1.

TOTAL REVENUE LOSS ESTIMATES FOR TAX EXPENDITURES IN THE INCOME TAX—Continued
(In millions of dollars)
Total revenue loss from corporate and individual Income taxes
1997

111

1998

1999

2000

2001

2002

2003

1999–
2003

185

190

200

210

220

230

240

1,099

112
113
114
115
116
117
118
119
120

Exclusion of employer provided death benefits ........................................................................................
Exclusion of other employee benefits:
Premiums on group term life insurance ...................................................................................................
Premiums on accident and disability insurance .......................................................................................
Income of trusts to finance supplementary unemployment benefits .......................................................
Special ESOP rules ...................................................................................................................................
Additional deduction for the blind .............................................................................................................
Additional deduction for the elderly ..........................................................................................................
Tax credit for the elderly and disabled .....................................................................................................
Deductibility of casualty losses .................................................................................................................
Earned income tax credit 3 ........................................................................................................................

2,065
165
5
735
25
1,545
50
465
6,065

2,110
175
5
720
30
1,710
50
485
6,210

2,150
185
5
740
30
1,785
50
510
4,635

2,200
195
5
760
30
1,800
50
535
4,515

2,240
205
5
790
30
1,800
50
560
4,625

2,290
215
5
820
35
1,805
50
590
4,790

2,340
225
5
850
35
1,845
50
620
4,965

11,220
1,025
25
3,960
160
9,035
250
2,815
23,530

121
122
123

Social Security:
Exclusion of social security benefits:
Social Security benefits for retired workers ..............................................................................................
Social Security benefits for disabled .........................................................................................................
Social Security benefits for dependents and survivors ............................................................................

17,470
2,270
3,825

18,330
2,495
4,000

19,115
2,685
4,160

20,025
2,875
4,310

20,840
3,090
4,470

21,830
3,325
4,640

22,930
3,590
4,795

104,740
15,565
22,375

124
125
126
127

Veterans benefits and services:
Exclusion of veterans death benefits and disability compensation ..............................................................
Exclusion of veterans pensions .....................................................................................................................
Exclusion of GI bill benefits ...........................................................................................................................
Exclusion of interest on veterans housing bonds .........................................................................................

2,770
70
50
75

2,930
70
60
75

3,100
65
70
75

3,280
70
80
75

3,470
75
90
75

3,675
80
95
80

3,890
85
100
85

17,415
376
435
390

128
129
130

General purpose fiscal assistance:
Exclusion of interest on public purpose bonds .............................................................................................
Deductibility of nonbusiness State and local taxes other than on owner-occupied homes .......................
Tax credit for corporations receiving income from doing business in U.S. possessions ...........................

13,800
30,720
2,700

14,315
32,145
2,770

14,760
33,490
2,800

15,125
34,910
2,885

15,390
36,410
2,970

15,600
37,995
3,060

15,750
39,695
3,075

76,625
182,500
14,790

131

Interest:
Deferral of interest on U.S. savings bonds ...................................................................................................

915

965

1,015

1,065

1,115

1,175

1,235

5,605

16,915
30,720

17,700
32,145

18,440
33,490

19,220
34,910

20,045
36,410

20,920
37,995

21,855
39,695

100,480
182,500

13,800
175
625
350
1,750
810
970
290
835
1,675
75

14,315
175
605
295
1,670
750
1,020
275
860
1,740
75

14,760
170
590
275
1,595
695
1,060
255
885
1,795
75

15,125
165
565
255
1,520
615
1,095
240
910
1,845
75

15,390
155
540
245
1,440
530
1,125
230
920
1,880
75

15,600
150
500
230
1,365
450
1,140
215
935
1,910
80

15,750
140
455
225
1,290
320
1,160
210
940
1,930
85

76,625
780
2,650
1,230
7,210
2,610
5,580
1,150
4,590
9,360
390

Addendum—Aid to State and local governments:
Deductibility of:
Property taxes on owner-occupied homes ...............................................................................................
Nonbusiness State and local taxes other than on owner-occupied homes ............................................
Exclusion of interest on:
Public purpose bonds ................................................................................................................................
Energy facility bonds .................................................................................................................................
Bonds for water, sewage, and hazardous waste facilities .......................................................................
Small-issue bonds ......................................................................................................................................
Owner-occupied mortgage revenue bonds ...............................................................................................
Rental housing bonds ................................................................................................................................
Bonds for airports, docks, and sports and convention facilities ..............................................................
Student loan bonds ....................................................................................................................................
Bonds for private nonprofit educational facilities ......................................................................................
Hospital construction bonds ......................................................................................................................
Veterans housing bonds ............................................................................................................................

Notes:
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 $5 million.
Figures in tables 5–1 are the arithmetic sums of corporate and individual income tax revenue loss estimates from table 5–2, and do not reflect possible interactions across these two taxes.
1
In addition, the partial exemption from the excise tax for alcohol fuels results in a reduction in excise tax receipts (in millions of dollars) as follows: 1997 $675; 1998 $720; 1999 $750; 2000 $780; 2001
$810; 2002 $845; 2003 $875.
2
The figures in the table indicate the effect of the child credit on receipts. The effect on outlays in (in millions of dollars) is as follows: 1997 $0; 1998 $0; 1999 $538; 2000 $685; 2001 $662; 2002 $624;
and 2003 $589.
3
The figures in the table indicate the effect of the earned income tax credit on receipts. The effect on outlays in (in millions of dollars) is as follows: 1997 $21,856; 1998 $22,295; 1999 $24,496; 2000
$25,334; 2001 $26,040; 2002 $26,715; and 2003 $27,414.

94

ANALYTICAL PERSPECTIVES

Table 5–2.

CORPORATE AND INDIVIDUAL INCOME TAX REVENUE LOSS ESTIMATES FOR TAX EXPENDITURES
(In millions of dollars)
Revenue Loss
Corporations
1997

1
2
3
4
5

6
7
8
9
10
11
12
13
14
15
16
17
18

National defense:
Exclusion of benefits and allowances to armed forces personnel

1998

1999

2000

Individuals
2001

2002

2003

............ ............ ............ ............ ............ ............ ............

1997

1998

1999

2000

2001

2002

2,080

2,095

2,120

2,140

2,160

2,180

2003

2,200

International affairs:
Exclusion of income earned abroad by U.S. citizens ...................... ............ ............ ............ ............ ............ ............ ............ 1,790 1,985 2,205 2,450 2,725 3,035
3,345
Exclusion of income of foreign sales corporations ...........................
1,600 1,700 1,800 1,900 2,000 2,100 2,200 ............ ............ ............ ............ ............ ............ ..............
Inventory property sales source rules exception ..............................
1,500 1,600 1,700 1,800 1,900 2,000 2,100 ............ ............ ............ ............ ............ ............ ..............
Deferral of income from controlled foreign corporations (normal tax
method) ..........................................................................................
2,200 2,400 2,600 2,800 3,000 3,200 3,400 ............ ............ ............ ............ ............ ............ ..............
General science, space, and technology:
Expensing of research and experimentation expenditures (normal
tax method) ....................................................................................
Credit for increasing research activities ............................................

190
860

420
2,095

570
845

670
370

725
165

750
55

770
10

5
20

10
30

10
15
15
15
15
15 ............ ............ ............ ..............

Energy:
Expensing of exploration and development costs, fuels ..................
–160
–95
–50
10
–10 ............
20 ............ ............ ............ ............ ............ ............ ..............
Excess of percentage over cost depletion, fuels ..............................
620
625
630
640
645
660
665
210
210
210
215
220
220
225
Alternative fuel production credit .......................................................
680
640
600
570
540
510
340
30
30
30
30
20
20
10
Exception from passive loss limitation for working interests in oil
and gas properties ......................................................................... ............ ............ ............ ............ ............ ............ ............
45
50
50
50
55
55
60
Capital gains treatment of royalties on coal ..................................... ............ ............ ............ ............ ............ ............ ............
50
50
50
55
60
60
60
Exclusion of interest on energy facility bonds ..................................
70
70
70
65
60
60
55
105
105
100
100
95
90
85
Enhanced oil recovery credit .............................................................
90
95
95
100
105
110
120
5
5
5
10
10
10
10
New technology credit .......................................................................
60
65
70
80
80
80
80 ............ ............ ............ ............ ............ ............ ..............
Alcohol fuel credit 1 ............................................................................
10
10
10
10
10
10
10
10
10
10
10
10
10
10
Tax credit and deduction for clean-fuel burning vehicles and properties ...............................................................................................
55
60
65
70
80
75
55
10
15
15
15
20
20
15
Exclusion from income of conservation subsidies provided by public utilities ........................................................................................
10
–45
–35
–30
–25
–25
–20
60
65
65
70
70
75
80

27

Natural resources and environment:
Expensing of exploration and development costs, nonfuel minerals
35
40
40
40
40
40
40
10
15
15
15
15
15
15
Excess of percentage over cost depletion, nonfuel minerals ..........
250
255
265
270
275
285
290
85
85
90
90
90
95
95
Capital gains treatment of iron ore ................................................... ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ..............
Special rules for mining reclamation reserves ..................................
20
20
20
20
20
20
20 ............ ............ ............ ............ ............ ............ ..............
Exclusion of interest on bonds for water, sewage, and hazardous
waste facilities ................................................................................
250
240
235
225
215
195
180
375
365
355
340
325
305
275
Capital gains treatment of certain timber income ............................. ............ ............ ............ ............ ............ ............ ............
50
50
50
55
60
60
60
Expensing of multiperiod timber growing costs ................................
285
300
315
325
335
345
355
175
180
190
200
205
210
220
Investment credit and seven-year amortization for reforestation expenditures .......................................................................................
20
20
25
25
25
25
25
25
25
25
25
25
25
30
Tax incentives for preservation of historic structures .......................
25
25
25
20
20
20
20
95
90
90
90
85
85
85

28
29
30
31
32

Agriculture:
Expensing of certain capital outlays ..................................................
10
10
10
10
10
10
10
55
Expensing of certain multiperiod production costs ...........................
10
10
10
10
10
10
10
70
Treatment of loans for solvent farmers ............................................. ............ ............ ............ ............ ............ ............ ............
10
Capital gains treatment of certain income ........................................ ............ ............ ............ ............ ............ ............ ............
505
Income averaging for farmers ........................................................... ............ ............ ............ ............ ............ ............ ............ ............

19
20
21
22
23
24
25
26

33
34
35
36
37
38
39
40
41
42
43

55
70
10
520
5

60
75
10
535
30

60
75
10
550
35

60
60
60
75
75
75
10
10
10
570
585
600
25 ............ ..............

Commerce and housing:
Financial institutions and insurance:
Exemption of credit union income ................................................
800
880
960 1,050 1,150 1,260 1,380 ............ ............ ............ ............ ............ ............
Excess bad debt reserves of financial institutions .......................
70
45
20
10
5
5 ............ ............ ............ ............ ............ ............ ............
Exclusion of interest on life insurance savings ............................
190
200
210
225
235
250
260 12,575 13,265 13,990 14,765 15,575 16,430
Special alternative tax on small property and casualty insurance
companies ..................................................................................
5
5
5
5
5
5
5 ............ ............ ............ ............ ............ ............
Tax exemption of insurance companies owned by tax-exempt
organizations ..............................................................................
200
215
230
245
260
280
300 ............ ............ ............ ............ ............ ............
Small life insurance company deduction ......................................
110
115
120
125
130
135
140 ............ ............ ............ ............ ............ ............
Housing:
Exclusion of interest on owner-occupied mortgage subsidy
bonds .........................................................................................
695
660
635
600
570
540
510 1,055 1,010
960
920
870
825
Exclusion of interest on rental housing bonds .............................
320
295
275
240
205
175
115
490
455
420
375
325
275
Deductibility of mortgage interest on owner-occupied homes ..... ............ ............ ............ ............ ............ ............ ............ 49,060 51,245 53,695 56,515 59,505 62,730
Deductibility of State and local property tax on owner-occupied
homes ........................................................................................ ............ ............ ............ ............ ............ ............ ............ 16,915 17,700 18,440 19,220 20,045 20,920
Deferral of income from post 1987 installment sales ..................
250
255
260
265
270
275
280
710
720
735
750
765
780

..............
..............
17,325
..............
..............
..............

780
205
66,245
21,855
795

95

5. TAX EXPENDITURES

Table 5–2.

CORPORATE AND INDIVIDUAL INCOME TAX REVENUE LOSS ESTIMATES FOR TAX EXPENDITURES—Continued
(In millions of dollars)
Revenue Loss
Corporations
1997

44
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
61
62
63
64
65
66
67
68
69
70

71
72
73
74
75
76
77
78
79
80
81
82
83
84
85
86
87
88
89
90
91
92

Deferral of capital gains on home sales ......................................
Exclusion of capital gains on home sales for persons age 55
and over .....................................................................................
Capital gains exclusion on home sales ........................................
Exception from passive loss rules for $25,000 of rental loss .....
Credit for low-income housing investment ....................................
Accelerated depreciation on rental housing (normal tax method)
Commerce:
Cancellation of indebtedness ........................................................
Exceptions from imputed interest rules ........................................
Capital gains (other than agriculture, timber, iron ore, and coal)
(normal tax method) ..................................................................
Capital gains exclusion of small corporation stock ......................
Step-up basis of capital gains at death ........................................
Carryover basis of capital gains on gifts ......................................
Ordinary income treatment of loss from small business corporation stock sale ...........................................................................
Accelerated depreciation of buildings other than rental housing
(normal tax method) ..................................................................
Accelerated depreciation of machinery and equipment (normal
tax method) ................................................................................
Expensing of certain small investments (normal tax method) .....
Amortization of start-up costs (normal tax method) .....................
Graduated corporation income tax rate (normal tax method) .....
Exclusion of interest on small-issue bonds ..................................

1998

1999

2000

Individuals
2001

2002

2003

1997

1998

1999

2000

2001

2002

2003

............ ............ ............ ............ ............ ............ ............ 12,245

5,770 ............ ............ ............ ............ ..............

............ ............ ............ ............ ............ ............ ............
............ ............ ............ ............ ............ ............ ............
............ ............ ............ ............ ............ ............ ............
460
485
475
470
475
485
500
865 1,025 1,215 1,390 1,460 1,705 1,865

3,740
8,750
4,175
1,840
500

1,110 ............ ............ ............ ............ ..............
9,100 9,465 9,845 10,235 10,645 11,070
3,910 3,680 3,465 3,270 3,080
2,900
1,935 1,890 1,870 1,910 1,930
1,990
560
630
710
775
855
1,015

............ ............ ............ ............ ............ ............ ............
............ ............ ............ ............ ............ ............ ............

40
155

............
............
............
............

............
............
............
............

............
............
............
............

............
............
............
............

............
............
............
............

............
............
............
............

15 ............
155
160

3,285

2,425

1,825

1,230

765

–5
160

–5 ..............
165
165

............ 24,620 25,360 26,120 26,900 27,710 28,540
............
35
35
35
35
40
40
............ 8,750 9,100 9,465 9,845 10,235 10,645
............
155
165
180
190
200
210

............ ............ ............ ............ ............ ............ ............ ............ ............
4,100

–10
160

245

1,730

1,405

29,395
40
11,070
220

5

20

40

70

95

1,045

705

475

305

105

19,770 21,030 22,390 23,090 23,755 24,610 24,820 5,200 5,625 6,145 6,320 6,865 7,010
7,115
660
620
570
540
955
810
615
390
350
310
275
405
475
315
95
100
100
105
105
110
110
105
105
110
110
115
115
120
4,695 4,950 5,085 5,280 5,525 5,820 6,130 ............ ............ ............ ............ ............ ............ ..............
135
115
110
100
95
90
90
215
180
165
155
150
140
135

Transportation:
Deferral of tax on shipping companies .............................................
20
20
20
20
20
20
20 ............ ............ ............ ............ ............ ............ ..............
Exclusion of reimbursed employee parking expenses ..................... ............ ............ ............ ............ ............ ............ ............ 1,280 1,315 1,340 1,370 1,405 1,440
1,475
Exclusion for employer-provided transit passes ............................... ............ ............ ............ ............ ............ ............ ............
60
70
80
95
110
125
145
Community and regional development:
Investment credit for rehabilitation of structures (other than historic) ...............................................................................................
15
Exclusion of interest for airport, dock, and similar bonds ................
390
Exemption of certain mutuals’ and cooperatives’ income ................
60
Empowerment zones and enterprise communities ...........................
75
Expensing of environmental remediation costs ................................ ............
Education, training, employment, and social services:
Education:.
Exclusion of scholarship and fellowship income (normal tax
method) ......................................................................................
HOPE tax credit .............................................................................
Lifetime Learning tax credit ...........................................................
Education Individual Retirement Accounts ...................................
Deductibility of student-loan interest .............................................
Deferral of state prepaid tuition plans ..........................................
Exclusion of interest on student loan bonds ................................
Exclusion of interest on bonds for private nonprofit educational
facilities ......................................................................................
Credit for holders of zone academy bonds ..................................
Exclusion of interest on savings bonds transferred to educational institutions ....................................................................
Parental personal exemption for students age 19 or over ..........
Child credit 2 ...................................................................................
Deductibility of charitable contributions (education) .....................
Exclusion of employer provided educational assistance ..............
Training, employment, and social services:
Work opportunity tax credit ...........................................................
Welfare-to-work tax credit .............................................................
Exclusion of employer provided child care ...................................
Adoption assistance .......................................................................
Exclusion of employee meals and lodging (other than military)
Credit for child and dependent care expenses ............................
Credit for disabled access expenditures .......................................
Expensing of costs of removing certain architectural barriers to
the handicapped ........................................................................

15
410
65
165
85

15
425
65
215
100

15
440
65
240
135

15
450
65
225
55

15
455
70
200
–10

............
............
............
............
............
............
110

............
............
............
............
............
............
100

............
............
............
............
............
............
95

............
............
............
............
............
............
90

............
............
............
............
............
............
85

335
345
............ ............

355
10

365
10

370
10

............
............
............
............
............
............
115

15
65
55
55
55
50
50
50
465
580
610
635
655
675
685
695
70 ............ ............ ............ ............ ............ ............ ..............
155
180
295
340
400
445
420
310
–25 ............
15
20
25
10 ............
–5

............
............
............
............
............
............
85

875
............
............
............
............
............
175

910
205
115
15
65
65
165

955
4,160
2,550
85
235
110
155

995
4,870
2,590
190
285
120
145

1,040
5,225
2,805
295
345
130
140

1,085
5,525
2,840
405
410
145
130

1,135
5,625
3,160
520
430
155
125

375
10

375
500
10 ............

515
5

530
25

545
35

550
35

560
35

565
35

............
............
............
920
............

............
............
............
970
............

............
............
............
1,000
............

............
............
............
1,025
............

............
............
............
1,065
............

............
............
............
1,120
............

............
10
............
845
............ ............
1,180 1,750
............
320

90
............
............
............
............
............
50

235
10
............
............
............
............
50

170
25
............
............
............
............
50

80
25
............
............
............
............
55

30
10
............
............
............
............
55

10
10
............
............
............
............
55

............
20
40
5 ............ ............
............
860
910
............
10
200
............
595
620
............ 2,515 2,510
55
15
15

15

15

15

15

15

15

15

5

10
10
15
15
15
15
875
925
970 1,025 1,070
1,125
3,590 19,175 19,240 19,015 18,845 18,580
1,920 2,010 2,120 2,230 2,340
2,460
215
215
210
15 ............ ..............

5

30
5
950
320
650
2,510
15
5

20 ............ ............ ..............
5
5 ............ ..............
995 1,040 1,085
1,135
355
370
365
225
680
710
740
775
2,505 2,500 2,500
2,495
15
15
15
15
5

5

5

5

96

ANALYTICAL PERSPECTIVES

Table 5–2.

CORPORATE AND INDIVIDUAL INCOME TAX REVENUE LOSS ESTIMATES FOR TAX EXPENDITURES—Continued
(In millions of dollars)
Revenue Loss
Corporations
1997

93
94
95
96
97
98
99
100
101
102

1998

1999

2000

Individuals
2001

2002

2003

1997

1998

1999

2000

2001

2002

Deductibility of charitable contributions, other than education
and health ..................................................................................
1,130 1,190 1,225 1,260 1,305 1,375 1,450 15,950 17,510 18,340 19,270 20,250 21,280
Exclusion of certain foster care payments ................................... ............ ............ ............ ............ ............ ............ ............
35
35
40
40
45
45
Exclusion of parsonage allowances .............................................. ............ ............ ............ ............ ............ ............ ............
295
315
340
360
385
410

2003

22,380
50
440

Health:
Exclusion of employer contributions for medical insurance premiums and medical care ............................................................... ............ ............ ............ ............ ............ ............ ............ 67,050 71,465 76,230 81,295 86,875 93,045 100,245
Medical savings accounts .................................................................. ............ ............ ............ ............ ............ ............ ............ ............
30
110
115
115
120
125
Deductibility of medical expenses ..................................................... ............ ............ ............ ............ ............ ............ ............ 4,175 4,550 4,815 5,110 5,425 5,775
6,150
Exclusion of interest on hospital construction bonds .......................
675
700
720
740
755
765
770 1,000 1,040 1,075 1,105 1,125 1,145
1,160
Deductibility of charitable contributions (health) ...............................
575
610
625
645
670
705
740 1,790 1,960 2,060 2,160 2,270 2,390
2,510
Tax credit for orphan drug research .................................................
15
40
50
55
60
70
80 ............ ............ ............ ............ ............ ............ ..............
Special Blue Cross/Blue Shield deduction ........................................
225
185
240
255
290
340
330 ............ ............ ............ ............ ............ ............ ..............

115
116
117
118
119
120

Income security:
Exclusion of railroad retirement system benefits ..............................
Exclusion of workmen’s compensation benefits ...............................
Exclusion of public assistance benefits (normal tax method) ..........
Exclusion of special benefits for disabled coal miners ....................
Exclusion of military disability pensions ............................................
Net exclusion of pension contributions and earnings:
Employer plans ..............................................................................
Individual Retirement Accounts .....................................................
Keogh plans ...................................................................................
Exclusion of employer provided death benefits ...........................
Exclusion of other employee benefits:
Premiums on group term life insurance .......................................
Premiums on accident and disability insurance ...........................
Income of trusts to finance supplementary unemployment benefits ..............................................................................................
Special ESOP rules .......................................................................
Additional deduction for the blind .................................................
Additional deduction for the elderly ..............................................
Tax credit for the elderly and disabled .........................................
Deductibility of casualty losses .....................................................
Earned income tax credit 3 ............................................................

5
60
35
1,805
50
590
4,790

5
60
35
1,845
50
620
4,965

121
122
123

Social Security:
Exclusion of social security benefits:.
Social Security benefits for retired workers .................................. ............ ............ ............ ............ ............ ............ ............ 17,470 18,330 19,115 20,025 20,840 21,830
Social Security benefits for disabled ............................................. ............ ............ ............ ............ ............ ............ ............ 2,270 2,495 2,685 2,875 3,090 3,325
Social Security benefits for dependents and survivors ................ ............ ............ ............ ............ ............ ............ ............ 3,825 4,000 4,160 4,310 4,470 4,640

22,930
3,590
4,795

124
125
126
127

Veterans benefits and services:
Exclusion of veterans death benefits and disability compensation
............ ............ ............ ............ ............ ............ ............
Exclusion of veterans pensions ......................................................... ............ ............ ............ ............ ............ ............ ............
Exclusion of GI bill benefits ............................................................... ............ ............ ............ ............ ............ ............ ............
Exclusion of interest on veterans housing bonds .............................
30
30
30
30
30
30
35

103
104
105
106
107
108
109
110
111
112
113
114

128
129
130

131

............
............
............
............
............

............
............
............
............
............

............
............
............
............
............

............
............
............
............
............

............
............
............
............
............

............
............
............
............
............

............
............
............
............
............

445
4,410
545
85
125

455
4,950
580
85
130

460
5,210
605
80
135

465
5,480
630
75
140

465
5,775
655
70
145

470
6,090
685
70
150

480
6,420
710
65
155

............
............
............
............

............
............
............
............

............
............
............
............

............
............
............
............

............
............
............
............

............
............
............
............

............ 71,145 72,135 72,375 73,500 73,285 73,225
............ 9,770 10,275 10,780 11,085 11,485 11,865
............ 3,520 3,655 3,755 3,895 4,070 4,260
............
185
190
200
210
220
230

73,480
12,160
4,450
240

............ ............ ............ ............ ............ ............ ............
............ ............ ............ ............ ............ ............ ............

2,065
165

2,110
175

2,150
185

2,200
195

2,240
205

2,290
215

2,340
225

............
675
............
............
............
............
............

5
60
25
1,545
50
465
6,065

5
60
30
1,710
50
485
6,210

5
60
30
1,785
50
510
4,635

5
60
30
1,800
50
535
4,515

5
60
30
1,800
50
560
4,625

............
660
............
............
............
............
............

............
680
............
............
............
............
............

............
700
............
............
............
............
............

............
730
............
............
............
............
............

............
760
............
............
............
............
............

............
790
............
............
............
............
............

2,770
70
50
45

2,930
70
60
45

3,100
65
70
45

3,280
70
80
45

3,470
75
90
45

3,675
80
95
50

3,890
85
100
50

General purpose fiscal assistance:
Exclusion of interest on public purpose bonds .................................
5,550 5,750 5,925 6,060 6,165 6,245 6,300 8,250 8,565 8,835 9,065 9,225 9,355
9,450
Deductibility of nonbusiness State and local taxes other than on
owner-occupied homes .................................................................. ............ ............ ............ ............ ............ ............ ............ 30,720 32,145 33,490 34,910 36,410 37,995 39,695
Tax credit for corporations receiving income from doing business
in U.S. possessions .......................................................................
2,700 2,770 2,800 2,885 2,970 3,060 3,075 ............ ............ ............ ............ ............ ............ ..............
Interest:
Deferral of interest on U.S. savings bonds ...................................... ............ ............ ............ ............ ............ ............ ............

915

965

1,015

1,065

1,115

1,175

Addendum—Aid to State and local governments:
Deductibility of:.
Property taxes on owner-occupied homes ................................... ............ ............ ............ ............ ............ ............ ............ 16,915 17,700 18,440 19,220 20,045 20,920
Nonbusiness State and local taxes other than on owner-occupied homes ................................................................................ ............ ............ ............ ............ ............ ............ ............ 30,720 32,145 33,490 34,910 36,410 37,995
Exclusion of interest on:
Public purpose bonds ....................................................................
5,550 5,750 5,925 6,060 6,165 6,245 6,300 8,250 8,565 8,835 9,065 9,225 9,355
Energy facility bonds .....................................................................
70
70
70
65
60
60
55
105
105
100
100
95
90
Bonds for water, sewage, and hazardous waste facilities ...........
250
240
235
225
215
195
180
375
365
355
340
325
305
Small-issue bonds ..........................................................................
135
115
110
100
95
90
90
215
180
165
155
150
140

1,235

21,855
39,695
9,450
85
275
135

97

5. TAX EXPENDITURES

Table 5–2.

CORPORATE AND INDIVIDUAL INCOME TAX REVENUE LOSS ESTIMATES FOR TAX EXPENDITURES—Continued
(In millions of dollars)
Revenue Loss
Corporations
1997

Owner-occupied mortgage revenue bonds ...................................
Rental housing bonds ....................................................................
Bonds for airports, docks, and sports and convention facilities
Student loan bonds .......................................................................
Bonds for private nonprofit educational facilities ..........................
Hospital construction bonds ..........................................................
Veterans housing bonds ................................................................

695
320
390
115
335
675
30

1998
660
295
410
110
345
700
30

1999
635
275
425
100
355
720
30

2000
600
240
440
95
365
740
30

Individuals
2001
570
205
450
90
370
755
30

2002
540
175
455
85
375
765
30

2003
510
115
465
85
375
770
35

1997

1998

1999

2000

2001

2002

1,055
490
580
175
500
1,000
45

1,010
455
610
165
515
1,040
45

960
420
635
155
530
1,075
45

920
375
655
145
545
1,105
45

870
325
675
140
550
1,125
45

825
275
685
130
560
1,145
50

2003
780
205
695
125
565
1,160
50

Notes:
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 $5 million.
Figures in table 5–1 are the arithmetic sums of corporate and individual income tax revenue loss estimates from table 5–2, and do not reflect possible interactions across these two taxes.
1
In addition, the partial exemption from the excise tax for alcohol fuels results in a reduction in excise tax receipts (in millions of dollars) as follows: 1997 $675; 1998 $720; 1999 $750; 2000 $780; 2001
$810; 2002 $845; 2003 $875.
2
The figures in the table indicate the effect of the child credit on receipts. The effect on outlays in (in millions of dollars) is as follows: 1997 $0; 1998 $0; 1999 $538; 2000 $685; 2001 $662; 2002 $624;
and 2003 $589.
3
The figures in the table indicate the effect of the earned income tax credit on receipts. The effect on outlays in (in millions of dollars) is as follows: 1997 $21,856; 1998 $22,295; 1999 $24,496; 2000
$25,334; 2001 $26,040; 2002 $26,715; and 2003 $27,414.

98

ANALYTICAL PERSPECTIVES

Table 5–3.

MAJOR TAX EXPENDITURES IN THE INCOME TAX, RANKED BY TOTAL 1999 REVENUE LOSS
(In millions of dollars)
Provision

1999

Exclusion of employer contributions for medical insurance premiums and medical care .............................................................................................................................
Net exclusion of employer pension-plan contributions and earnings .............................................................................................................................................................
Deductibility of mortgage interest on owner-occupied homes ........................................................................................................................................................................
Deductibility of nonbusiness State and local taxes other than owner-occupied homes ...............................................................................................................................
Accelerated depreciation of machinery and equipment (normal tax method) ...............................................................................................................................................
Capital gains (other than agriculture, timber, iron ore, and coal) (Normal tax method) ...............................................................................................................................
Deductibility of charitable contributions ...........................................................................................................................................................................................................
Child credit 1 .....................................................................................................................................................................................................................................................
Exclusion of Social Security benefits for retired workers ...............................................................................................................................................................................
Deductibility of State and local property tax on owner-occupied homes .......................................................................................................................................................
Exclusion of interest on public purpose bonds ...............................................................................................................................................................................................
Exclusion of interest on life insurance savings ...............................................................................................................................................................................................
Net Exclusion of Individual Retirement Account contributions and earnings .................................................................................................................................................
Capital gains exclusion on home sales ...........................................................................................................................................................................................................
Step-up basis of capital gains at death ..........................................................................................................................................................................................................
Exclusion of interest on State and local debt for various non-public purposs ..............................................................................................................................................
Exclusion of workmen’s compensation benefits ..............................................................................................................................................................................................
Graduated corporation income tax rate (normal tax method) ........................................................................................................................................................................
Deductibility of medical expenses ....................................................................................................................................................................................................................
Earned income tax credit 2 ...............................................................................................................................................................................................................................
HOPE tax credit ...............................................................................................................................................................................................................................................
Exclusion of Social Security benefits for dependents and survivors .............................................................................................................................................................
Net exclusion of Keogh plan contributions and earnings ...............................................................................................................................................................................
Exception from passive loss rules for $25,000 of rental loss ........................................................................................................................................................................
Accelerated depreciation of buildings other than rental housing (normal tax method) .................................................................................................................................
Exclusion of veterans death benefits and disability compensation ................................................................................................................................................................
Tax credit for corporations receiving income from doing business in U.S. possessions ..............................................................................................................................
Exclusion of Social Security benefits for disabled ..........................................................................................................................................................................................
Deferral of income from controlled foreign corporations (normal tax method) ..............................................................................................................................................
Lifetime Learning tax credit ..............................................................................................................................................................................................................................
Credit for child and dependent care expenses ...............................................................................................................................................................................................
Credit for low-income housing investment ......................................................................................................................................................................................................
Exclusion of income earned abroad by U.S. citizens .....................................................................................................................................................................................
Premiums on group term life insurance ..........................................................................................................................................................................................................
Exclusion of benefits and allowances to armed forces personnel .................................................................................................................................................................
Accelerated depreciation on rental housing (normal tax method) ..................................................................................................................................................................
Exclusion of income of foreign sales corporations .........................................................................................................................................................................................
Additional deduction for the elderly .................................................................................................................................................................................................................
Inventory property sales source rules exception ............................................................................................................................................................................................
Exclusion of reimbursed employee parking expenses ....................................................................................................................................................................................
Deferral of interest on U.S. savings bonds .....................................................................................................................................................................................................
Deferral of income from post 1987 installment sales .....................................................................................................................................................................................
Exemption of credit union income ...................................................................................................................................................................................................................
Exclusion of scholarship and fellowship income (normal tax method) ..........................................................................................................................................................
Exclusion of employer provided child care .....................................................................................................................................................................................................
Parental personal exemption for students age 19 or over .............................................................................................................................................................................
Expensing of certain small investments (normal tax method) ........................................................................................................................................................................
Credit for increasing research activities ..........................................................................................................................................................................................................
Excess of percentage over cost depletion, fuels ............................................................................................................................................................................................
Special ESOP rules ..........................................................................................................................................................................................................................................
Exclusion of employee meals and lodging (other than military) ....................................................................................................................................................................
Alternative fuel production credit .....................................................................................................................................................................................................................
Exclusion of public assistance benefits (normal tax method) ........................................................................................................................................................................
Expensing of research and experimentation expenditures (normal tax method) ..........................................................................................................................................
Empowerment zones and enterprise communities .........................................................................................................................................................................................
Capital gains treatment of certain income ......................................................................................................................................................................................................
Deductibility of casualty losses ........................................................................................................................................................................................................................
Expensing of multiperiod timber growing costs ..............................................................................................................................................................................................
Exclusion of railroad retirement system benefits ............................................................................................................................................................................................
Excess of percentage over cost depletion, nonfuel minerals .........................................................................................................................................................................
Exclusion of parsonage allowances .................................................................................................................................................................................................................
Adoption assistance ..........................................................................................................................................................................................................................................
Special Blue Cross/Blue Shield deduction ......................................................................................................................................................................................................
Deductibility of student-loan interest ................................................................................................................................................................................................................
Tax exemption of insurance companies owned by tax-exempt organizations ..............................................................................................................................................
Exclusion of employer provided educational assistance ................................................................................................................................................................................
Amortization of start-up costs (normal tax method) ........................................................................................................................................................................................
Work opportunity tax credit ..............................................................................................................................................................................................................................
Exclusion of employer provided death benefits ..............................................................................................................................................................................................

76,230
72,375
53,695
33,490
28,535
26,120
25,260
19,175
19,115
18,440
14,760
14,200
10,780
9,465
9,465
7,395
5,210
5,085
4,815
4,635
4,160
4,160
3,755
3,680
3,470
3,100
2,800
2,685
2,600
2,550
2,510
2,365
2,205
2,150
2,120
1,845
1,800
1,785
1,700
1,340
1,015
995
960
955
950
925
880
860
840
740
650
630
605
580
555
535
510
505
460
355
340
320
240
235
230
215
210
200
200

1999–2003
437,690
365,865
298,690
182,500
152,120
138,665
139,460
94,855
104,740
100,480
76,625
79,265
57,375
51,260
51,260
35,550
28,975
27,840
27,275
23,530
25,405
22,375
20,430
16,395
9,125
17,415
14,790
15,565
15,000
13,945
12,510
11,995
13,760
11,220
10,800
11,620
10,000
9,035
9,500
7,030
5,605
5,175
5,800
5,210
5,205
5,115
5,270
1,460
4,330
3,960
3,555
2,670
3,285
3,555
2,950
2,840
2,815
2,700
2,340
1,845
1,935
1,635
1,455
1,705
1,315
440
1,100
340
1,099

99

5. TAX EXPENDITURES

Table 5–3.

MAJOR TAX EXPENDITURES IN THE INCOME TAX, RANKED BY TOTAL 1999 REVENUE LOSS—Continued
(In millions of dollars)
Provision

Premiums on accident and disability insurance ..............................................................................................................................................................................................
Carryover basis of capital gains on gifts .........................................................................................................................................................................................................
Exceptions from imputed interest rules ...........................................................................................................................................................................................................
Exclusion of military disability pensions ..........................................................................................................................................................................................................
Expensing of environmental remediation costs ...............................................................................................................................................................................................
Small life insurance company deduction .........................................................................................................................................................................................................
Tax incentives for preservation of historic structures .....................................................................................................................................................................................
Medical savings accounts ................................................................................................................................................................................................................................
Deferral of state prepaid tuition plans .............................................................................................................................................................................................................
Enhanced oil recovery credit ...........................................................................................................................................................................................................................
Expensing of certain multiperiod production costs .........................................................................................................................................................................................
Education Individual Retirement Accounts ......................................................................................................................................................................................................
Tax credit and deduction for clean-fuel burning vehicles and properties ......................................................................................................................................................
Exclusion for employer-provided transit passes ..............................................................................................................................................................................................
Exclusion of special benefits for disabled coal miners ...................................................................................................................................................................................
Investment credit for rehabilitation of structures (other than historic) ............................................................................................................................................................
Expensing of certain capital outlays ................................................................................................................................................................................................................
New technology credit ......................................................................................................................................................................................................................................
Exclusion of GI bill benefits .............................................................................................................................................................................................................................
Exclusion of veterans pensions .......................................................................................................................................................................................................................
Exemption of certain mutuals’ and cooperatives’ income ..............................................................................................................................................................................
Credit for disabled access expenditures .........................................................................................................................................................................................................
Expensing of exploration and development costs, nonfuel minerals .............................................................................................................................................................
Investment credit and seven-year amortization for reforestation expenditures .............................................................................................................................................
Capital gains treatment of certain timber income ...........................................................................................................................................................................................
Tax credit for orphan drug research ...............................................................................................................................................................................................................
Exception from passive loss limitation for working interests in oil and gas properties ................................................................................................................................
Capital gains treatment of royalties on coal ...................................................................................................................................................................................................
Tax credit for the elderly and disabled ...........................................................................................................................................................................................................
Exclusion of certain foster care payments ......................................................................................................................................................................................................
Capital gains exclusion of small corporation stock .........................................................................................................................................................................................
Credit for holders of zone academy bonds .....................................................................................................................................................................................................
Welfare-to-work tax credit ................................................................................................................................................................................................................................
Income averaging for farmers ..........................................................................................................................................................................................................................
Additional deduction for the blind ....................................................................................................................................................................................................................
Exclusion from income of conservation subsidies provided by public utilities ..............................................................................................................................................
Expensing of costs of removing certain architectural barriers to the handicapped ......................................................................................................................................
Special rules for mining reclamation reserves ................................................................................................................................................................................................
Deferral of tax on shipping companies ...........................................................................................................................................................................................................
Excess bad debt reserves of financial institutions ..........................................................................................................................................................................................
Alcohol fuel credit 3 ...........................................................................................................................................................................................................................................
Treatment of loans for solvent farmers ...........................................................................................................................................................................................................
Exclusion of interest on savings bonds transferred to educational institutions .............................................................................................................................................
Special alternative tax on small property and casualty insurance companies ..............................................................................................................................................
Ordinary income treatment of loss from small business corporation stock sale ...........................................................................................................................................
Income of trusts to finance supplementary unemployment benefits ..............................................................................................................................................................

1999
185
180
160
135
120
120
115
110
110
100
85
85
80
80
80
70
70
70
70
65
65
65
55
50
50
50
50
50
50
40
35
35
30
30
30
30
20
20
20
20
20
10
10
5
5
5

1999–2003
1,025
1,000
810
725
305
650
540
585
660
575
425
1,495
430
555
360
335
350
390
435
376
335
345
275
255
285
315
270
285
250
220
190
215
90
90
160
225
100
100
100
40
100
50
70
25
230
25

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 $5 million.
Figures in table 5–3 are the arithmetic sums of corporate and individual income taxrevenue loss estimates from table 5–2, and do not reflect possible interactions across these two taxes.
1
The figures in the table indicate the effect of the child credit on receipts. The effect on outlays in (in millions of dollars) is as follows: 1997 $0; 1998 $0; 1999 $538; 2000 $685; 2001 $662; 2002 $624;
and 2003 $589.
2
The figures in the table indicate the effect of the earned income tax credit on receipts. The effect on outlays in (in millions of dollars) is as follows: 1997 $21,856; 1998 $22,295; 1999 $24,496; 2000
$25,334; 2001 $26,040; 2002 $26,715; and 2003 $27,414.
3
In addition, the partial exemption from the excise tax for alcohol fuels results in a reduction in excise tax receipts (in millions of dollars) as follows: 1997 $675; 1998 $720; 1999 $750; 2000 $780; 2001
$810; 2002 $845; and 2003 $875.

100

ANALYTICAL PERSPECTIVES

Table 5–4.

PRESENT VALUE OF SELECTED TAX EXPENDITURES FOR
ACTIVITY IN CALENDAR YEAR 1998
(In millions of dollars)
Present
Value of
Revenue
Loss

Provision

Deferral of income from controlled foreign corporation (normal tax method) ....................................................
Expensing of research and experimentation expenditure (normal tax method) .................................................
Expensing of exploration and development costs—fuels ....................................................................................
Expensing of exploration and development costs—nonfuels ..............................................................................
Expensing of multiperiod timber growing costs ...................................................................................................
Expensing of certain multiperiod production costs—agriculture ..........................................................................
Expensing of certain capital outlays—agriculture ................................................................................................
Deferral of income on life insurance and annuity contracts ...............................................................................
Accelerated depreciation of rental housing (normal tax method) .......................................................................
Accelerated depreciation of buildings other than rental housing (normal tax method) .....................................
Accelerated depreciation of machinery and equipment (normal tax method) ....................................................
Expensing of certain small investments (normal tax method) ............................................................................
Amortization of start-up costs (normal tax method) ............................................................................................
Deferral of tax on shipping companies ................................................................................................................
Credit for low-income housing investments .........................................................................................................
Exclusion of pension contributions and earnings—employer plans ....................................................................
Exclusion of IRA contributions and earnings .......................................................................................................
Exclusions of contribution and earnings for Keogh plans ...................................................................................
Exclusion of interest on State and local public-purpose bonds ..........................................................................
Exclusion of interest on State and local non-public purposes bonds ................................................................
Deferral of interest on U.S. savings bonds .........................................................................................................

2,350
1,655
160
75
285
70
85
19,635
2,230
535
30,730
1,065
180
10
1,930
77,260
10,525
3,185
21,940
8,665
230

Note: Provisions with estimates denoted ‘‘normal tax method’’ have no revenue loss under the reference tax law method.

Outlay Equivalents
The concept of ‘‘outlay equivalents’’ complements
‘‘revenue losses’’ as a measure of the budget effect of
tax expenditures. It is the amount of outlay that would
be required to provide the taxpayer the same aftertax income as would be received through the tax preference. The outlay equivalent measure allows a comparison of the cost of the tax expenditure with that
of a direct Federal outlay. Outlay equivalents are reported in table 5–5.
The measure is larger than the revenue loss estimate
when the tax expenditure is judged to function as a
Government payment for service. This occurs because

an outlay program would increase the taxpayer’s pretax income. For some tax expenditures, however, the
revenue loss equals the outlay equivalent measure. This
occurs when the tax expenditure is judged to function
like a price reduction or tax deferral that does not
directly enter the taxpayer’s pre-tax income.1
1
Budget outlay figures generally reflect the pre-tax price of the resources. In some instances, however, Government purchases or subsidies are exempted from tax by a special
tax provision. When this occurs, the outlay figure understates the resource cost of the
program and is, therefore, not comparable with other outlay amounts. For example, the
outlays for certain military personnel allowances are not taxed. If this form of compensation
were treated as part of the employee’s taxable income, the Defense Department would
have to make larger cash payments to its military personnel to leave them as well off
after tax as they are now. The tax subsidy must be added to the tax-exempt budget
outlay to make this element of national defense expenditures comparable with other outlays.

101

5. TAX EXPENDITURES

Table 5–5.

OUTLAY EQUIVALENT ESTIMATES FOR TAX EXPENDITURES IN THE INCOME TAX
(In millions of dollars)
Outlay Equivalents
1997

1998

1999

2000

2001

2002

2003

1999–
2003

1

National defense:
Exclusion of benefits and allowances to armed forces personnel ...............................................................

2,425

2,445

2,470

2,495

2,520

2,545

2,570

12,600

2
3
4
5

International affairs:
Exclusion of income earned abroad by U.S. citizens ..................................................................................
Exclusion of income of foreign sales corporations .......................................................................................
Inventory property sales source rules exception ..........................................................................................
Deferral of income from controlled foreign corporations (normal tax method) ............................................

2,355
2,460
2,310
2,200

2,610
2,615
2,460
2,400

2,900
2,770
2,615
2,600

3,225
2,925
2,770
2,800

3,585
3,075
2,925
3,000

3,990
3,230
3,075
3,200

4,440
3,385
3,230
3,400

18,140
15,385
14,615
15,000

6
7

General science, space, and technology:
Expensing of research and experimentation expenditures (normal tax method) ........................................
Credit for increasing research activities ........................................................................................................

190
1,360

430
3,270

585
1,315

680
565

740
250

765
85

785
15

3,555
2,230

8
9
10
11
12
13
14
15
16
17
18

Energy:
Expensing of exploration and development costs, fuels ..............................................................................
Excess of percentage over cost depletion, fuels ..........................................................................................
Alternative fuel production credit ...................................................................................................................
Exception from passive loss limitation for working interests in oil and gas properties ..............................
Capital gains treatment of royalties on coal .................................................................................................
Exclusion of interest on energy facility bonds ..............................................................................................
Enhanced oil recovery credit .........................................................................................................................
New technology credit ....................................................................................................................................
Alcohol fuel credit 1 ........................................................................................................................................
Tax credit and deduction for clean-fuel burning vehicles and properties ....................................................
Exclusion from income of conservation subsidies provided by public utilities ............................................

–300
1,160
1,090
45
65
255
145
80
20
95
95

–180
1,175
1,120
50
65
245
150
90
20
100
25

–95
1,185
960
50
70
245
160
100
20
110
40

10
1,200
910
50
75
240
170
105
20
125
55

–20
1,215
860
55
75
225
180
110
20
135
60

..............
1,240
820
55
75
210
190
110
20
130
65

30
1,255
550
60
80
200
195
110
20
100
80

–75
6,095
4,100
270
375
1,120
895
535
100
600
300

19
20
21
22
23
24
25
26
27

Natural resources and environment:
Expensing of exploration and development costs, nonfuel minerals ...........................................................
Excess of percentage over cost depletion, nonfuel minerals ......................................................................
Capital gains treatment of iron ore ...............................................................................................................
Special rules for mining reclamation reserves ..............................................................................................
Exclusion of interest on bonds for water, sewage, and hazardous waste facilities ...................................
Capital gains treatment of certain timber income .........................................................................................
Expensing of multiperiod timber growing costs ............................................................................................
Investment credit and seven-year amortization for reforestation expenditures ...........................................
Tax incentives for preservation of historic structures ...................................................................................

65
465
..............
25
895
65
460
45
120

75
480
..............
25
870
65
480
50
115

75
495
..............
25
845
70
505
50
115

75
505
..............
25
810
75
525
50
110

75
515
..............
25
775
75
540
50
105

75
535
..............
25
720
75
555
55
105

75
540
..............
25
650
80
575
55
105

375
2,590
..............
125
3,800
375
2,700
260
540

28
29
30
31
32

Agriculture:
Expensing of certain capital outlays ..............................................................................................................
Expensing of certain multiperiod production costs .......................................................................................
Treatment of loans for solvent farmers .........................................................................................................
Capital gains treatment of certain income ....................................................................................................
Income averaging for farmers ........................................................................................................................

65
80
10
675
..............

65
80
10
695
5

70
85
10
715
30

70
85
10
735
35

70
85
10
755
25

70
85
10
780
..............

70
85
10
805
..............

350
425
50
3,790
90

1,020
70
12,765
5
280
145

1,120
45
13,465
5
300
150

1,225
20
14,200
5
320
160

1,340
10
14,990
5
340
165

1,465
5
15,810
5
360
170

1,605
5
16,680
5
390
180

1,760
..............
17,585
5
415
190

7,395
40
79,265
25
1,825
865

2,510
1,165
49,060
16,915
960
12,245
3,740
11,670
4,175
3,490
1,365

2,395
1,075
51,245
17,700
975
5,770
1,110
12,135
3,910
3,670
1,585

2,290
990
53,695
18,440
995
..............
..............
12,620
3,680
3,590
1,840

2,185
880
56,515
19,220
1,015
..............
..............
13,125
3,465
3,550
2,100

2,060
755
59,505
20,045
1,035
..............
..............
13,650
3,270
3,615
2,235

1,955
645
62,730
20,920
1,055
..............
..............
14,195
3,080
3,665
2,560

1,845
440
66,245
21,855
1,075
..............
..............
14,765
2,900
3,775
2,885

10,335
3,710
298,690
100,480
5,175
..............
..............
68,355
16,395
18,195
11,620

40
155
32,825
..............
11,670

15
155
33,810
..............
12,135

..............
160
34,815
5
12,620

–10
160
35,870
25
13,125

–5
160
36,950
55
13,650

–5
165
38,060
95
14,195

..............
165
39,195
125
14,765

–20
810
184,890
305
68,355

33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48
49
50
51
52
53
54

Commerce and housing:
Financial institutions and insurance:
Exemption of credit union income ............................................................................................................
Excess bad debt reserves of financial institutions ...................................................................................
Exclusion of interest on life insurance savings ........................................................................................
Special alternative tax on small property and casualty insurance companies .......................................
Tax exemption of insurance companies owned by tax-exempt organizations ........................................
Small life insurance company deduction ..................................................................................................
Housing:
Exclusion of interest on owner-occupied mortgage subsidy bonds .........................................................
Exclusion of interest on rental housing bonds .........................................................................................
Deductibility of mortgage interest on owner-occupied homes .................................................................
Deductibility of State and local property tax on owner-occupied homes ................................................
Deferral of income from post 1987 installment sales ..............................................................................
Deferral of capital gains on home sales ...................................................................................................
Exclusion of capital gains on home sales for persons age 55 and over ...............................................
Capital gains exclusion on home sales ....................................................................................................
Exception from passive loss rules for $25,000 of rental loss .................................................................
Credit for low-income housing investment ................................................................................................
Accelerated depreciation on rental housing (normal tax method) ...........................................................
Commerce:
Cancellation of indebtedness ....................................................................................................................
Exceptions from imputed interest rules ....................................................................................................
Capital gains (other than agriculture, timber, iron ore, and coal) (normal tax method) .........................
Capital gains exclusion of small corporation stock ..................................................................................
Step-up basis of capital gains at death ....................................................................................................

102

ANALYTICAL PERSPECTIVES

Table 5–5.

OUTLAY EQUIVALENT ESTIMATES FOR TAX EXPENDITURES IN THE INCOME TAX—Continued
(In millions of dollars)
Outlay Equivalents
1997

1998

1999

2000

2001

2002

2003

1999–
2003

55
56
57
58
59
60
61
62

Carryover basis of capital gains on gifts ..................................................................................................
Ordinary income treatment of loss from small business corporation stock sale ....................................
Accelerated depreciation of buildings other than rental housing (normal tax method) ..........................
Accelerated depreciation of machinery and equipment (normal tax method) .........................................
Expensing of certain small investments (normal tax method) .................................................................
Amortization of start-up costs (normal tax method) .................................................................................
Graduated corporation income tax rate (normal tax method) ..................................................................
Exclusion of interest on small-issue bonds ..............................................................................................

155
45
5,830
24,970
1,055
200
6,345
495

165
45
4,690
26,655
965
205
6,690
425

180
50
3,470
28,535
880
210
6,870
395

190
50
2,530
29,410
820
215
7,135
370

200
55
1,700
30,620
1,360
220
7,465
350

210
55
1,070
31,620
1,285
225
7,865
335

220
55
350
31,935
930
230
8,280
320

1,000
265
9,120
152,120
5,275
1,100
37,615
1,770

63
64
65

Transportation:
Deferral of tax on shipping companies .........................................................................................................
Exclusion of reimbursed employee parking expenses .................................................................................
Exclusion for employer-provided transit passes ...........................................................................................

20
1,670
80

20
1,710
100

20
1,750
115

20
1,790
135

20
1,835
155

20
1,885
175

20
1,935
200

100
9,195
780

66
67
68
69
70

Community and regional development:
Investment credit for rehabilitation of structures (other than historic) .........................................................
Exclusion of interest for airport, dock, and similar bonds ............................................................................
Exemption of certain mutuals’ and cooperatives’ income ............................................................................
Empowerment zones and enterprise communities .......................................................................................
Expensing of environmental remediation costs ............................................................................................

80
1,400
60
255
..............

70
1,470
65
460
130

70
1,530
65
555
155

70
1,580
65
635
210

65
1,620
65
670
85

65
1,645
70
620
–20

65
1,665
70
465
–35

335
8,040
335
2,945
395

970
..............
..............
..............
..............
..............
415
1,200
..............
10
935
..............
3,680
395

1,015
265
145
20
85
80
390
1,245
10
15
970
4,785
3,975
270

1,060
5,335
3,270
110
300
140
365
1,280
45
20
1,025
25,565
4,140
270

1,105
6,245
3,320
250
355
155
345
1,305
65
20
1,075
25,655
4,315
260

1,155
6,700
3,595
395
435
170
325
1,325
65
20
1,135
25,355
4,520
20

1,210
7,085
3,640
535
510
185
310
1,340
65
20
1,185
25,125
4,750
..............

1,265
7,210
4,050
690
535
200
300
1,350
65
20
1,245
24,775
5,000
..............

5,795
32,575
17,875
1,980
2,135
850
1,645
6,600
305
100
5,665
126,475
22,725
550

110
..............
1,145
10
725
3,350
115
20
22,675
40
365

275
10
1,215
240
760
3,350
115
20
24,820
45
390

200
30
1,265
385
795
3,345
115
20
25,960
45
415

100
30
1,325
430
830
3,340
120
20
27,235
50
445

30
15
1,385
450
862
3,335
120
20
28,590
50
475

10
10
1,445
435
905
3,330
120
20
30,050
55
505

..............
5
1,515
270
945
3,330
120
20
31,600
55
540

340
90
6,935
1,970
4,337
16,680
595
100
143,435
255
2,380

85,585
..............
4,175
2,420
3,220
25
280

91,445
40
4,550
2,510
3,500
65
230

97,690
150
4,815
2,590
3,645
75
300

104,225
155
5,110
2,655
3,815
80
320

111,355
155
5,425
2,705
3,990
95
360

119,245
160
5,775
2,750
4,190
105
425

128,370
170
6,150
2,780
4,415
115
415

560,885
790
27,275
13,480
20,055
470
1,820

445
4,410
545
85
125

455
4,950
580
85
130

460
5,210
605
80
135

465
5,480
630
75
130

465
5,775
655
70
145

470
6,090
685
70
150

480
6,420
710
65
155

2,340
28,975
3,285
360
715

96,455
13,555
4,635
235

97,615
14,250
4,815
245

98,130
15,025
4,950
260

99,880
15,570
5,130
270

99,780
16,215
5,360
280

99,990
16,890
5,615
295

100,540
17,395
5,865
310

498,320
81,095
26,920
1,415

85
86
87
88
89
90
91
92
93
94
95

Education, training, employment, and social services:
Education:
Exclusion of scholarship and fellowship income (normal tax method) ....................................................
HOPE tax credit .........................................................................................................................................
Lifetime Learning tax credit .......................................................................................................................
Education Individual Retirement Accounts ................................................................................................
Deductibility of student-loan interest .........................................................................................................
Deferral of state prepaid tuition plans ......................................................................................................
Exclusion of interest on student loan bonds ............................................................................................
Exclusion of interest on bonds for private nonprofit educational facilities ..............................................
Credit for holders of zone academy bonds ..............................................................................................
Exclusion of interest on savings bonds transferred to educational institutions ......................................
Parental personal exemption for students age 19 or over ......................................................................
Child credit 2 ...............................................................................................................................................
Deductibility of charitable contributions (education) .................................................................................
Exclusion of employer provided educational assistance ..........................................................................
Training, employment, and social services:
Work opportunity tax credit .......................................................................................................................
Welfare-to-work tax credit ..........................................................................................................................
Exclusion of employer provided child care ...............................................................................................
Adoption assistance ...................................................................................................................................
Exclusion of employee meals and lodging (other than military) ..............................................................
Credit for child and dependent care expenses ........................................................................................
Credit for disabled access expenditures ...................................................................................................
Expensing of costs of removing certain architectural barriers to the handicapped ................................
Deductibility of charitable contributions, other than education and health ..............................................
Exclusion of certain foster care payments ...............................................................................................
Exclusion of parsonage allowances ..........................................................................................................

96
97
98
99
100
101
102

Health:
Exclusion of employer contributions for medical insurance premiums and medical care ..........................
Medical savings accounts ..............................................................................................................................
Deductibility of medical expenses .................................................................................................................
Exclusion of interest on hospital construction bonds ...................................................................................
Deductibility of charitable contributions (health) ...........................................................................................
Tax credit for orphan drug research .............................................................................................................
Special Blue Cross/Blue Shield deduction ....................................................................................................

71
72
73
74
75
76
77
78
79
80
81
82
83
84

103
104
105
106
107
108
109
110
111

Income security:
Exclusion of railroad retirement system benefits ..........................................................................................
Exclusion of workmen’s compensation benefits ...........................................................................................
Exclusion of public assistance benefits (normal tax method) ......................................................................
Exclusion of special benefits for disabled coal miners ................................................................................
Exclusion of military disability pensions ........................................................................................................
Net exclusion of pension contributions and earnings:
Employer plans ..........................................................................................................................................
Individual Retirement Accounts .................................................................................................................
Keogh plans ...............................................................................................................................................
Exclusion of employer provided death benefits ........................................................................................

103

5. TAX EXPENDITURES

Table 5–5.

OUTLAY EQUIVALENT ESTIMATES FOR TAX EXPENDITURES IN THE INCOME TAX—Continued
(In millions of dollars)
Outlay Equivalents
1997

1998

1999

2000

2001

2002

2003

1999–
2003

112
113
114
115
116
117
118
119
120

Exclusion of other employee benefits:
Premiums on group term life insurance ...................................................................................................
Premiums on accident and disability insurance .......................................................................................
Income of trusts to finance supplementary unemployment benefits .......................................................
Special ESOP rules ...................................................................................................................................
Additional deduction for the blind .............................................................................................................
Additional deduction for the elderly ..........................................................................................................
Tax credit for the elderly and disabled .....................................................................................................
Deductibility of casualty losses .................................................................................................................
Earned income tax credit 3 ........................................................................................................................

2,730
210
5
1,020
30
1,870
60
600
5,340

2,790
225
5
1,000
35
2,070
60
630
5,460

2,845
235
5
1,030
35
2,160
60
665
3,790

2,905
250
5
1,055
35
2,175
60
695
3,635

2,965
260
5
1,095
40
2,180
60
730
3,860

3,030
275
5
1,140
40
2,180
60
765
4,005

3,090
290
5
1,190
40
2,230
65
805
4,245

14,835
1,310
25
5,510
190
10,925
305
3,660
19,535

121
122
123

Social Security:
Exclusion of social security benefits:
Social Security benefits for retired workers ..............................................................................................
Social Security benefits for disabled .........................................................................................................
Social Security benefits for dependents and survivors ............................................................................

17,470
2,270
3,825

18,330
2,495
4,000

19,115
2,685
4,160

20,025
2,875
4,310

20,840
3,090
4,470

21,830
3,325
4,640

22,930
3,590
4,795

104,740
15,565
22,375

124
125
126
127

Veterans benefits and services:
Exclusion of veterans death benefits and disability compensation ..............................................................
Exclusion of veterans pensions .....................................................................................................................
Exclusion of GI bill benefits ...........................................................................................................................
Exclusion of interest on veterans housing bonds .........................................................................................

2,770
70
60
110

2,930
65
70
110

3,100
70
80
105

3,280
75
90
110

3,470
80
95
110

3,675
85
100
115

3,890
90
105
120

17,415
400
470
560

128
129
130

General purpose fiscal assistance:
Exclusion of interest on public purpose bonds .............................................................................................
Deductibility of nonbusiness State and local taxes other than on owner-occupied homes .......................
Tax credit for corporations receiving income from doing business in U.S. possessions ...........................

19,915
30,720
3,860

20,650
32,145
3,960

21,285
33,490
4,000

21,795
34,910
4,120

22,170
36,410
4,245

22,475
37,995
4,370

22,680
39,695
4,390

110,405
182,500
21,125

131

Interest:
Deferral of interest on U.S. savings bonds ...................................................................................................

915

965

1,015

1,065

1,115

1,175

1,235

5,605

16,915
30,720

17,700
32,145

18,440
33,490

19,220
34,910

20,045
36,410

20,920
37,995

21,855
39,695

100,480
182,500

19,915
255
895
495
2,510
1,165
1,400
415
1,200
2,420
110

20,650
245
870
425
2,395
1,075
1,470
390
1,245
2,510
110

21,285
245
845
395
2,290
990
1,530
365
1,280
2,590
105

21,795
240
810
370
2,185
880
1,580
345
1,305
2,655
110

22,170
225
775
350
2,060
755
1,620
325
1,325
2,705
110

22,475
210
720
335
1,955
645
1,645
310
1,340
2,750
115

22,680
200
650
320
1,845
440
1,665
300
1,350
2,780
120

110,405
1,120
3,800
1,770
10,335
3,710
8,040
1,645
6,600
13,480
560

Addendum—Aid to State and local governments:
Deductibility of:
Property taxes on owner-occupied homes ...............................................................................................
Nonbusiness State and local taxes other than on owner-occupied homes ............................................
Exclusion of interest on:
Public purpose bonds ................................................................................................................................
Energy facility bonds .................................................................................................................................
Bonds for water, sewage, and hazardous waste facilities .......................................................................
Small-issue bonds ......................................................................................................................................
Owner-occupied mortgage revenue bonds ...............................................................................................
Rental housing bonds ................................................................................................................................
Bonds for airports, docks, and sports and convention facilities ..............................................................
Student loan bonds ....................................................................................................................................
Bonds for private nonprofit educational facilities ......................................................................................
Hospital construction bonds ......................................................................................................................
Veterans housing bonds ............................................................................................................................

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 $5 million.
Figures in table 5–1 are the arithmetic sums of corporate and individual income tax revenue loss estimates from table 5–2, and do not reflect possible interactions across these two taxes.
1
In addition, the partial exemption from the excise tax for alcohol fuels results in a reduction in excise tax receipts (in millions of dollars) as follows: 1997 $675; 1998 $720; 1999 $750; 2000 $780; 2001
$810; 2002 $845; 2003 $875.
2
The figures in the table indicate the effect of the child credit on receipts. The effect on outlays in (in millions of dollars) is as follows: 1997 $0; 1998 $0; 1999 $538; 2000 $685; 2001 $662; 2002 $624;
and 2003 $589.
3
The figures in the table indicate the effect of the earned income tax credit on receipts. The effect on outlays in (in millions of dollars) is as follows: 1997 $21,856; 1998 $22,295; 1999 $24,496; 2000
$25,334; 2001 $26,040; 2002 $26,715; and 2003 $27,414.

Tax Expenditure Baselines
A tax expenditure is a preferential exception to the
baseline provisions of the tax structure. The 1974 Congressional Budget Act does not, however, specify the
baseline provisions of the tax law. Deciding whether
provisions are preferential exceptions, therefore, is a
matter of judgement. As in prior years, this year’s tax
expenditure estimates are presented using two baselines: the normal tax baseline, which is used by the
Joint Committee on Taxation, and the reference tax

law baseline, which has been reported by the Administration since 1983.
The normal tax baseline is patterned on a comprehensive income tax, which defines income as the
sum of consumption and the change in net wealth in
a given period of time. The normal tax baseline allows
personal exemptions, a standard deduction, and deductions of the expenses incurred in earning income. It
is not limited to a particular structure of tax rates,
or by a specific definition of the taxpaying unit.

104
The reference tax law baseline is also patterned on
a comprehensive income tax, but in practice is closer
to existing law. Reference law tax expenditures are limited to special exceptions in the tax code that serve
programmatic functions. These functions correspond to
specific budget categories such as national defense, agriculture, or health care. While tax expenditures under
the reference law baseline are generally tax expenditures under the normal tax baseline, 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:
• Income is taxable when 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) is regarded as a tax expenditure. Both
accrued and imputed income would be taxed under
a comprehensive income tax.
• There is a separate corporation income tax. Under
a comprehensive income tax corporate income
would be taxed only once—at the shareholder
level, whether or not distributed in the form of
dividends.
• Values of assets and debt are not 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).
While 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 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. Similarly, under the reference law baseline, preferential tax rates for capital gains generally do not yield a tax expenditure;
only capital gains treatment of otherwise ‘‘ordinary income,’’ such as that from coal and iron
ore royalties and the sale of timber and certain
agricultural products, is considered a tax expenditure. The alternative minimum tax is treated as
part of the baseline rate structure under both the
reference and normal tax methods.

ANALYTICAL PERSPECTIVES

• Income subject to the tax. Income subject to tax
is defined as gross income less the costs of earning
that income. The Federal income tax defines gross
income to include: (1) consideration received in
the exchange of goods and services, including labor
services or property; and (2) the taxpayer’s share
of gross or net income earned and/or reported by
another entity (such as a partnership). Under the
reference tax rules, therefore, gross income does
not include gifts—defined as receipts of money or
property that are not consideration in an exchange—or most transfer payments, which can be
thought of as gifts from the Government.2 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.3
• Capital recovery. Under the reference tax law
baseline no tax expenditures arise from accelerated depreciation. Under the normal tax baseline,
the depreciation allowance for machinery and
equipment is determined using straight-line depreciation over tax lives equal to mid-values of
the asset depreciation range (a depreciation system in effect from 1971 through 1980). The normal
tax baseline for real property is computed using
40-year straight-line depreciation.
• 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
2
Gross income does, however, include transfer payments associated with past employment,
such as social security benefits.
3
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.

5. TAX EXPENDITURES

set of tax expenditures under its normal tax baseline
than is considered here.
Performance Measures and the Economic
Effects of Tax Expenditures
Under the Government Performance and Results Act
of 1993 (GPRA), Federal agencies are directed to develop both strategic and annual plans for their programs and activities. These plans set out performance
objectives to be achieved over a specific time period.
Achieving most of these objectives will largely be the
result of direct expenditures of funds. However, tax
expenditures may also contribute to goal achievement.
The Senate Governmental Affairs Committee report
on this Act4 called on the Executive branch to undertake a series of analyses to assess the effect of specific
tax expenditures on the achievement of the goals and
objectives in these strategic and annual plans. As described in OMB’s May 1997 report on this Act,5 Treasury in 1997 initiated pilot studies of three specific tax
expenditures in order to explore evaluation methods
and resource needs associated with evaluating the relationship between tax expenditures and performance
goals. Tax expenditures were selected in each of the
three main areas—individual, business, and international taxation—within the Office of Tax Analysis.
The specific provisions considered were: the tax exemption for worker’s compensation benefits; the tax credit
for nonconventional fuels; and the tax exclusion for certain amounts of income earned by Americans living
abroad. The results of these studies are summarized
in the context of the three specific provisions in the
section that follows, which provides provision descriptions.
For the next year, the Administration’s plan is to
complete additional studies that will focus on the availability of the data needed to assess the effects of selected significant tax expenditures. In addition, summarized data on the beneficiaries and other economic properties of such provisions will be developed where feasible. This effort will complement information published
by the Joint Committee on Taxation and the Senate
Budget Committee on the rationale, beneficiaries, and
effects of tax expenditures.6 One finding of the pilot
studies is that much of the data needed for thorough
analysis is not currently available. Hence, assessment
of data needs and availability from Federal statistical
agencies, program-agency studies, or private-sector
sources, and, when feasible, publication of data on selected tax expenditures should prove valuable to broader efforts to assess the effects tax expenditures and
to compare their effectiveness with outlay, regulatory
and other tax polices as means of achieving objectives.
4
Committee on Government Affairs, United States Senate, ‘‘Government Performance and
Results Act of 1993’’ (Report 103–58, 1993).
5
Director of the Office of Management and Budget, ‘‘The Government Performance and
Results Act,’’ Report to the President and the Congress, May 1997.
6
Joint Committee on Taxation, ‘‘Estimates of Federal Tax Expenditures for Fiscal Years
1998–2992,’’ JCS–22–97, December 15, 1997; and Committee on the Budget, United States
Senate, ‘‘Tax Expenditures: Compendium of Background Material on Individual Provisions,’’
prepared by the Congressional Research Service (S. Prt. 104–69, December 1996).

105
Comparisons 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.7
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, though not all,
cases. In addition, tax expenditures may help simplify
the tax system, as where they leave certain income
sources untaxed (e.g, exemptions for employer fringe
benefits or exclusions for up to $500,000 of capital gains
on home sales). Tax expenditures also implicitly subsidize certain activities, which benefits recipients; the
beneficiaries experience reduced taxes that are offset
by higher taxes (or spending reductions) elsewhere.
Regulatory or tax-disincentive policies, which can also
modify behavior, would have a different distributional
impact. Finally, a variety of tax expenditure tools can
be used—e.g., deductions, credits, exemptions and deferrals; floors and ceilings; and phase-ins and phaseouts, dependent on income, expenses, or demographic
characteristics (age, number of family members, etc.).
This wide range means that tax expenditures can be
flexible and can have very different distributional and
cost-effectiveness properties.
Tax expenditures also have limitations. In some cases
they can add to the complexity of the tax system, which
can raise both administrative and compliance costs; for
example, various holding periods and tax rates for capital gains can complicate filing and decisionmaking.
Also, the income tax system does not gather information on wealth, in contrast to certain loan programs
that are based on recipients’ assets and income. In addition, the tax system may have little or no contact
with persons who have no or very low incomes, and
incentives for such persons may need to take the form
of refunds. 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 which activities are
addressed with what amount of resources in a way
that is difficult to emulate with tax expenditures. Finally, tax expenditures tend to escape the budget scrutiny afforded to other programs. For instance, a program funded by a tax expenditure does not increase
government outlays as a share of national product and
it may even decrease receipts as a share of output.
However, the effective government compensation to a
service provider can be identical to that of a spending
program under which the outlay (and possibly the receipts) share of GDP may increase.
7
While this section focuses upon tax expenditures under the income tax, tax preferences
also arise under the unified transfer, payroll, and excise tax systems. Such preferences
can be useful when they relate to the base of those taxes, such as an excise tax exemption
for certain types of meritorious consumption.

106
Outlay programs, in contrast, 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 return.
Outlay programs may also receive more year-to-year
oversight and fine tuning, through the legislative and
executive budget process. In addition, there are many
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—which provides flexibility for policy design. Regarding limitations, 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. Finally, spending programs, particularly on the discretionary side, may respond less readily
to changing activity levels and economic conditions than
tax expenditures.
Regulations have a key distributional difference from
outlay and tax-expenditure programs in that the immediate distributional burden of the regulation typically
falls on the regulated party (i.e., the intended actor)—
generally in the private sector. While the regulated parties can pass costs along through product or input
prices, the initial incidence is on the regulated party.
Regulations can be fine-tuned more quickly than tax
expenditures, as they can generally be changed by the
executive branch without legislation. Like tax expenditures, regulations often largely rely upon voluntary
compliance, rather than detailed inspections and policing. As such, the public administrative costs tend to
be modest, relative to the private resource costs associated with modifying activities. Historically, regulations
have tended to rely on proscriptive measures, as opposed to economic incentives, which can diminish their
efficiency, though this feature can also promote full
compliance where (as in certain safety-related cases)
policymakers believe that trade-offs with economic considerations are unnecessary. Also, regulations generally
do not directly affect the Federal budget and outlays
and receipts as a percentage of national output. Thus,
like tax expenditures, they may escape the type of scrutiny that outlay programs receive. However, most regulations are subjected to a formal type of benefit-cost
analysis that goes well beyond the analysis required
for outlay and tax-expenditure programs. To some extent, the GPRA requirement for performance evaluation
will address this lack of formal analysis.
Tax expenditures, like spending and regulatory programs, have a variety of objectives and effects. 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., favor-

ANALYTICAL PERSPECTIVES

able tax treatment of social security income); reducing
private compliance costs and government administrative costs (e.g., favorable treatment of certain employerprovided fringe benefits); 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,
favorable treatment of employer-provided pensions
might be argued to have aspects of most, or even all,
of the goals mentioned above. 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 tax revenue loss. 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). Distributional effects on
incomes 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 of the provisions for some time. In addition, such assessments can
raise significant challenges in economic modeling,
which has inherent uncertainties. For these reasons,
and related time, staffing, and resource constraints, the
evaluation process is likely to take a number of years
and to include qualitative assessments and estimated
ranges of effects, in many cases, as opposed to point
estimates.

5. TAX EXPENDITURES

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 promoting U.S. exports. These include the
exclusion for income earned abroad by nongovernmental
employees and preferences for income from exports and
U.S.-controlled foreign corporations. Measuring the effectiveness of these provisions raises challenging issues.
In addition to determining their effectiveness in markets of the benefitting firms, analysis should consider
the extent to which macroeconomic factors lead to offsetting effects, such as increased imports, which could
moderate any net effects on employment, national output, and trade deficits. Similar issues arise in the case
of export promotion programs supported by outlays.
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—such as research spending, exploration activity, or equipment—could 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 degree of tax subsidy provided. Measures could also indicate the provisions’ effects on production from these investments—such as
numbers or values of patents, energy production and
reserves, and industrial production. Issues to be considered include the extent to which the preferences increase production (as opposed to benefitting existing
output) and their cost-effectiveness relative to other
policies. Analysis could also consider objectives that are

107
more difficult to measure but still are ultimate goals,
such as promoting the Nation’s technological base, energy security, environmental quality, or economic
growth. Such an assessment is likely to involve tax
analysis as well as consideration of non-tax matters
such as market structure, scientific, and other information (such as the effects of increased domestic fuel production on imports from various regions, or the effects
of various energy sources on the environment).
Housing investment also benefits from tax expenditures, including the mortgage interest deduction and
preferential treatment of capital gains on homes. Measures of the effectiveness of these provisions could include their effects on increasing the extent of home
ownership and the quality of housing. In addition, the
mortgage interest deduction offsets the taxable nature
of investment income received by homeowners, so the
relationship between the deduction and such earnings
is also relevant to evaluation of this provision. Similarly, analysis of the extent of accumulated inflationary
gains is likely to be relevant to evaluation of the capital
gains preference 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 revenue loss 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 employerprovided 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 grant 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

108
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 the distribution of this coverage across different
income groups. 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. The distribution of employer-provided health
insurance is not readily evident from tax return information; thus, the distribution of benefits from this exclusion must be imputed using tax as well as other
forms of information.
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). In considering
the provisions’ distributional effects, it may be useful
to consider beneficiaries’ incomes while retired and over
their entire lifetimes. 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 benefits of the firm-level contributions
back to individuals.
Other provisions principally have income distribution,
rather than incentive, effects. 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 distribution of these benefits may be a useful performance
measure. The earned-income tax credit, in contrast,
should be evaluated both for its effects on labor force
participation and its distributional properties.
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

ANALYTICAL PERSPECTIVES

U.S. possessions are also included here. These provisions can be compared with other tax and spending
policies as means of benefitting fiscal and economic conditions in the States, localities, and possessions. Finally, the tax deferral for interest on U.S. savings
bonds benefits savers who invest in these instruments;
the extent of these benefits and any effects on Federal
borrowing costs could be evaluated.
The above illustrative discussion, while broad, is nevertheless incomplete, 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.
Particularly over the next few years, a significant portion of this effort is likely to be devoted to data issues.
Because the compilation of data is resource intensive,
and must be balanced with other objectives (including
minimizing information collection burdens), careful
planning will be essential. Given the challenges inherent in this work, the nature of the analyses is likely
to evolve and improve over the next several years.
Other Considerations
The tax expenditure analysis could be extended beyond the income and transfer taxes to include payroll
and excise taxes. The exclusion of certain forms of compensation from the wage base, for instance, reduces
payroll taxes, as well as income taxes. Payroll tax exclusions are complex to analyze, however, because they
also affect social insurance benefits. Certain targeted
excise tax provisions might also be considered tax expenditures. In this case challenges include determining
an appropriate baseline.
Descriptions of Income Tax Provisions
Descriptions of the individual and corporate income
tax expenditures reported upon in this chapter follow.
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.—A U.S. citizen or resident alien who resides or stays overseas for at least
11 of the past 12 months may exclude $70,000 per
year of foreign-earned income. Beginning in 1998, the
exclusion limit is increased to $80,000 in $2,000 annual
increments. Eligible taxpayers also may exclude or deduct reasonable housing costs in excess of one-sixth
of the salary of a civil servant at grade GS–14, step
1 ($60,270 in 1997). Federal employees working abroad
are not eligible for the foreign-earned income exclusion.

109

5. TAX EXPENDITURES

Federal employees, however, may exclude certain allowances from their taxable income.
The exclusion for certain income earned abroad was
one of the tax expenditures examined by the Department of the Treasury in its pilot performance evaluations this year. This tax expenditure consists of two
specific components: section 911 of the tax code, which
covers private-sector employees, and section 912, which
covers civilian government employees.8
The benefits for private-sector employees account for
about 85 percent of the combined revenue loss from
the two tax expenditures. The private-sector provision
is intended to promote U.S. exports, help make U.S.
companies competitive when doing business abroad,
and to offset the costs of living abroad, which can be
higher than costs in the United States. Because American workers in higher-tax nations can offset their U.S.
taxes through use of the foreign tax credit, in practice
the provision primarily benefits U.S. citizens who work
in nations with income taxes that are lower than U.S.
taxes. Using tax-return data from 1987, Treasury finds
that 70 percent of the benefit of the provision goes
to taxpayers with income (defined here as adjusted
gross income plus the exclusion) above $50,000; over
98 percent of the housing exclusion, went to this group
of taxpayers.
The provision benefiting civilian government employees is intended to help them maintain their standard
of living when stationed abroad by compensating them
for the higher costs of living abroad. To the extent
that this compensation is carried out via the tax code,
as opposed to agency appropriations, costs are shifted
from outlays to revenue losses.
3. Income of Foreign Sales Corporations.—The
Foreign Sales Corporation (FSC) provisions exempt
from tax a portion of U.S. exporters’ foreign trading
income to reflect the FSC’s sales functions as foreign
corporations. These provisions conform to the General
Agreement on Tariffs and Trade.
4. 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.
5. 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 subject to U.S. taxation, whether or not distributed. Thus,
8
Section 911 was also the subject of a January 1993 Treasury report to Congress, ‘‘Taxation of Americans Working Overseas.’’

the normal tax method considers the amount of controlled foreign corporation income not distributed to a
U.S. shareholder as tax-deferred income.
General Science, Space, and Technology
6. 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.
7. R&E credit.—The research and experimentation
(R&E) credit, which expired on May 31, 1997, was reinstated under the Taxpayer Relief Act of 1997 for 13
months (through June 30, 1998). The tax 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’’ (limited
to a maximum of .16) by the average amount of the
company’s gross receipts for the 1984 to 1988 period.
Certain start-up companies are assigned a fixed-base
percentage of .03 for the first five taxable years, which
is gradually phased out in years 6 through 10 and
replaced by the firm’s actual fixed-base percentage.
Taxpayers may also elect an alternative credit regime.
Under the alternative credit regime, the credit rate is
reduced and the taxpayer is assigned a three-tiered
fixed-base percentage that is lower than the fixed-base
percentage that would otherwise apply. A credit with
a separate threshold is provided for a taxpayer’s payments to universities for basic research.
Energy
8. 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.
9. 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

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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.
10. Alternative fuel production credit.—A nontaxable credit of $3 per barrel (in 1979 dollars) of oilequivalent production is provided for several forms of
alternative fuels. The credit is generally available if
the price of oil stays below $29.50 (in 1979 dollars).
The credit generally expires on December 31, 2002.
Treasury reviewed the nonconventional fuel production tax credit as one of its pilot studies of tax expenditures under the Government Performance and Results
Act. The provision provides a significant credit—currently about $6 per barrel of oil equivalent or $1 per
thousand cubic feet of natural gas, or roughly half of
the wellhead price of gas. Coalbed methane (natural
gas) and gas from tight formations currently account
for most of the credit. While the credit has been effective in stimulating the coalbed methane industry, increased domestic production of natural gas tends to
discourage imports from stable suppliers (in particular,
Canada), so there is relatively little benefit to U.S. energy security. In addition, there are indications that
credit-qualified gas displaced some non-qualified domestic gas.
11. 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.
12. Capital gains treatment of royalties on
coal.—Sales of certain coal under royalty contracts can
be treated as capital gains rather than ordinary income.
13. Energy facility bonds.—Interest earned on state
and local bonds used to finance construction of certain
energy facilities is tax-exempt. These bonds are generally subject to the state private-activity bond annual
volume cap.
14. Enhanced oil recovery credit.—A credit is provided equal to 15 percent of the taxpayer’s costs for
tertiary oil recovery on U.S. projects. Qualifying costs
include tertiary injectant expenses, intangible drilling
and development costs on a qualified enhanced oil recovery project, and amounts incurred for tangible depreciable property.
15. New technology credits.—A credit of 10 percent
is available for investment in solar and geothermal energy facilities. In addition, a credit of 1.5 cents is provided per kilowatt hour of electricity produced from
renewable resources such as wind and biomass. The
renewable resources credit applies only to electricity

ANALYTICAL PERSPECTIVES

produced by a facility placed in service before July 1,
1999.
16. Alcohol fuel credits.—Gasohol, a motor fuel
composed of at least 10 percent alcohol, is exempt from
5.4 of the 18.4 cents per gallon Federal excise tax on
gasoline. Smaller exemptions are allowed for motor fuel
with lower alcohol content. There is a corresponding
income tax credit for alcohol used as a fuel in applications where the excise tax is not assessed. This credit,
equal to a subsidy of 54 cents per gallon for alcohol
used as a motor fuel, is intended to encourage substitution of alcohol for petroleum-based gasoline. In addition, small producers of ethanol are eligible for a 10
cent per gallon credit.
17. Credit and deduction for clean-fuel vehicles
and property.—A tax credit of 10 percent (not to exceed $4,000) is provided for purchasers of electric vehicles. Purchasers of other clean-fuel burning vehicles
and owners of clean-fuel refueling property may deduct
part of their expenditures. The credit and deduction
are phased out from 2002 through 2005.
18. Exclusion of utility conservation subsidies.—
Subsidies by public utilities for customer expenditures
on energy conservation measures are excluded from the
gross income of the customer. The exclusion does not
apply to subsidies provided to businesses after December 31, 1996.
Natural Resources and Environment
19. 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.
20. Percentage depletion.—Most nonfuel mineral
extractors may use percentage depletion rather than
cost depletion, with percentage depletion rates ranging
from 22 percent for sulphur to 5 percent for sand and
gravel.
21. Capital gains treatment of iron ore.—Iron ore
sold under a royalty contract can be treated as capital
gains rather than ordinary income.
22. Mining reclamation reserves.—Taxpayers are
allowed to establish reserves to cover certain costs of
mine reclamation and of closing solid waste disposal
properties. Net increases in reserves may be taken as
a deduction against taxable income.
23. Sewage, water, and hazardous waste
bonds.—Interest earned on state and local bonds used
to finance the construction of sewage, water, or hazardous waste facilities is tax-exempt. These bonds are generally subject to the state private-activity bond annual
volume cap.
24. Capital gains treatment of certain timber.—
Certain timber sold under a royalty contract can be
treated as capital gains rather than ordinary income.
25. Expensing multiperiod timber growing
costs.—Most of the production costs of growing timber
may be expensed rather than capitalized and deducted
when the timber is sold. In most other industries, these

111

5. TAX EXPENDITURES

costs are capitalized under the uniform capitalization
rules.
26. Credit and seven-year amortization for reforestation.—A 10-percent investment tax credit is allowed for up to $10,000 invested annually to clear land
and plant trees for the production of timber. Up to
$10,000 in forestation investment may also be amortized over a seven-year period rather than capitalized
and deducted when the trees are sold or harvested.
The amount of forestation investment that is amortizable is not reduced by any of the allowable investment
credit.
27. Historic preservation.—Expenditures to preserve and restore historic structures qualify for a 20percent investment credit, but the depreciable basis
must be reduced by the full amount of the credit taken.
Agriculture
28. 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.
29. Expensing multiperiod livestock and crop
production costs.—The production of livestock and
crops with a production period of less than two years
is exempt from the uniform cost capitalization rules.
Farmers establishing orchards, constructing farm facilities for their own use, or producing any goods for sale
with a production period of two years or more may
elect not to capitalize costs. If they do, they must apply
straight-line depreciation to all depreciable property
they use in farming.
30. Loans forgiven solvent farmers.—Farmers are
forgiven the tax liability on certain forgiven debt. Normally, the debtor must include the amount of loan forgiveness as income or reduce his recoverable basis in
the property to which the loan relates. If the debtor
elects to reduce basis and the amount of forgiveness
exceeds his basis in the property, the excess forgiveness
is taxable. For insolvent (bankrupt) debtors, however,
the amount of loan forgiveness never results in an income tax liability.9 Farmers with forgiven debt are considered insolvent for tax purposes, and thus qualify
for income tax forgiveness.
31. Capital gains treatment of certain income.—
Certain agricultural income, such as unharvested crops,
can be treated as capital gains rather than ordinary
income.
32. Income averaging for farmers.—The Taxpayer
Relief Act of 1997 allows taxpayers to lower their tax
liability by averaging, over the prior three-year period,
their taxable income from farming. Taxpayers may av9
The insolvent taxpayer’s carryover losses and unused credits are extinguished first,
and then his basis in assets reduced to no less than amounts still owed creditors. Finally,
the remainder of the forgiven debt is excluded from tax.

erage their farm income beginning in 1998; the provision generally expires on December 31, 2000.
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.
33. Credit union income.—The earnings of credit
unions not distributed to members as interest or dividends are exempt from income tax.
34. 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.
35. Deferral of income on life insurance and annuity contracts.—Favorable tax treatment is provided
for investment income within qualified life insurance
and annuity contracts. Investment income earned on
qualified life insurance contracts held until death is
permanently exempt from income tax. Investment income distributed prior to the death of the insured is
tax-deferred, if not tax-exempt. Investment income
earned on annuities is treated less favorably than income earned on life insurance contracts, but it benefits
from tax deferral without annual contribution or income
limits generally applicable to other tax-favored retirement income plans.
36. Small property and casualty insurance companies.— Insurance companies that have annual net
premium incomes of less than $350,000 are exempt
from tax; those with $350,000 to $2,100,000 of net premium incomes may elect to pay tax only on the income
earned by their investment portfolio.
37. 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.
38. 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.
39. 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 such private activity is
limited. The combined volume cap for mortgage housing
bonds, rental housing bonds, student loan bonds, and
industrial development bonds is $50 per capita ($150
million minimum) per state. States may issue mortgage
credit certificates (MCCs) in lieu of mortgage revenue

112
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.
40. 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.
41. 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 taxpayers are not required to report the value of
owner-occupied housing services as gross income.
42. 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.
43. Installment sales.—Dealers in real and personal
property (i.e., sellers that 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
$5,000,000 is, therefore, a tax expenditure.
44. Capital gains deferral on home sales.—Homeowners can defer paying capital gains tax on the sale
of a principal residence by buying or constructing a
home at least equal in value to that of the sold home
(net of sales and qualified fix-up costs) within two
years. This deferral applies to homes sold before May
7, 1997. For homes sold between May 7, 1997 and July
28, 1997, taxpayers may defer paying the capital gains
tax if they elect not to use the $500,000 ($250,000 for

ANALYTICAL PERSPECTIVES

singles) exclusion on the sale of a principal residence.
The $500,000 exclusion was created by the Taxpayer
Relief Act of 1997. For homes sold after July 28, 1997,
no capital gains deferral is allowed.
45. Capital gains on sales by owners aged 55
or older.—A taxpayer who is 55 years of age or older
may elect to exclude from gross income up to $125,000
of the capital gain from the sale of a principal residence. The exclusion is a once-in-a-lifetime election.
This exclusion applies to homes sold before May 7,
1997. For homes sold between May 7, 1997 and July
28, 1997, taxpayers may exclude the $125,000 from
gross income if they elect not to use the $500,000
($250,000 for singles) exclusion on the sale of a principal residence. The $500,000 exclusion was created by
the Taxpayer Relief Act of 1997. For homes sold after
July 28, 1997, the $125,000 exclusion is not allowed.
46. Capital gains exclusion on home sales.—A
homeowner can exclude from tax up to $500,000
($250,000 for singles) of the capital gains from the sale
of a principal residence. The exclusion was created by
the Taxpayer Relief Act of 1997 and applies only to
homes sold after May 6, 1997. The exclusion may not
be used more than once every two years.
47. 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.
48. 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. States
agencies determine who receives the credit; states are
limited in the amount of credit they may authorize
annually to $1.25 per resident.
49. Accelerated depreciation of rental property.—
The tax depreciation allowance provisions are part of
the reference law rules, and thus do not cause tax
expenditures under the reference method. Under the
normal tax method, however, a 40-year tax life for depreciable real property is the norm. Thus, statutory
depreciation period for rental property of 27.5 years
is a tax expenditure. In addition, tax expenditures arise
from pre-1987 tax allowances for rental property.
50. 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.
51. 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

5. TAX EXPENDITURES

principal and interest stipulated in the instrument.10
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.
52. 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. The lower rate on capital gains is
considered a tax expenditure under the normal tax
method but not under the reference law method.
For assets held for more than 1 year and sold before
May 7, 1997, the top tax rate is 28 percent. For assets
held for more than 1 year and sold between May 7,
1997 and July 28, 1997, the top rate is 20 percent
(10 percent for taxpayers who would otherwise pay capital gains tax at the 15-percent rate). For assets held
for more than 1.5 years and sold after July 28, 1997,
the top rate is 20 percent (10 percent for taxpayers
who would otherwise pay capital gains tax at the 15percent rate). For assets held for more than 1 year
but not more than 1.5 years and sold after July 28,
1997, the top rate is 28 percent.
In addition, for assets acquired after December 31,
2000, the maximum capital gains tax rates for assets
held more than 5 years are 8 percent and 18 percent
(rather than 10 percent and 20 percent). On January
1, 2001, taxpayers may mark-to-market existing assets
to start the 5-year holding period.
53. 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.
54. 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. The step-up
in the heir’s cost basis means that, in effect, the tax
on the capital gain is forgiven.
55. Carryover basis of capital gains on gifts.—
When a gift is made, the transferred property carries
to the donee the donor’s basis—the cost that was incurred when the property was first acquired. The carryover of the donor’s basis allows a continued deferral
of unrealized capital gains.
10
For example, if a borrower on December 31, 1997 issues a promise to pay $1,000
plus interest at 10 percent on December 30, 1998, for a total repayment of $1,100 and
accepts $900 from a lender in exchange for the contract, the rules require that both parties
(a) recognize that $900 is the amount lent, so that the effective loan interest rate is
not the stated 10 percent but is 22.2 percent, and (b) report $200 as interest paid or
received in 1998.

113
56. Ordinary income treatment of losses from
sale of small business corporate stock shares.—
Up to $100,000 in losses from the sale of small business
corporate stock (capitalization less than $1 million) may
be treated as ordinary losses. Such losses would, thus,
not be subject to the $3,000 annual capital loss writeoff limit.
57. Accelerated depreciation of non-rental-housing buildings.—The tax depreciation allowance provisions are part of the reference law rules, and thus
do not cause tax expenditures under reference law.
Under normal law, however, a 40-year life for nonrental-housing buildings is the norm. Thus, the 39-year
depreciation period for property placed in service after
February 25, 1993, the 31.5-year depreciation period
for property placed in service from 1987 to February
25, 1993, and the pre-1987 depreciation periods create
a tax expenditure.
58. Accelerated depreciation of machinery and
equipment.—The tax depreciation allowance provisions
are part of the reference law rules, and thus do not
cause tax expenditures under reference law. Statutory
depreciation of machinery and equipment, however, is
accelerated somewhat relative to the normal tax baseline, creating a tax expenditure.
59. Expensing of certain small investments.—In
1997, qualifying investments in tangible property up
to $18,000 can be expensed rather than depreciated
over time. (The expensing limit increases annually until
2003, when it reaches $25,000). To the extent that
qualifying investment during the year exceeds
$200,000, the amount eligible for expensing is decreased. In 1997, the amount expensed is completely
phased out when qualifying investments exceed
$218,000.
60. Business start-up costs.—When taxpayers enter
into a new business, certain start-up expenses, such
as the cost of legal services, are normally incurred.
Taxpayers may elect to amortize these outlays over 60
months even though they are similar to other payments
made for nondepreciable intangible assets that are not
recoverable until the business is sold. The normal tax
method treats this amortization as a tax expenditure;
the reference tax method does not.
61. 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 $10 million. 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

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ANALYTICAL PERSPECTIVES

with taxable incomes exceeding $15 million by a 3percent additional tax on income over $15 million but
less than $18.33 million. Because the corporate rate
schedule is part of reference tax law, it is not considered a tax expenditure under the reference method.
A flat corporation income tax rate is taken as the baseline under the normal tax method; therefore the lower
rates is considered a tax expenditure under this concept.
62. 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.
Transportation
63. 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.
64. Exclusion of reimbursed employee parking
expenses.—Parking at or near an employer’s business
premises that is paid for by the employer is excludable
from the income of the employee. In 1997, the maximum amount of the parking exclusion is $170 (indexed)
per month. The tax expenditure estimate does not include parking at facilities owned by the employer.
65. Exclusion of employer-provided transit
passes.—Transit passes, tokens, and fare cards provided by an employer to defray an employee’s commuting costs are excludable from the employee’s income
if the total value of the benefit does not exceed the
transit limit. In 1997, the limit is $70 (indexed) per
month.
Community and Regional Development
66. 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.
67. 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.
68. 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.
69. Empowerment zones and enterprise 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, and
accelerated depreciation. A tax credit for contributions
to certain community development corporations can also
be available. In addition, certain first-time buyers of
a principal residence in the District of Columbia can
receive a tax credit, and investors in certain D.C. property can receive a capital gains break.
70. Expensing of environmental remediation
costs.—The Taxpayer Relief Act of 1997 allows taxpayers who clean up hazardous substances at a qualified site to expense the clean-up costs, rather than capitalize the costs, even though the expenses will generally increase the value of the property significantly
or appreciably prolong the life of the property. The
expensing only applies to clean-up costs incurred after
August 5, 1997 and before January 1, 2001.
Education, Training, Employment, and Social
Services
71. 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).
72. HOPE tax credit.—The Taxpayer Relief Act of
1997 created the non-refundable HOPE tax credit,
which allows a credit for 100 percent of an eligible
student’s first $1,000 of tuition and fees and 50 percent
of the next $1,000 of tuition and fees. The credit only
covers tuition and fees paid during the first two years
of a student’s post-secondary education. The credit is
phased out ratably for taxpayers with modified AGI
between $80,000 and $100,000 ($40,000 and $50,000
for singles).
73. Lifetime Learning tax credit.—The Taxpayer
Relief Act of 1997 created the non-refundable Lifetime
Learning tax credit, which allows a credit for 20 percent
of an eligible student’s tuition and fees. For tuition
and fees paid between July 1, 1998 and December 31,
2002, the maximum credit per return is $1,000. For
tuition and fees paid after December 31, 2002, the maximum credit per return is $2,000. The credit is phased

5. TAX EXPENDITURES

out ratably for taxpayers with modified AGI between
$80,000 and $100,000 ($40,000 and $50,000 for singles).
The credit applies to both undergraduate and graduate
students.
74. Education Individual Retirement Accounts.—
The Taxpayer Relief Act of 1997 created education
IRAs. Contributions to an education IRA are not taxdeductible. Investment income earned by education
IRAs is not taxed when earned, and investment income
from an education IRA is tax-exempt when withdrawn
to pay for a student’s tuition and fees. The maximum
contribution to an education IRA is $500 per year per
beneficiary. Contributions can be made after December
31, 1997. The maximum contribution is phased down
ratably for taxpayers with modified AGI between
$150,000 and $160,000 ($95,000 and $110,000 for singles). Contributions may not be made to an education
IRA in any year in which a contribution has been made
to a state tuition plan for the same beneficiary.
75. Student-loan interest.—Taxpayers may claim
an above-the-line deduction of up to $2,500 ($1,000 in
1998, $1,500 in 1999, and $2,000 in 2000) on interest
paid on an education loan. Interest may only be deducted for the first five years in which interest payments are required. The maximum deduction is phased
down ratably for taxpayers with modified AGI between
$60,000 and $75,000 ($40,000 and $55,000 for singles).
Only interest paid and due after December 31, 1997
may be deducted.
76. State prepaid tuition plans.—Some states have
adopted prepaid tuition plans, which allow persons to
pay in advance for college tuition for designated beneficiaries. Taxes on the earnings from these plans are
paid by the beneficiaries and are deferred until the
tuition is actually paid. The Taxpayer Relief Act of
1997 expanded state prepaid tuition plans to include
pre-payment for room and board expenses.
77. Student-loan bonds.—Interest earned on state
and local bonds issued to finance student loans is taxexempt. The volume of all such private activity bonds
that each state may issue annually is limited.
78. 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. The aggregate volume of all such private
activity bonds that each state may issue during any
calendar year is limited.
79. Credit for holders of zone academy bonds.—
Financial institutions that own zone academy bonds
receive a non-refundable tax credit rather than interest.
The credit is included in gross income. Proceeds from
zone academy bonds may only be use to improve impoverished schools. The total amount of zone academy
bonds that may be issued is limited to $800 million;
no bonds may be issued before January 1, 1998.
80. 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 ex-

115
penses. The tax exemption is phased out for taxpayers
with AGI between $76,250 and $106,250 ($50,850 and
$65,850 for singles) in 1997.
81. Dependent students age 19 or older.—Taxpayers may claim personal exemptions for dependent
children age 19 or over who (1) receive parental support
payments of $1,000 or more per year, (2) are full-time
students, and (3) do not claim a personal exemption
on their own tax returns.
82. Child credit.—The Taxpayer Relief Act of 1997
provides for a $500 child credit for taxpayers with children under age 17, beginning January 1, 1999. (The
Act also provides for a $400 credit in 1998.) 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). The child credit is refundable for taxpayers
with three or more children.
83. Charitable contributions to educational institutions.—Taxpayers may deduct contributions to
nonprofit educational institutions. Taxpayers who donate capital assets to educational institutions 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.
84. 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. This exclusion applies only to non-graduate courses beginning before July 1, 2000.
85. Work opportunity tax credit.—Employers can
claim a tax credit for qualified wages paid to individuals who begin work after September 30, 1996 and
before July 1, 1998 and who are certified as members
of various targeted groups. For employees hired before
October 1, 1997, the amount of the credit that can
be claimed is 35 percent of the first $6,000 paid during
the first year of employment. For employees hired after
September 30, 1997, the credit is 25 percent for employment of less than 400 hours and 40 percent for employment of 400 hours or more. Employers must reduce
their deduction for wages paid by the amount of the
credit claimed.
86. Welfare-to-work tax credit.—The Taxpayer Relief Act of 1997 provides for an employer tax credit
on the first $20,000 of eligible wages paid to qualified
long-term family assistance recipients during the first
two years of employment. The credit is 35 percent of
the first $10,000 of wages in the first year of employment and 50 percent of the first $10,000 of wages in
the second year of employment. The maximum credit
is $8,500 per employee. The credit applies to wages
paid to employees who are hired after December 31,
1997 and before May 1, 1999.
87. Employer-provided child care.—Employer-provided child care is excluded from an employee’s gross

116
income even though the employer’s costs for the child
care are a deductible business expense.
88. Adoption assistance.—Beginning January 1,
1997, taxpayers can receive a nonrefundable tax credit
for qualified adoption expenses. The maximum credit
is $5,000 per child ($6,000 for special needs adoptions,
except foreign adoptions). The credit is phased-out ratably for taxpayers with modified AGI between $75,000
and $115,000. Unused credits may be carried forward.
In lieu of the tax credit, taxpayers may exclude qualified adoption expenses from income, subject to the same
maximum amounts and phase-out as the credit. The
non-special needs adoption assistance and foreign special needs assistance expire on December 31, 2001.
89. 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.
90. 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 divorced or separated
parents who have custody of children, and by single
parents. Expenditures up to a maximum $2,400 for one
dependent and $4,800 for two or more dependents are
eligible for the credit. The credit is equal to 30 percent
of qualified expenditures for taxpayers with incomes
of $10,000 or less. The credit is reduced to a minimum
of 20 percent by one percentage point for each $2,000
of income between $10,000 and $28,000.
91. 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.
92. Expensing costs of removing architectural
barriers.—Taxpayers can expense (up to $15,000 annually) the cost of removing architectural barriers to the
handicapped rather than depreciate the cost over the
useful life of the asset.
93. 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.
94. 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.

ANALYTICAL PERSPECTIVES

95. Parsonage allowances.—The value of a minister’s housing allowance and the rental value of parsonages are not included in a minister’s taxable income.
Health
96. Employer-paid medical insurance and expenses.—Employer-paid health insurance premiums
and other medical expenses (including long-term care)
is deducted as a business expense by employers, but
it is not included in employee gross income. The selfemployed also may deduct part of their family health
insurance premiums.
97. Medical savings accounts.—Beginning January
1, 1997, some employees may deduct annual contributions to a medical savings account (MSA); employer
contributions to MSAs (except those made through cafeteria plans) for qualified employees are also excluded
from income. An employee may contribute to an MSA
in a given year only if the employer does not contribute
to the MSA in that year. MSAs are only available to
self-employed individuals or employees covered under
an employer-sponsored high deductible health plan of
a small employer. The maximum annual MSA contribution is 75 percent of the deductible under the high
deductible plan for family coverage (65 percent for individual coverage). Earnings from MSAs are excluded
from taxable income. Distributions from an MSA for
medical expenses are not taxable. The number of taxpayers who may benefit annually from MSAs is generally limited to 750,000. No new MSAs may be established after December 31, 2000.
98. 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.
99. Hospital construction bonds.—Interest earned
on state and local government debt issued to finance
hospital construction is excluded from income subject
to tax.
100. 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.
101. 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.
102. 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.

5. TAX EXPENDITURES

Income Security
103. 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.
104. Workmen’s compensation benefits.—Workmen’s compensation provides payments to disabled
workers. These benefits, although income to the recipients, are not subject to the income tax.
Treasury reviewed the Federal income tax exemption
for workers’ compensation wage replacement benefits
as one of its pilot analyses of tax expenditures. Workers’ compensation programs, with the principal exception of the program covering Federal employees, are
State programs that do not have to conform to any
national criteria. While the legislative history does not
explain the goal of the tax exemption, the exemption
has the effect of reducing taxes on families with unexpected losses of earnings from work-related injuries or
death. Because the tax exemption may have been considered in setting the levels of benefits mandated by
State laws, the net benefit of the tax exemption to
recipients is uncertain.
105. 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.
106. 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.
107. Military disability pensions.—Most of the
military pension income received by current disabled
retired veterans is excluded from their income subject
to tax.
108. 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.
109. 401(k) plans and Individual Retirement Accounts.—Individual taxpayers can take advantage of
several different tax-preferenced retirement plans: deductible IRAs, non-deductible IRAs, Roth IRAs, and
401(k) plans (and 401(k)-type plans like 403(b) plans
and the government’s Thrift Savings Plan).
In 1997, an employee could exclude up to $9,500 (indexed) of wages from AGI under a qualified arrangement with an employer’s 401(k). Employees can annually contribute to a deductible IRA up to $2,000 (or
100 percent of compensation, if less) or $4,000 on a
joint return with only one working spouse if: (a) neither
the individual nor spouse is an active participant in
an employer-provided retirement plan, or (b) their AGI
is below $40,000 ($25,000 for singles). The IRA deduction is phased out for AGI between $40,000 and $50,000

117
($25,000 and $35,000 for singles). The Taxpayer Relief
Act of 1997 raises the phaseout range in 1998 to
$50,000 and $60,000 ($30,000 and $40,000 for singles).
Taxpayers whose AGI is above the start of the IRA
phase-out range or who are active participants in an
employer-provided retirement plan can contribute to a
non-deductible IRA. The tax on the investment income
earned by 401(k) plans, non-deductible IRAs, and deductible IRAs is deferred until the money is withdrawn.
The Taxpayer Relief Act of 1997 created Roth IRAs,
effective January 1, 1998. An employed taxpayer can
make a non-deductible contribution of up to $2,000 (a
non-employed spouse can also contribute up to $2,000
if a joint return is filed) to a Roth IRA. Investment
income of a Roth IRA is not taxed when earned. Withdrawals from a Roth IRA are tax free if (1) the Roth
IRA was opened at least 5 years before the withdrawal,
and (2) the taxpayer either (a) is at least 59-1/2, (b)
dies, (c) is disabled, or (d) purchases a first-time house.
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). Total annual contributions to a taxpayer’s deductible, non-deductible, and Roth IRAs cannot exceed $2,000 ($4,000
for joints).
110. 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 $30,000 per year. In addition, the
tax on the investment income earned by Keogh plans
is deferred until the money is withdrawn.
111. Employer-provided death benefits.—Employer-provided death benefits are excluded from an
employee’s gross income even though the employer’s
costs for the death benefits are a deductible business
expense.
112. 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.
113. 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.
114. Employer-provided supplementary unemployment
benefits.—Employer-provided
supplementary unemployment benefits are excluded from an
employee’s gross income even though the employer’s
costs for the benefits are a deductible business expense.
115. 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 cor-

118
porations 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.
116. Additional deduction for the blind.—Taxpayers who are blind may take an additional $1,000
standard deduction if single, or $800 if married.
117. Additional deduction for the elderly.—Taxpayers who are 65 years or older may take an additional $1,000 standard deduction if single, or $800 if
married.
118. 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.
119. 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.
120. 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 $6,500 of earned income in 1997. The credit
is 40 percent of the first $9,140 of income for a family
with two or more qualifying children. When the taxpayer’s income exceeds $11,930, the credit is phased
out at the rate of 15.98 percent (21.06 percent if two
or more qualifying children are present). It is completely phased out at $25,760 of modified adjusted gross
income ($29,290 if two or more qualifying children are
present).
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 1997,
the credit is 7.65 percent of the first $4,340 of earned
income. When the taxpayer’s income exceeds $5,430,
the credit is phased out at the rate of 7.65 percent.
It is completely phased out at $9,770 of modified adjusted gross income.

ANALYTICAL PERSPECTIVES

For workers with or without children, the income
level at which the credit’s phase-outs begin and the
maximum amounts of income on which the credit can
be taken are adjusted for inflation. Earned income tax
credits in excess of tax liabilities owed through the
individual income tax system are refundable to individuals. This portion of the credit is shown as an outlay,
while the amount that offsets tax liabilities is shown
as a tax expenditure.
Social Security
121. Social Security benefits for retired workers.—Social security benefits that exceed the beneficiary’s contributions out of taxed income are deferred
employee compensation and the deferral of tax on that
compensation 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.
122. Social Security benefits for the disabled.—
Benefit payments from the Social Security Trust Fund,
for disability and for dependents and survivors, are excluded from the beneficiaries’ gross incomes.
123. Social Security benefits for dependents and
survivors.—Benefit payments from the Social Security
Trust Fund for dependents and survivors are excluded
from the beneficiaries’ gross income.
Veterans Benefits and Services
124. Veterans death benefits and disability compensation.—All compensation due to death or disability paid by the Veterans Administration is excluded
from taxable income.
125. Veterans pension payments.—Pension payments made by the Veterans Administration are excluded from gross income.
126. G.I. Bill benefits.—G.I. Bill benefits paid by
the Veterans Administration are excluded from gross
income.
127. Tax-exempt mortgage bonds for veterans.—
Interest earned on general obligation bonds issued by
State and local governments to finance housing for veterans is excluded from taxable income. The issuance
of such bonds is limited, however, to five pre-existing
State programs and to amounts based upon previous
volume levels for the period January 1, 1979 to June
22, 1984. Furthermore, future issues are limited to veterans who served on active duty before 1977.

119

5. TAX EXPENDITURES

General Government
128. 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) is tax-exempt.
129. 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.

130. Business income earned in U.S. possessions.—U.S. corporations receiving income from investments or businesses located in a U.S. possession (e.g.,
Puerto Rico) can claim a credit against U.S. tax, which
effectively excludes some of this income from tax. The
credit expires December 31, 2005.
Interest
131. U.S. savings bonds.—Taxpayers may defer paying tax on interest earned on U.S. savings bonds until
the bonds are redeemed.

TAX EXPENDITURES IN THE UNIFIED TRANSFER TAX
Exceptions to the general terms of the Federal unified
transfer tax favor particular transferees or dispositions
of transferors, similar to Federal direct expenditure or
loan programs. The transfer tax provisions identified
as tax expenditures satisfy the reference law criteria
for inclusion in the tax expenditure budget that were
described above. There is no generally accepted normal
tax baseline for transfer taxes.
Unified Transfer Tax Reference Rules
The reference tax rules for the unified transfer tax
from which departures represent tax expenditures include:
• Definition of the taxpaying unit. The payment of
the tax is the liability of the transferor whether
the transfer of cash or property was made by gift
or bequest.
• Definition of the tax base. The base for the tax
is the transferor’s cumulative, taxable lifetime
gifts made plus the net estate at death. Gifts in
the tax base are all annual transfers in excess
of $10,000 to any donee except the donor’s spouse.
Excluded are, however, payments on behalf of
family members’ educational and medical expenses, as well as the cost of ceremonial gatherings and celebrations that are not in honor of
the donor.
• Property valuation. In general, property is valued
at its fair market value at the time it is transferred. This is not necessarily the case in the valuation of property for transfer tax purposes. Executors of estates are provided the option to value
assets at the time of the testator’s death or up
to six months later.
• Tax rate schedule. A single graduated tax rate
schedule applies to all taxable transfers. This is
reflected in the name of the ‘‘unified transfer tax’’
that has replaced the former separate gift and
estate taxes. The tax rates vary from 18 percent
on the first $10,000 of aggregate taxable transfers,
to 55 percent on amounts exceeding $3 million.
A lifetime credit is provided against the tax in
determining the final amount of transfer taxes
that are due and payable. For decedents dying
in 1998, this credit allows each taxpayer to make
a $625,000 tax-free transfer of assets that other-

wise would be liable to the unified transfer tax.
This figure is scheduled to increase in steps to
$1 million in 2005.11
• Time when tax is due and payable. Donors are
required to pay the tax annually as gifts are
made. The generation-skipping transfer tax is payable by the donees whenever they accede to the
gift. The net estate tax liability is due and payable
within nine months after the decedent’s death.
The Internal Revenue Service may grant an extension of up to 10 years for a reasonable cause.
Interest is charged on the unpaid tax liability at
a rate equal to the cost of Federal short-term borrowing, plus three percentage points.
Tax Expenditures by Function
The estimates of tax expenditures in the Federal unified transfer tax for fiscal years 1997-2003 are displayed by functional category in table 5–6. Outlay
equivalent estimates are similar to revenue loss estimates for transfer tax expenditures and, therefore, are
not shown separately. A description of the provisions
follows.
Natural Resources and Environment
1. Donations of conservation easements.—Bequests of property and easements (in perpetuity) for
conservation purposes can be excluded from taxable estates. Use of the property and easements must be restricted to at least one of the following purposes: outdoor recreation or scenic enjoyment for the general public; protection of the natural habitats of fish, wildlife,
plants, etc.; and preservation of historic land areas and
structures. Conservation gifts are similarly excluded
from the gift tax. The Taxpayer Relief Act of 1997
(TRA97) allows up to 40 percent of the value of land
subject to certain conservation easements to be excluded from taxable estates; the maximum amount of
the exclusion is $100,000 in 1998 and increases by
$100,000 in each year through 2002. The TRA97 exclusion applies to the estates of decedents dying after December 31, 1997.
11
An additional tax, at a flat rate of 55 percent, is imposed on lifetime, generationskipping transfers in excess of $1 million. It is considered a generation-skipping transfer
whenever the transferee is at least two generations younger than the transferor, as it
would be in the case of transfers to grandchildren or great-grandchildren. The liability
of this tax is on the recipients of the transfer.

120

ANALYTICAL PERSPECTIVES

Agriculture
2. Special-use valuation of farms.—Up to $750,000
in farmland owned and operated by a decedent and/
or a member of the family may be valued for estate
tax purposes on the basis of its ‘‘continued use’’ as
farmland if: (1) the value of the farmland is at least
25 percent of the gross estate; (2) the entire value of
all farm property is at least 50 percent of the gross
estate; and (3) family heirs to the farm agree to continue to operate the property as a farm for at least
10 years. The $750,000 limit is indexed at 1998 levels,
beginning in 1999.
3. Tax deferral of closely held farms.—The tax
on a decedent’s farm can be deferred for up to 14 years
if the value of the farm is at least 35 percent of the
net estate. For the first 4 years of deferral, no tax
need be paid. During the last 10 years of deferral, the
tax liability must be paid in equal annual installments.
Throughout the 14 year period, interest is charged at
a special, favorable rate. The Taxpayer Relief Act of
1997 (TRA97) lowered the applicable interest rates and
made the interest non-deductible. The TRA97 provision
applies to the estates of decedents dying after December
31, 1997.
Commerce and Housing
4. Special-use valuation of closely-held businesses.—The special-use valuation rule available for
family farms is also available for nonfarm family businesses. To be eligible for the special-use valuation, the
same three conditions previously described must be
met.
5. Tax deferral of closely-held businesses.—The
tax-deferral rule available for family farms is also available for nonfarm family businesses. To be eligible for

Table 5–6.

the tax deferral, the value of stock in closely-held corporations must exceed 35 percent of the decedent’s
gross estate, less debt and funeral expenses.
6. Exclusion for family-owned businesses.—The
Taxpayer Relief Act of 1997 added a provision excluding
from taxable estates certain family-owned businesses
that are bequeathed to qualified heirs. The exclusion
cannot exceed $1.3 million less the value of the unified
credit. The exclusion is recaptured if certain conditions
are not maintained for 10 years. The exclusion applies
to the estates of decedents dying after December 31,
1997.
Education, Training, Employment, and Social
Services
7. Charitable contributions to educational institutions.—Bequests to educational institutions can be
deducted from taxable estates.
8. Charitable contributions, other than education and health.— Bequests to charitable, religious,
and certain other nonprofit organizations can be deducted from taxable estates.
Health
9. Charitable contributions to health institutions.—Bequests to health institutions can be deducted
from taxable estates.
General Government
10. State and local death taxes.—A credit against
the federal estate tax is allowed for State taxes on
bequests. The amount of this credit is determined by
a rate schedule that reaches a maximum of 16 percent
of the taxable estate in excess of $60,000.

REVENUE LOSS ESTIMATES FOR TAX EXPENDITURES IN THE FEDERAL UNIFIED TRANSFER TAX
(In millions of dollars)
Description

1997

1998

1999

2000

2001

2002

1999–
2003

2003

0

0

10

25

40

55

75

205

2
3

Natural Resources and Environment:
Donations of conservation easements ..........................................................
Agriculture:
Special use valuation of farm real property ..................................................
Tax deferral of closely held farms .................................................................

80
10

85
10

90
15

95
15

100
15

105
20

110
20

500
85

4
5
6

Commerce:
Special use valuation of real property used in closely held businesses .....
Tax deferral of closely held business ...........................................................
Exclusion for family owned businesses ........................................................

20
65
0

25
70
0

25
75
390

25
80
395

30
85
400

30
95
420

35
105
435

145
440
2,040

7
8

Education, training, employment, and social services:
Deduction for charitable contributions (education) ........................................
Deduction for charitable contributions (other than education and health) ...

835
2,460

905
2,670

930
2,745

975
2,880

1,025
3,035

1,100
3,245

1,160
3,425

5,190
15,330

755

820

840

880

930

995

1,050

4,695

3,910

4,120

4,260

4,465

4,685

4,930

5,215

23,555

1

9
10

Health:
Deduction for charitable contributions (health) .............................................
General government:
Credit for State death taxes ..........................................................................

Note: All estimates have been rounded to the nearest $5 million.

SPECIAL ANALYSES AND PRESENTATIONS

121

6.

FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING

Investment spending is spending that yields longterm benefits. Its purpose may be to improve the efficiency of internal Federal agency operations or to increase the Nation’s overall stock of capital for economic
growth. The spending can be direct Federal spending
or grants to State and local governments. It can be
for physical capital, which yields a stream of services
over a period of years, or for research and development
or education and training, which are intangible but also
increase income in the future or provide other longterm benefits.
Most presentations in the Federal budget combine
investment spending with spending for current use.
This chapter focuses solely on Federal and federally
financed investment. These investments are discussed
in the following sections:
• description of the size and composition of Federal
investment spending;

• a discussion of capital assets used to provide Federal services, and efforts to improve planning and
budgeting for these assets. An Appendix to Part
II presents the ‘‘Principles of Budgeting for Capital Asset Acquisitions,’’ which are being used to
guide the analysis of Administration requests for
spending for capital assets.
• a presentation of trends in the stock of federally
financed physical capital, research and development, and education;
• alternative capital budget and capital expenditure
presentations; and
• projections of Federal physical capital outlays and
recent assessments of public civilian capital needs,
as required by the Federal Capital Investment
Program Information Act of 1984.

Part I: DESCRIPTION OF FEDERAL INVESTMENT
For more than forty years, a chapter in the budget
has shown Federal investment outlays—defined as
those outlays that yield long-term benefits—separately
from outlays for current use. Again this year the discussion of the composition of investment includes estimates
of budget authority as well as outlays and extends
these estimates four years beyond the budget year, to
2003.
The classification of spending into investment and
current outlays is a matter of judgment. The budget
has historically employed a relatively broad classification, including physical investment, research, development, education, and training. But presentations for
particular purposes could adopt different definitions of
investment:
• To suit the purposes of a traditional balance sheet,
investment might include only those physical assets owned by the Federal Government, excluding
capital financed through grants and intangible assets such as research, education, and training.
• Focusing on the role of investment in improving
national productivity and enhancing economic
growth would exclude items such as national defense assets, the benefits of which are enhanced
national security rather than economic growth.
• Concern with the efficiency of Federal operations
would lead to a focus solely on investments to
reduce costs or improve the effectiveness of internal Federal agency operations, such as computer
systems.
• A ‘‘social investment’’ perspective might broaden
the coverage of investment beyond what is in-

cluded in this chapter to encompass programs
such as childhood immunization, maternal health,
certain nutrition programs, and substance abuse
treatment, which are designed in part to prevent
more costly health problems in future years.
The relatively broad definition of investment used
in this section provides consistency over time: historical
figures on investment outlays back to 1940 can be
found in the separate Historical Tables volume. The
detailed tables at the end of this section allow
disaggregation of the data to focus on those investment
outlays that best suit a particular purpose.
In addition to this basic issue of definition, there
are two technical problems in the classification of investment data, involving the treatment of grants to
State and local governments and the classification of
spending that could be shown in more than one category.
First, for some grants to State and local governments
it is the recipient jurisdiction, not the Federal Government, that ultimately determines whether the money
is used to finance investment or current purposes. This
analysis classifies all of the outlays in the category
where the recipient jurisdictions are expected to spend
most of the money. Hence, the community development
block grant is classified as physical investment, although some may be spent for current purposes. General purpose fiscal assistance is classified as current
spending, although some may be spent by recipient jurisdictions on physical investment.
Second, some spending could be classified in more
than one category of investment. For example, outlays

123

124
for construction of research facilities finance the acquisition of physical assets, but they also contribute to
research and development. To avoid double counting,
the outlays are classified in the category that is most
commonly recognized as investment. Consequently outlays for the conduct of research and development do
not include outlays for research facilities, because these
outlays are included in the category for physical investment. Similarly, physical investment and research and
development related to education and training are included in the categories of physical assets and the conduct of research and development.
When direct loans and loan guarantees are used to
fund investment, the subsidy value is included as investment. The subsidies are classified according to their
program purpose, such as construction, education and
training, or non-investment outlays. For more information about the treatment of Federal credit programs,
refer to Chapter 8, ‘‘Underwriting Federal Credit and
Insurance.’’
This section presents spending for gross investment,
without adjusting for depreciation. A subsequent section discusses depreciation, shows investment both
gross and net of depreciation, and displays net capital
stocks.
Composition of Federal Investment Outlays
Major Federal Investment
The composition of major Federal investment outlays
is summarized in Table 6–1. They include major public
physical investment, the conduct of research and development, and the conduct of education and training. Defense and nondefense investment outlays were $228.8
billion in 1997. They are estimated to decline to $225.3
billion in 1998 and to increase to $236.9 billion in 1999.
Major Federal investment will comprise an estimated
13.7 percent of total Federal outlays in 1999 and 2.7
percent of the Nation’s gross domestic product (GDP).
Greater detail on Federal investment is available in
tables 6–2 and 6–3 at the end of this section. Those
tables include both budget authority and outlays.
Physical investment.—Outlays for major public physical capital investment (hereafter referred to as physical
investment outlays) are estimated to be $113.2 billion
in 1999. Physical investment outlays are for construction and rehabilitation, the purchase of major equipment, and the purchase or sale of land and structures.
Slightly more than three-fifths of these outlays are for
direct physical investment by the Federal Government,
with the remaining being grants to State and local governments for physical investment.
Direct physical investment outlays by the Federal
Government are primarily for national defense. Defense
outlays for physical investment were $52.4 billion in
1997 and are estimated to be $50.3 billion in 1999.
Almost all of these outlays, or $45.7 billion, are for
the procurement of weapons and other defense equipment, and the remainder is primarily for construction
on military bases, family housing for military personnel, and Department of Energy defense facilities.

ANALYTICAL PERSPECTIVES

Outlays for direct physical investment for nondefense
purposes are estimated to be $18.5 billion in 1999.
These outlays include $12.0 billion for construction and
rehabilitation. This amount funds water, power, and
natural resources projects of the Corps of Engineers,
the Bureau of Reclamation within the Department of
the Interior, the Tennessee Valley Authority, and the
power administrations in the Department of Energy;
construction and rehabilitation of veterans hospitals
and Postal Service facilities; and facilities for space and
science programs. Outlays for the acquisition of major
equipment are estimated to be $6.5 billion in 1999.
The largest amounts are for the air traffic control system and the Postal Service. For the purchase or sale
of land and structures, collections are expected to exceed disbursements by $3.6 billion in 1998, largely due
to the sale of the United States Enrichment Corporation and the privatization of Elk Hills. Sale of these
assets has been enacted. These sales explain most of
the decline in outlays in this category from 1997 to
1998.
Grants to State and local governments for physical
investment are estimated to be $44.4 billion in 1999.
More than three-fifths of these outlays, or $27.6 billion,
are to assist States and localities with transportation
infrastructure. Other major grants for physical investment fund sewage treatment plants, community development, and public housing.
Conduct of research and development.—Outlays for
the conduct of research and development are estimated
to be $73.7 billion in 1999. These outlays are devoted
to increasing basic scientific knowledge and promoting
related research and development. They increase the
Nation’s security, improve the productivity of capital
and labor for both public and private purposes, and
enhance the quality of life. More than half of these
outlays, an estimated $39.4 billion in 1999, are for national defense. Physical investment for research and
development facilities and equipment is included in the
physical investment category.
Nondefense outlays for the conduct of research and
development are estimated to be $34.3 billion in 1999.
This is almost entirely direct spending by the Federal
Government, and is largely for the space programs, the
National Science Foundation, the National Institutes
of Health, and research for nuclear and non-nuclear
energy programs.
Conduct of education and training.—Outlays for the
conduct of education and training are estimated to be
$50.0 billion in 1999. These outlays add to the stock
of human capital by developing a more skilled and productive labor force. Grants to State and local governments for this category are estimated to be $29.8 billion
in 1999, more than half of the total. They include education programs for the disadvantaged and the handicapped, vocational and adult education programs, training programs in the Department of Labor, and Head
Start. Direct education and training outlays by the Federal Government are estimated to be $20.1 billion in
1999. Programs in this category are primarily aid for

6.

125

FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING

Table 6–1.

COMPOSITION OF FEDERAL INVESTMENT OUTLAYS
(In billions of dollars)
1997
actual

Estimate
1998

1999

Federal Investment
Major public physical capital investment:
Direct Federal:
National defense ...................................................................................................
Nondefense ...........................................................................................................

52.4
19.7

48.7
15.4

50.3
18.5

Subtotal, direct major public physical capital investment ...............................
Grants to State and local governments ...................................................................

72.2
41.5

64.1
44.1

68.8
44.4

Subtotal, major public physical capital investment .........................................
Conduct of research and development:
National defense .......................................................................................................
Nondefense ...............................................................................................................

113.6

108.2

113.2

40.2
30.9

39.0
32.4

39.4
34.3

Subtotal, conduct of research and development .................................................

71.1

71.4

73.7

Conduct of education and training:
Grants to State and local governments ...................................................................
Direct Federal ............................................................................................................

25.0
19.0

26.3
19.5

29.8
20.1

Subtotal, conduct of education and training ........................................................

44.0

45.7

50.0

Major Federal investment outlays .............................................................................
MEMORANDUM
Major Federal investment outlays:
National defense .......................................................................................................
Nondefense ...............................................................................................................

228.8

225.3

236.9

92.6
136.2

87.7
137.6

89.7
147.2

Total, major Federal investment outlays ..............................................................
Miscellaneous physical investments:
Commodity inventories. .............................................................................................
Other physical investment (direct) ............................................................................

228.8

225.3

236.9

–1.0
3.4

–0.3
3.9

–0.2
3.8

Total, miscellaneous physical investment ............................................................

2.4

3.5

3.5

Total, Federal investment outlays, including miscellaneous physical investment .......

231.1

228.8

240.4

higher education through student financial assistance,
loan subsidies, the veterans GI bill, and health training
programs.
This category does not include outlays for education
and training of Federal civilian and military employees.
Outlays for education and training that are for physical
investment and for research and development are in
the categories for physical investment and the conduct
of research and development.
Miscellaneous Physical Investment Outlays
In addition to the categories of major Federal investment, several miscellaneous categories of investment
outlays are shown at the bottom of Table 6–1. These
items, all for physical investment, are generally unrelated to improving Government operations or enhancing
economic activity.
Outlays for commodity inventories are for the purchase or sale of agricultural products pursuant to farm
price support programs and the purchase and sale of

other commodities such as oil and gas. Sales are estimated to exceed purchases by $0.2 billion in 1999.
Outlays for other miscellaneous physical investment
are estimated to be $3.8 billion in 1999. This category
includes primarily conservation programs. These outlays are entirely for direct Federal spending.
Detailed Tables on Investment Spending
This section provides data on budget authority as
well as outlays for major Federal investment. These
estimates extend four years beyond the budget year
to 2003. Table 6–2 displays budget authority (BA) and
outlays (O) by major programs according to defense
and nondefense categories. The greatest level of detail
appears in Table 6–3, which shows budget authority
and outlays divided according to grants to State and
local governments and direct Federal spending. Miscellaneous investment is not included in these tables
because it is generally unrelated to improving Government operations or enhancing economic activity.

126

ANALYTICAL PERSPECTIVES

Table 6–2. FEDERAL INVESTMENT BUDGET AUTHORITY AND OUTLAYS: DEFENSE AND NONDEFENSE PROGRAMS
(in millions of dollars)

1997
Actual

Description

Estimate
1998

1999

2000

2001

2002

2003

4,805
4,710
42,993
47,778
–85
–85

4,504
4,776
45,189
44,020
–76
–76

3,857
4,605
48,784
45,730
–77
–77

4,387
3,947
54,838
48,203
–80
–80

4,151
4,118
61,966
51,058
–80
–80

4,336
4,227
61,363
53,974
–80
–80

4,680
4,386
64,246
58,977
–65
–65

BA
O

47,713
52,403

49,617
48,720

52,564
50,258

59,145
52,070

66,037
55,096

65,619
58,121

68,861
63,298

Conduct of research and development .............................................................

BA
O
Conduct of education and training (civilian) ..................................................... BA
O

39,591
40,177
5
7

39,873
39,024
2
3

39,716
39,417
5
4

36,770
37,407
10
8

35,839
36,339
10
10

36,359
36,186
10
10

37,253
36,669
10
10

Subtotal, national defense investment ..................................................... BA
O
NONDEFENSE
Major public physical investment:
Construction and rehabilitation:
Highways ................................................................................................... BA
O
Mass transportation ................................................................................... BA
O
Rail transportation ..................................................................................... BA
O
Air transportation ....................................................................................... BA
O
Water transportation .................................................................................. BA
O
Community development block grants ..................................................... BA
O
Other community and regional development ........................................... BA
O
Pollution control and abatement ............................................................... BA
O
Water resources ........................................................................................ BA
O
Housing assistance ................................................................................... BA
O
Energy ........................................................................................................ BA
O
Veterans hospitals and other health ......................................................... BA
O
Postal Service ............................................................................................ BA
O
GSA real property activities ...................................................................... BA
O
Other programs ......................................................................................... BA
O

87,309
92,587

89,492
87,747

92,285
89,679

95,925
89,485

101,886
91,445

101,988
94,317

106,124
99,977

21,373
20,502
3,757
4,041
263
372
1,487
1,514
136
111
4,854
4,517
1,308
1,507
3,764
3,646
2,366
2,078
917
6,849
1,098
1,128
1,684
1,538
1,595
1,261
1,381
1,362
2,449
2,610

22,374
21,751
4,460
3,753
264
236
1,714
1,609
142
136
4,924
4,989
1,459
1,666
4,127
3,504
2,487
2,757
6,219
6,812
1,046
1,051
1,732
1,845
1,971
1,243
242
1,080
2,502
2,675

22,101
22,319
4,635
3,660
632
500
1,714
1,650
119
96
4,725
4,959
2,023
1,399
4,464
3,955
1,632
2,021
5,890
6,864
1,042
1,005
1,485
1,715
1,439
1,355
712
885
2,702
2,793

22,010
22,331
4,636
3,998
582
539
1,716
1,689
109
66
4,015
4,959
1,563
1,555
3,609
4,124
1,959
1,880
5,191
7,000
1,196
1,186
1,503
1,686
932
1,231
702
895
2,400
2,952

21,955
22,197
4,636
4,298
532
577
1,717
1,715
102
66
3,981
4,639
1,388
1,743
3,392
4,043
1,856
2,319
4,793
6,726
1,165
1,153
1,524
1,647
799
1,026
821
1,001
2,130
2,895

21,935
22,045
4,636
4,611
524
545
1,719
1,726
102
76
3,933
4,155
1,362
1,615
3,344
3,689
1,863
1,633
4,786
6,311
1,142
1,132
1,550
1,619
686
891
934
940
2,115
2,390

21,935
21,980
4,636
4,791
522
528
1,721
1,722
102
82
4,040
4,026
1,388
1,534
3,343
3,557
2,076
1,965
4,882
5,955
1,232
1,217
1,611
1,663
846
850
750
844
2,021
2,264

BA
O

48,432
53,036

55,663
55,107

55,315
55,176

52,123
56,091

50,791
56,045

50,631
53,378

51,105
52,978

BA
O
BA
O
BA
O

1,969
2,350
1,360
905
4,529
3,638

1,923
1,825
1,298
649
5,137
4,367

2,167
1,838
1,320
617
5,130
4,169

2,422
1,945
1,144
1,448
5,061
4,628

2,686
2,129
846
1,447
5,079
4,778

2,948
2,350
424
806
5,065
4,847

3,214
2,773
93
365
5,100
4,882

BA
O

7,858
6,893

8,358
6,841

8,617
6,624

8,627
8,021

8,611
8,354

8,437
8,003

8,407
8,020

NATIONAL DEFENSE
Major public physical investment:
Construction and rehabilitation ......................................................................

BA
O
Acquisition of major equipment ..................................................................... BA
O
Purchase or sale of land and structures ...................................................... BA
O
Subtotal, major public physical investment ..............................................

Subtotal, construction and rehabilitation ..............................................
Acquisition of major equipment:
Air transportation .......................................................................................
Postal Service ............................................................................................
Other ..........................................................................................................
Subtotal, acquisition of major equipment .............................................

6.

127

FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING

Table 6–2. FEDERAL INVESTMENT BUDGET AUTHORITY AND OUTLAYS: DEFENSE AND NONDEFENSE PROGRAMS—Continued
(in millions of dollars)

1997
Actual

Description
Purchase or sale of land and structures ...................................................... BA
O
Other physical assets (grants) ...................................................................... BA
O

Estimate
1998

1999

2000

2001

2002

2003

335
334
943
969

–3,237
–3,616
937
1,142

–183
–12
1,200
1,144

635
736
1,293
1,221

682
760
1,183
1,230

140
185
1,191
1,221

671
723
1,209
1,224

BA
O

57,568
61,232

61,721
59,474

64,949
62,932

62,678
66,069

61,267
66,389

60,399
62,787

61,392
62,945

BA
O
BA
O
BA
O
BA
O
BA
O
BA
O

10,813
10,855
2,388
2,641
1,780
1,782
12,655
11,223
1,861
1,590
2,674
2,805

12,427
11,524
1,303
1,527
1,916
1,920
13,534
12,799
1,983
1,734
2,764
2,851

12,703
11,974
1,460
1,573
1,900
2,255
14,820
13,794
1,990
1,785
2,939
2,906

12,822
12,530
1,310
1,634
1,830
2,028
15,692
14,794
1,984
1,793
2,973
2,975

13,113
12,828
1,306
1,608
1,816
1,972
16,662
15,692
2,005
1,799
2,976
3,013

13,397
13,165
1,271
1,481
1,796
1,984
17,643
16,417
2,030
1,829
3,007
3,042

13,589
13,376
1,279
1,483
1,796
1,954
19,721
17,887
2,007
1,808
3,016
3,081

BA
O

32,171
30,896

33,927
32,355

35,812
34,287

36,611
35,754

37,878
36,912

39,144
37,918

41,408
39,589

BA
O
Higher education ....................................................................................... BA
O
Research and general education aids ...................................................... BA
O
Training and employment ......................................................................... BA
O
Social services ........................................................................................... BA
O

16,997
15,025
13,513
12,290
1,991
1,769
5,675
4,769
6,515
6,435

18,737
15,310
13,080
12,403
1,866
2,109
6,378
5,448
6,988
6,767

20,751
18,183
13,784
12,445
2,195
2,027
6,723
6,163
7,368
7,308

21,003
20,477
13,756
12,381
2,246
2,214
5,218
6,058
7,689
7,433

21,122
20,836
14,146
12,621
2,299
2,315
5,240
5,492
7,893
7,659

20,895
21,063
13,516
11,999
2,297
2,321
5,310
5,238
8,104
7,859

20,843
20,955
14,841
13,390
2,309
2,340
5,382
5,304
8,168
8,013

BA
O

44,691
40,288

47,049
42,037

50,821
46,126

49,912
48,563

50,700
48,923

50,122
48,480

51,543
50,002

Veterans education, training, and rehabilitation ........................................... BA
O
Health ............................................................................................................. BA
O
Other education and training ......................................................................... BA
O

1,499
1,477
880
880
1,447
1,396

1,496
1,499
894
860
1,376
1,349

1,313
1,513
981
927
1,467
1,388

1,477
1,482
1,010
965
1,483
1,433

1,576
1,604
1,046
999
1,465
1,458

1,578
1,583
1,097
1,039
1,482
1,468

1,589
1,591
1,195
1,101
1,498
1,478

Subtotal, conduct of education and training ............................................ BA
O

48,517
44,041

50,815
45,745

54,582
49,954

53,882
52,443

54,787
52,984

54,279
52,570

55,825
54,172

BA
O

138,256
136,169

146,463
137,574

155,343
147,173

153,171
154,266

153,932
156,285

153,822
153,275

158,625
156,706

Total, Federal investment ............................................................................... BA
O

225,565
228,756

235,955
225,321

247,628
236,852

249,096
243,751

255,818
247,730

255,810
247,592

264,749
256,683

Subtotal, major public physical investment ..............................................
Conduct of research and development:
General science, space, and technology ......................................................
Energy ............................................................................................................
Transportation ................................................................................................
Health .............................................................................................................
Natural resources and environment ..............................................................
All other research and development .............................................................
Subtotal, conduct of research and development .....................................
Conduct of education and training:
Education, training, employment and social services:
Elementary, secondary, and vocational education ...................................

Subtotal, education, training, and social services ...............................

Subtotal, nondefense investment ..............................................................

128

ANALYTICAL PERSPECTIVES

Table 6–3. FEDERAL INVESTMENT BUDGET AUTHORITY AND OUTLAYS: GRANT AND DIRECT FEDERAL PROGRAMS
(in millions of dollars)

1997
Actual

Description
GRANTS TO STATE AND LOCAL GOVERNMENTS
Major public physical investments:
Construction and rehabilitation:
Highways ................................................................................................... BA
O
Mass transportation ................................................................................... BA
O
Rail transportation ..................................................................................... BA
O
Air transportation ....................................................................................... BA
O
Pollution control and abatement ............................................................... BA
O
Other natural resources and environment ................................................ BA
O
Community development block grants ..................................................... BA
O
Other community and regional development ........................................... BA
O
Housing assistance ................................................................................... BA
O
Other construction ..................................................................................... BA
O

Estimate
1998

1999

2000

2001

2002

2003

21,372
20,498
3,757
4,041
78
30
1,460
1,489
2,430
2,319
269
179
4,854
4,517
1,185
1,224
891
6,015
129
149

22,372
21,742
4,460
3,753
..................
35
1,700
1,554
2,655
2,086
47
283
4,924
4,989
1,138
1,233
6,193
6,790
460
430

22,101
22,312
4,635
3,660
..................
41
1,700
1,636
2,424
2,286
51
71
4,725
4,959
1,813
1,226
5,864
6,841
113
134

22,010
22,326
4,636
3,998
..................
6
1,700
1,674
2,095
2,469
49
67
4,015
4,959
1,372
1,404
5,165
6,976
113
134

21,955
22,195
4,636
4,298
..................
..................
1,700
1,699
1,984
2,476
49
57
3,981
4,639
1,190
1,550
4,767
6,702
113
135

21,935
22,043
4,636
4,611
..................
..................
1,700
1,708
1,934
2,173
49
50
3,933
4,155
1,161
1,413
4,760
6,285
113
113

21,935
21,978
4,636
4,791
..................
..................
1,700
1,700
1,934
2,059
49
50
4,040
4,026
1,162
1,307
4,856
5,929
113
113

Subtotal, construction and rehabilitation ..............................................

BA
O

36,425
40,461

43,949
42,895

43,426
43,166

41,155
44,013

40,375
43,751

40,221
42,551

40,425
41,953

Other physical assets ....................................................................................

BA
O

993
1,024

997
1,217

1,251
1,220

1,346
1,277

1,238
1,283

1,248
1,274

1,268
1,279

Subtotal, major public physical capital .....................................................

BA
O

37,418
41,485

44,946
44,112

44,677
44,386

42,501
45,290

41,613
45,034

41,469
43,825

41,693
43,232

BA
O
BA
O

237
208
109
82

223
229
113
72

235
234
148
192

237
247
147
190

217
255
149
191

217
246
149
192

217
243
151
193

BA
O

346
290

336
301

383
426

384
437

366
446

366
438

368
436

Conduct of education and training:
Elementary, secondary, and vocational education ....................................... BA
O
Higher education ............................................................................................ BA
O
Research and general education aids .......................................................... BA
O
Training and employment .............................................................................. BA
O
Social services ............................................................................................... BA
O
Agriculture ...................................................................................................... BA
O
Other .............................................................................................................. BA
O

16,149
14,212
83
75
440
277
4,513
3,769
6,229
6,185
448
420
79
89

17,703
14,471
80
84
296
456
5,135
4,261
6,685
6,484
423
429
84
82

19,551
17,185
39
69
472
318
5,197
4,745
7,057
6,986
455
432
82
82

19,827
19,331
44
42
489
454
3,639
4,495
7,368
7,117
453
439
82
83

19,945
19,666
50
40
502
488
3,634
3,914
7,564
7,337
423
444
81
77

19,718
19,890
53
39
497
498
3,684
3,630
7,767
7,529
423
439
81
75

19,666
19,784
54
39
496
497
3,734
3,672
7,826
7,676
423
432
81
73

Subtotal, conduct of education and training ............................................ BA
O

27,941
25,027

30,406
26,267

32,853
29,817

31,902
31,961

32,199
31,966

32,223
32,100

32,280
32,173

BA
O

65,705
66,802

75,688
70,680

77,913
74,629

74,787
77,688

74,178
77,446

74,058
76,363

74,341
75,841

BA

3,220

2,938

2,430

3,250

3,015

3,205

3,514

Conduct of research and development:
Agriculture ......................................................................................................
Other ..............................................................................................................
Subtotal, conduct of research and development .....................................

Subtotal, grants for investment .................................................................
DIRECT FEDERAL PROGRAMS
Major public physical investment:
Construction and rehabilitation:
National defense:
Military construction ..............................................................................

6.

129

FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING

Table 6–3. FEDERAL INVESTMENT BUDGET AUTHORITY AND OUTLAYS: GRANT AND DIRECT FEDERAL PROGRAMS—Continued
(in millions of dollars)

1997
Actual

Description

Estimate
1998

1999

2000

2001

2002

2003

O
BA
O
BA
O

3,161
1,014
1,012
571
537

3,108
887
991
679
677

2,900
623
901
804
804

2,652
333
481
804
814

2,811
334
494
802
813

2,919
330
496
801
812

3,060
354
506
812
820

BA
O

4,805
4,710

4,504
4,776

3,857
4,605

4,387
3,947

4,151
4,118

4,336
4,227

4,680
4,386

BA
O
General science, space, and technology ................................................. BA
O
Water resources projects .......................................................................... BA
O
Other natural resources and environment ................................................ BA
O
Energy ........................................................................................................ BA
O
Postal Service ............................................................................................ BA
O
Transportation ............................................................................................ BA
O
Housing assistance ................................................................................... BA
O
Veterans hospitals and other health facilities .......................................... BA
O
Federal Prison System .............................................................................. BA
O
GSA real property activities ...................................................................... BA
O
Other construction ..................................................................................... BA
O

209
315
374
615
2,101
1,904
1,881
1,691
1,098
1,128
1,595
1,261
349
482
26
834
1,637
1,497
350
307
1,381
1,514
1,006
1,027

218
260
410
492
2,440
2,478
1,812
1,789
1,046
1,051
1,971
1,243
422
401
26
22
1,652
1,798
151
22
423
1,370
1,143
1,286

448
261
477
506
1,583
1,953
2,316
2,023
1,042
1,005
1,439
1,355
765
576
26
23
1,448
1,663
326
499
712
885
1,307
1,261

309
263
475
455
1,910
1,814
1,842
2,041
1,196
1,186
932
1,231
707
619
26
24
1,466
1,630
328
602
702
895
1,075
1,318

313
262
488
462
1,807
2,263
1,785
1,932
1,165
1,153
799
1,026
651
661
26
24
1,487
1,588
90
750
821
1,001
984
1,172

303
258
503
479
1,814
1,584
1,771
1,894
1,142
1,132
686
891
645
641
26
26
1,513
1,582
90
349
934
940
983
1,051

281
235
503
482
2,027
1,916
1,736
1,881
1,232
1,217
846
850
645
634
26
26
1,574
1,626
90
265
750
844
970
1,049

BA
O

16,812
17,285

16,218
16,988

15,746
16,615

15,355
16,025

14,567
16,412

14,746
15,054

15,360
15,411

BA
O
BA
O

42,789
47,563
204
215

44,861
43,699
328
321

48,463
45,411
321
319

54,519
47,887
319
316

61,653
50,745
313
313

61,054
53,664
309
310

63,925
58,660
321
317

BA
O

42,993
47,778

45,189
44,020

48,784
45,730

54,838
48,203

61,966
51,058

61,363
53,974

64,246
58,977

BA
O
Space flight, research, and supporting activities ..................................... BA
O
Energy ........................................................................................................ BA
O
Postal Service ............................................................................................ BA
O
Air transportation ....................................................................................... BA
O
Water transportation (Coast Guard) ......................................................... BA
O
Other transportation (railroads) ................................................................. BA
O
Social security ........................................................................................... BA
O
Hospital and medical care for veterans ................................................... BA
O
Department of Justice ............................................................................... BA
O

243
275
592
607
182
192
1,360
905
1,969
2,350
245
232
304
297
89
52
876
469
543
337

338
315
640
641
128
125
1,298
649
1,923
1,825
255
181
..................
145
50
89
861
1,101
603
266

376
392
658
654
143
139
1,320
617
2,167
1,838
268
214
3
26
..................
69
605
586
667
325

380
425
641
649
138
137
1,144
1,448
2,422
1,945
244
152
..................
1
..................
73
609
587
667
404

392
458
628
632
135
133
846
1,447
2,686
2,129
231
189
..................
..................
..................
78
612
593
667
381

400
465
609
614
121
120
424
806
2,948
2,350
231
227
..................
..................
..................
84
615
596
668
381

401
467
591
596
88
87
93
365
3,214
2,773
231
243
..................
..................
..................
91
638
616
669
381

Family housing ......................................................................................
Atomic energy defense activities and other .........................................
Subtotal, national defense ................................................................
International affairs ....................................................................................

Subtotal, construction and rehabilitation ..............................................
Acquisition of major equipment:
National defense:
Department of Defense ........................................................................
Atomic energy defense activities ..........................................................
Subtotal, national defense ................................................................
General science and basic research ........................................................

130

ANALYTICAL PERSPECTIVES

Table 6–3. FEDERAL INVESTMENT BUDGET AUTHORITY AND OUTLAYS: GRANT AND DIRECT FEDERAL PROGRAMS—Continued
(in millions of dollars)

1997
Actual

Description
Department of the Treasury ......................................................................

Estimate
1998

1999

2000

2001

2002

2003

BA
O
BA
O
BA
O

329
297
541
541
535
284

1,004
632
565
565
633
232

962
696
573
573
824
419

929
832
613
613
787
699

934
886
636
636
789
739

937
893
666
666
761
748

944
898
696
696
783
752

BA
O

50,801
54,616

53,487
50,786

57,350
52,278

63,412
56,168

70,522
59,359

69,743
61,924

72,594
66,942

BA
O
International affairs .................................................................................... BA
O
Sale of the United States Enrichment Corporation ................................. BA
O
Privatization of Elk Hills ............................................................................ BA
O
Other .......................................................................................................... BA
O

–85
–85
11
11
..................
..................
..................
..................
324
323

–76
–76
10
10
–1,600
–1,600
–2,415
–2,415
768
389

–77
–77
18
18
..................
..................
–728
–728
527
698

–80
–80
12
19
..................
..................
..................
..................
623
717

–80
–80
12
19
..................
..................
..................
..................
670
741

–80
–80
12
18
..................
..................
..................
..................
128
167

–65
–65
11
17
..................
..................
..................
..................
660
706

Subtotal, purchase or sale of land and structures .............................. BA
O

250
249

–3,313
–3,692

–260
–89

555
656

602
680

60
105

606
658

BA
O

67,863
72,150

66,392
64,082

72,836
68,804

79,322
72,849

85,691
76,451

84,549
77,083

88,560
83,011

BA
O
Atomic energy and other .......................................................................... BA
O

37,116
37,702
2,475
2,475

37,295
36,446
2,578
2,578

36,891
36,593
2,825
2,824

33,953
34,570
2,817
2,837

33,043
33,511
2,796
2,828

33,583
33,376
2,776
2,810

34,398
33,813
2,855
2,856

BA
O

39,591
40,177

39,873
39,024

39,716
39,417

36,770
37,407

35,839
36,339

36,359
36,186

37,253
36,669

International affairs ........................................................................................ BA
O
General science, space, and technology
NASA ......................................................................................................... BA
O
National Science Foundation .................................................................... BA
O
Department of Energy ............................................................................... BA
O

191
394

172
333

176
264

173
272

176
282

180
294

185
302

7,845
8,137
2,272
2,015
696
703

8,193
7,975
2,381
2,111
1,853
1,438

8,038
7,880
2,671
2,360
1,994
1,734

8,060
8,098
2,756
2,548
2,006
1,884

8,162
8,023
2,844
2,698
2,107
2,107

8,306
8,209
2,931
2,817
2,160
2,139

8,427
8,327
3,025
2,920
2,137
2,129

General supply fund ..................................................................................
Other ..........................................................................................................
Subtotal, acquisition of major equipment .............................................
Purchase or sale of land and structures:
National defense ........................................................................................

Subtotal, major public physical investment ..............................................
Conduct of research and development:
National defense
Department of Defense .............................................................................

Subtotal, national defense ....................................................................

Subtotal, general science, space, and technology ..............................

BA
O

11,004
11,249

12,599
11,857

12,879
12,238

12,995
12,802

13,289
13,110

13,577
13,459

13,774
13,678

Energy ............................................................................................................

BA
O

2,388
2,641

1,303
1,527

1,460
1,573

1,310
1,634

1,306
1,608

1,271
1,481

1,279
1,483

BA
O
BA
O

505
492
1,194
1,237

569
457
1,264
1,424

672
747
1,147
1,370

678
776
1,071
1,114

641
766
1,094
1,068

600
735
1,115
1,111

577
686
1,138
1,130

BA
O

4,087
4,370

3,136
3,408

3,279
3,690

3,059
3,524

3,041
3,442

2,986
3,327

2,994
3,299

BA
O
BA
O

12,023
10,599
622
614

12,894
12,171
630
618

13,943
13,066
838
694

14,754
14,038
899
722

15,668
14,866
955
792

16,951
15,879
653
504

19,011
17,346
671
507

Transportation:
Department of Transportation ...................................................................
NASA .........................................................................................................
Subtotal, transportation .........................................................................
Health:
National Institutes of Health ......................................................................
All other health ..........................................................................................

6.

131

FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING

Table 6–3. FEDERAL INVESTMENT BUDGET AUTHORITY AND OUTLAYS: GRANT AND DIRECT FEDERAL PROGRAMS—Continued
(in millions of dollars)

1997
Actual

Description

Estimate
1998

1999

2000

2001

2002

2003

Subtotal, health .....................................................................................

BA
O

12,645
11,213

13,524
12,789

14,781
13,760

15,653
14,760

16,623
15,658

17,604
16,383

19,682
17,853

Agriculture ......................................................................................................

BA
O
BA
O
BA
O
BA
O
BA
O

971
970
1,858
1,589
392
399
263
235
605
581

1,024
999
1,980
1,732
371
394
272
270
685
605

1,039
1,013
1,987
1,783
447
423
300
293
717
661

1,054
1,035
1,981
1,791
474
434
300
300
711
671

1,050
1,036
2,002
1,797
497
452
300
301
710
670

1,053
1,033
2,027
1,827
516
479
300
301
715
671

1,052
1,032
2,004
1,806
522
503
300
301
712
681

BA
O

71,416
70,783

73,464
71,078

75,145
73,278

72,997
72,724

73,351
72,805

75,137
73,666

78,293
75,822

Conduct of education and training:
Elementary, secondary, and vocational education ....................................... BA
O
Higher education ............................................................................................ BA
O
Research and general education aids .......................................................... BA
O
Training and employment .............................................................................. BA
O
Health ............................................................................................................. BA
O
Veterans education, training, and rehabilitation ........................................... BA
O
General science and basic reserach ............................................................ BA
O
National defense ............................................................................................ BA
O
International affairs ........................................................................................ BA
O
Other .............................................................................................................. BA
O

848
813
13,430
12,215
1,551
1,492
1,162
1,000
880
880
1,499
1,477
519
483
5
7
220
247
467
407

1,034
839
13,000
12,319
1,570
1,653
1,243
1,187
894
860
1,496
1,499
526
478
2
3
199
214
447
429

1,200
998
13,745
12,376
1,723
1,709
1,526
1,418
981
927
1,313
1,513
570
512
5
4
200
202
471
482

1,176
1,146
13,712
12,339
1,757
1,760
1,579
1,563
1,010
965
1,477
1,482
585
547
10
8
200
201
484
479

1,177
1,170
14,096
12,581
1,797
1,827
1,606
1,578
1,046
999
1,576
1,604
601
575
10
10
200
201
489
483

1,177
1,173
13,463
11,960
1,800
1,823
1,626
1,608
1,097
1,039
1,578
1,583
617
591
10
10
200
201
498
492

1,177
1,171
14,787
13,351
1,813
1,843
1,648
1,632
1,195
1,101
1,589
1,591
633
610
10
10
200
201
503
499

Subtotal, conduct of education and training ............................................ BA
O

20,581
19,021

20,411
19,481

21,734
20,141

21,990
20,490

22,598
21,028

22,066
20,480

23,555
22,009

Subtotal, direct Federal investment .......................................................... BA
O

159,860
161,954

160,267
154,641

169,715
162,223

174,309
166,063

181,640
170,284

181,752
171,229

190,408
180,842

Total, Federal investment ............................................................................... BA
O

225,565
228,756

235,955
225,321

247,628
236,852

249,096
243,751

255,818
247,730

255,810
247,592

264,749
256,683

Natural resources and environment ..............................................................
National Institute of Standards and Technology ..........................................
Hospital and medical care for veterans ........................................................
All other research and development .............................................................
Subtotal, conduct of research and development .....................................

132

ANALYTICAL PERSPECTIVES

Part II: PLANNING, BUDGETING, AND ACQUISITION OF CAPITAL ASSETS
The previous section discussed Federal investment
broadly defined. The focus of this section is much narrower—the review of planning and budgeting for capital
assets during the past year and the resultant budget
proposals for capital assets owned by the Federal Government and used to deliver Federal services. Capital
assets consist of Federal buildings, information technology, and other facilities and major equipment, including weapons systems, federally owned infrastructure, and space satellites.1 With proposed major agency
restructuring, organizational streamlining, and other
reforms, good planning may suggest reduced spending
for some assets, such as office buildings, and increased
spending for others, such as information technology,
to increase the productivity of a smaller workforce.
In recent years the Administration and the Congress
have reviewed the Federal Government’s performance
in planning, budgeting, risk management, and the acquisition of capital assets. The reviews indicate that
the performance is uneven across the Government; the
problems have many causes and as a result, there is
no single solution. However, in meeting the objective
of improving the Government’s performance, it is essential that the caliber of Government planning and budgeting for capital assets be improved. The Administration, working with the Congress, is on course to make
capital management in the Federal Government a
model worthy of emulation.
Improving Planning, Budgeting, and Acquisition
of Capital Assets
Risk Management.—Recent Executive Branch reviews have found a recurring theme in many capital
asset acquisitions—that risk management should become more central to the planning, budgeting, and acquisition process. Failure to analyze and manage the
inherent risk in all capital asset acquisitions may have
contributed to cost overruns, schedule shortfalls, and
acquisitions that fail to perform as expected. Failure
to adopt capital asset requirements that are within the
capabilities of the market and budget limitations may
also have contributed to these problems. For each major
project a risk analysis that includes how risks will be
isolated, minimized, monitored, and controlled may help
prevent these problems. The proposals in this budget,
together with recent legislation enacted by Congress,
are designed to help the Government manage better
its portfolio of capital assets.
Long-Term Planning and Analysis.—Planning and
managing capital assets, especially better management
of risk, has historically been a low priority for some
agencies. Attention focuses on coming-year appropriations, and justifications are often limited to lists of de1
This is almost the same as the definition in Part I of this chapter for spending for
direct Federal construction and rehabilitation, major equipment, and purchase of land, except
that capital assets excludes grants to private groups for these purposes (e.g., grants to
universities for research equipment and grants to AMTRAK). A more complete definition
can be found in the glossary to the ‘‘Principles of Budgeting for Capital Asset Acquisitions,’’
which is at the end of this Part.

sired projects. The increased use of long-range planning
linked to performance goals required by the Government Performance and Results Act would provide a
better basis for justifications. It would increase foresight and improve the odds for cost-effective investments.
A need for better risk management, integrated lifecycle planning, and operation of capital assets at many
agencies was evident in the Executive Branch reviews.
Research equipment was acquired with inadequate
funding for its operation. New medical facilities sometimes were built without funds for maintenance and
operation. New information technology sometimes was
acquired without planning for associated changes in
agency operations.
Congressional concern.—Congress has expressed its
concern about planning for capital assets with legislation and other actions that complement Administration
efforts to ensure better performance:
• The Government Performance and Results Act of
1993 (GPRA) is designed to help ensure that program objectives are more clearly defined and resources are focused on meeting these objectives.
• The Federal Acquisition Streamlining Act of 1994
(FASA), Title V, requires agencies to improve the
management of large acquisitions. Title V requires
agencies to institute a performance-based planning, budgeting, and management approach to the
acquisition of capital assets. As a result of improved planning efforts, agencies are required to
establish cost, schedule, and performance goals
that have a high probability of successful achievement. For projects that are not achieving 90 percent of original goals, agencies are required to discuss corrective actions taken or planned to bring
the project within goals. If they cannot be brought
within goals, agencies should identify how and
why the goals should be revised, whether the
project is still cost beneficial and justified for continued funding, or whether the project should be
canceled.
• The Clinger-Cohen Act of 1996 is designed to ensure that information technology acquisitions support agency missions developed pursuant to
GPRA. The Clinger-Cohen Act also requires a performance-based planning, budgeting, and management approach to the acquisition of capital assets.
• The General Accounting Office published a study,
Budget Issues: Budgeting for Federal Capital (November 1996), written in response to a congressional request, which recommended that OMB
continue its focus on capital assets.
Administration concern.—Since 1994, the Administration has devoted particular attention to improving the
process of planning, budgeting, and acquiring capital
assets. After seeking out and analyzing the problems,
which differed from agency to agency, OMB issued
guidance on this issue in 1994. This guidance was re-

6.

FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING

peated in 1995 and reissued in 1996 and 1997 as OMB
Circular A–11: Part 3: ‘‘Planning, Budgeting, and Acquisition of Capital Assets’’ (June 1997) (hereafter referred to as Part 3). Part 3 identified other OMB guidance on this issue.2
Part 3 requests agencies to approach planning for
capital assets in the context of strategic plans to carry
out their missions, and to consider alternative methods
of meeting their goals. Systematic analysis of the full
life-cycle expected costs and benefits is required, along
with risk analysis and assessment of alternative means
of acquiring assets. The Administration proposes to
make agencies responsible for using good capital programming principles for managing the capital assets
they use, and to work throughout the coming year to
improve agency practices in risk management, planning, budgeting, acquisition, and operation of these assets. In support of this, in July 1997 OMB issued a
Capital Programming Guide. This Guide was developed
by an interagency task force with representation from
14 agencies along with participation from the General
Accounting Office. The Guide’s purpose is to provide
professionals in the Federal Government a basic reference on capital assets management principles to assist them in planning, budgeting, acquiring, and managing the asset once in use. The Guide emphasizes
risk management and the importance of analyzing capital assets as a portfolio. In addition, other recent actions by the Administration include:
• OMB memorandum 97–02, ‘‘Funding Information
Systems Investments’’ (October 25, 1996) was issued to establish clear and concise decision criteria regarding investments in major information
technology investments.
• As part of this Budget, the Administration is:
—requesting full funding in regular or advance
appropriations for new capital projects and for
many capital projects formerly funded incrementally. These requests are shown in Table 6–5
and discussed in the accompanying text.
—reissuing the ‘‘Principles of Budgeting for Capital Asset Acquisitions,’’ which appear at the end
of this Part and are also available as a separate
publication. These principles offer guidelines to
agencies to help carry out better planning, analysis, risk management, and budgeting for capital asset acquisitions.
2
Other guidance published by OMB with participation by other agencies includes: (1)
OMB Circular No. A–109, Major System Acquisitions, which establishes policies for planning
major systems that are generally applicable to capital asset acquisitions. (2) OMB Circular
No. A–94, Guidelines and Discount Rates for Benefit-Cost Analysis of Federal Programs,
which provides guidance on benefit-cost, cost-effectiveness, and lease-purchase analysis to
be used by agencies in evaluating Federal activities including capital asset acquisition.
It includes guidelines on the discount rate to use in evaluating future benefits and costs,
the measurement of benefits and costs, the treatment of uncertainty, and other issues.
This guidance must be followed in all analyses in support of legislative and budget programs.
(3) Executive Order No. 12893, ‘‘Principles for Federal Infrastructure Investments,’’ which
provides principles for the systematic economic analysis of infrastructure investments and
their management. (4) OMB Bulletin No. 94–16, Guidance on Executive Order No. 12893,
‘‘Principles for Federal Infrastructure Investments,’’ which provides guidance for implementing this order and appends the order itself. (5) the revision of OMB Circular A–130, Management of Federal Information Resources (February 20, 1996), which provides principles for
internal management and planning practices for information systems and technology; and
(6) OMB Circular No. A–127, Financial Management Systems, which prescribes policies
and standards for executive departments and agencies to follow in developing, evaluating,
and reporting on financial management standards.

133

From Planning to Budgeting.—Long-range agency
plans should channel fully justified budget-year and
out-year capital acquisition proposals into the budget
process. Agencies were asked to submit projections of
both budget authority and outlays for high-priority capital asset proposals not only for the budget year but
for the four subsequent years through 2003 as well.
In addition, agency-specific capital asset issues were
highlighted in the agency reviews.
Attention was given to whether the ‘‘lumpiness’’ of
some capital assets—large one-year temporary increases in funding—disadvantaged them in the budget
review process. In some cases, agencies aggregate capital asset acquisitions into budget accounts containing
only such acquisitions; such accounts tend to smooth
out year-to-year changes in budget authority and outlays and avoid crowding other expenditures. In other
cases, agencies or program managers do not hesitate
to request ‘‘spikes’’ in spending for asset acquisitions,
and the review process accommodates them. But some
agencies go out of their way to avoid such spikes, and
some agencies have trouble accommodating them. Part
3 encouraged agencies to accommodate justified spikes
in their own internal reviews.
Full Funding of Capital Assets.—Good budgeting requires that appropriations for the full costs of asset
acquisition be provided up front to help ensure that
all costs and benefits are fully taken into account when
decisions are made about providing resources. Full
funding was endorsed by the General Accounting Office
in its report, Budgeting for Federal Capital (November
1996). This rule is followed for most Department of
Defense procurement and construction programs and
for General Services Administration buildings. In other
areas, however, too often it is not. When it is not followed and capital assets are funded in increments,
without certainty if or when future funding will be
available, it can and occasionally does result in poor
risk management, weak planning, acquisition of assets
not fully justified, higher acquisition costs, cancellation
of major projects, the loss of sunk costs, and inadequate
funding to maintain and operate the assets. Full funding is also an important element in managing large
acquisitions effectively and holding management responsible for achieving goals.
This budget requests full funding with regular or advance appropriations for new capital projects and for
many capital projects funded incrementally in the past.
Projects that might have been funded in increments
in past years and are fully funded in this budget are
identified below in Table 6–5 and discussed in the accompanying text. Next year additional effort will be
made to include full funding for all new capital projects,
or at least economically and programmatically viable
segments (or modules) of new projects.
Other Budgeting Issues.—Other budgeting decisions
can also aid in acquiring capital assets. Availability
of funds for one year often may not be enough time
to complete the acquisition process. Most agencies request that funds be available for more than one year

134
to complete acquisitions efficiently, and Part 3 encouraged this. As noted, many agencies aggregate asset acquisition in budget accounts to avoid lumpiness. In
some cases, these are revolving funds that ‘‘rent’’ the
assets to the agency’s programs.
To promote better program performance, agencies are
also being encouraged by OMB to examine their budget
account structures to align them better with program
outputs and outcomes and to charge the appropriate
account with significant costs used to achieve these results. The asset acquisition rental accounts, mentioned
above, would contribute to this. Budgeting this way
would provide information and incentives for better resource allocation among programs and a continual
search for better ways to deliver services. It would also
provide incentives for efficient capital asset acquisition
and management.
Acquisition of Capital Assets.—Improved planning,
budgeting, and acquisition strategies are necessary to
increase the ability of agencies to acquire capital assets
within, or close to, the original estimates of cost, schedule, and performance used to justify project budgets
and to maintain budget discipline. The Administration
initiative along with enactment of FASA (Title V) and
the Clinger-Cohen Act require agencies to institute a
performance-based planning, budgeting, and management approach to the acquisition of capital assets.
OMB, working with the agencies over the last several
years, began separate but related efforts to develop an
integrated management approach that employs performance based acquisition management as part of a
disciplined capital programming process. The Administration also wants the capital asset acquisition goals
incorporated into the annual performance plan called
for by GPRA so that a unified picture of agency management activities is presented and acquisition performance goals are linked to the achievement of program
and policy goals. This integrated approach will not only
eliminate duplication in reporting agency actions but,
most importantly, will foster more effective implementation of performance-based acquisition management.
The first effort was the issuance of OMB Circular
A–11, Part 3, ‘‘Planning, Budgeting and Acquisition of
Capital Assets,’’ in July 1996. Part 3 was reissued in
June 1997 with the Capital Programming Guide as a
supplement. These documents present unified guidance
on planning, budgeting, acquisition, and management
of capital assets. It also presents unified guidance designed to coordinate the collection of agency information
for reports to the Congress required by FASA Title
V. Part 3 for this year asked agencies to report on
all major acquisitions and provide information on the
extent of planning and risk mitigation efforts accomplished for new projects to ensure a high probability
that the cost, schedule and performance goals established will be successfully achieved. For ongoing
projects agencies are to provide information on the
achievement of, or deviation from, goals. For projects
that are not achieving 90 percent of original goals,
agencies are required to discuss corrective actions

ANALYTICAL PERSPECTIVES

taken, or contemplated, to bring the project within
goals or, if not, how and why the goals should be revised and whether the project is still cost beneficial
and justified for continued funding or should be canceled. Approved acquisition goals submitted with the
1999 Budget are the baseline goals for all future monitoring of project progress for both management purposes and reporting to Congress as required by FASA
Title V. This more disciplined capital management approach is new to many agencies, and some agencies
were not yet able to provide all the required information for all major acquisitions for this year. OMB expects that agencies will be able to meet the requirements for next year’s budget.
Part 3 complements OMB memorandum 97–02,
‘‘Funding Information Systems Investments’’ (October
25, 1996), which was issued to establish clear and concise decision criteria regarding investments in major
information technology investments. These policy documents establish the general presumption that OMB will
recommend new or continued funding only for those
major investments in assets that comply with good capital programming principles.
At the Appendix to this Part are the ‘‘Principles of
Budgeting for Capital Asset Acquisitions,’’ which incorporate the above criteria and expand coverage to all
capital investments. The Administration recognizes that
many agencies are in the middle of ongoing projects
initiated prior to enactment of the Clinger-Cohen Act
and FASA Title V, and may not be able to satisfy
the criteria immediately. For those systems that do not
satisfy the criteria, the Administration considered requests to use 1998 and 1999 funds to support reevaluation and replanning of the project as necessary to
achieve compliance with the criteria or to determine
that the project would not meet the criteria and should
be canceled.
As a result of these two initiatives, capital asset acquisitions are to have baseline cost, schedule, and performance goals for future tracking purposes or they
are to be either reevaluated and changed or canceled
if no longer cost beneficial.
Outlook.—The effort to improve planning and budgeting for capital assets will continue in 1998 and 1999.
• The Administration will work with the Congress
to increase the number of projects that are fully
funded with regular or advance appropriations.
• OMB will be working with congressional committees, the President’s Management Council, the
Chief Financial Officers Council, and the Chief
Information Officers Council to help agencies with
their responsibility for capital assets through the
alignment of budgetary resources with program
results. OMB will also work with these groups
to implement the ‘‘Principles of Budgeting for Capital Asset Acquisitions,’’ which are shown as an
Appendix to this Part.
• Interagency working groups will be established to
address: (1) program manager qualification standards; (2) enhanced systems of incentives to encour-

6.

135

FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING

age excellence in the acquisition workforce; and
(3) government-wide implementation of performance-based management systems (e.g., earned
value or similar systems) to monitor achievement
or deviation from goals of in-process acquisitions.
• In the review process, proposals for the acquisition
of capital assets and related issues of lumpiness
or ‘‘spikes’’ will continue to receive special attention. Agencies will be encouraged to give the same
special attention to future asset acquisition proposals.
• To ensure that the full costs and benefits of all
budget proposals are fully taken into account in
allocating resources, agencies will be required to
propose full funding for acquisitions in their budget requests.
• OMB will issue a revised Capital Programming
Guide that will incorporate specific examples of
good capital programming practices found by the
GAO in a study of State and local government
and private industry practices and by Federal
agencies as a result of the new, more stringent
requirements.
Major Acquisition Proposals
For the definition of major capital assets described
above this budget requests $69.7 billion of budget authority for 1999. This includes $51.6 billion for the Department of Defense and $18.1 billion for other agencies. The major requests are shown in the accompanying Table 6–4: ‘‘Capital Asset Acquisitions,’’ which distributes the funds according to the categories for construction and rehabilitation, major equipment, and purchases of land and structures.
Construction and Rehabilitation
This budget includes $12.7 billion of budget authority
for 1999 for construction and rehabilitation.
Department of Defense.—The budget requests $3.1 billion for 1999 for general construction on military bases
and family housing. This funding will be used to:
• support the fielding of new systems;
• enhance operational readiness, including deployment and support of military forces;
• provide housing for military personnel and their
families;
• implement base closure and realignment actions;
and
• correct safety deficiencies and environmental problems.
Department of Energy.—This budget requests $1.4
billion for 1999 for construction and rehabilitation for
the Department of Energy. The largest item is a request for $284 million for the National Ignition Facility,
which will be used to perform experiments, including
inertial confinement fusion experiments, at high pressures and temperatures. These investments are also
discussed in the text that accompanies Table 6–5.
Corps of Engineers.—This budget requests $1.2 billion
for 1999 for construction and rehabilitation for the

Table 6–4.

CAPITAL ASSET ACQUISITIONS

(Budget authority in billions of dollars)
1997
actual

MAJOR ACQUISITIONS
Construction and rehabilitation:
Defense military construction and family housing .......
Department of Energy ...................................................
Corps of Engineers .......................................................
Department of the Interior .............................................
General Services Administration ...................................
Other agencies ..............................................................

1998
proposed

1999
proposed

4.2
1.2
1.6
1.0
1.4
5.6

3.8
1.2
2.0
0.8
0.4
7.2

3.1
1.4
1.2
0.8
0.7
7.1

Subtotal, construction and rehabilitation ..................
Major equipment:
Department of Defense. ................................................
Department of Transportation .......................................
Department of the Treasury ..........................................
NASA .............................................................................
Other agencies. .............................................................

15.1

14.2

12.7

42.8
2.2
0.3
0.6
5.1

44.9
2.1
1.0
0.7
5.4

48.5
2.4
1.0
0.7
5.4

Subtotal, major equipment. .......................................
Purchases of land and structures .....................................

50.3
0.3

53.3
1.1

57.2
0.5

Total, major acquisitions. ..............................................
Sale of major assets .........................................................

65.7
–*

68.7
–4.4

70.4
–0.7

Total, capital asset acquisitions 1 ......................................

65.7

64.2

69.7

* Indicates $50 million or less.
1
This total is derived from the direct Federal major public physical investment budget authority on Table
6–3 ($72.8 billion for 1999). Table 6–4 excludes an estimate of spending for assets not owned by the Federal Government ($3.2 billion for 1999).

Corps of Engineers. These funds finance construction,
rehabilitation, and related activity for water resources
development projects that provide navigation, flood control, environmental restoration, and other benefits.
Table 6–5 identifies the advance appropriations requested for programs that can be completed by 2003.
Department of the Interior.—This budget requests
$0.8 billion for construction and rehabilitation for the
Department of the Interior. The largest items are for
water resources projects for the Bureau of Reclamation
and construction for the National Parks. Advance appropriations requested for these programs are shown
in Table 6–5 and discussed in the accompanying text.
General Services Administration (GSA).—The 1999
budget includes $0.7 billion in budget authority for GSA
for the construction or renovation of buildings. These
funds will allow for new construction and the acquisition of border stations and general purpose office space
in locations where long-term needs show that ownership is preferable to leasing.
Other agencies.—This budget includes $7.1 billion for
construction and rehabilitation for other agencies. The
largest items are for the Postal Service ($1.4 billion
in 1999) and the Tennessee Valley Authority ($0.7 billion in 1999).
Major Equipment
This category covers capital purchases for major
equipment, including information technology, such as
computer hardware, major software, and renovations
required for this equipment. This budget includes $57.2

136

ANALYTICAL PERSPECTIVES

billion in budget authority for 1999 for the purchase
of major equipment.
Department of Defense.—The budget requests $48.5
billion for 1999 to procure or modify weapons systems,
related support equipment, and purchase of other capital goods. This includes tactical fighter aircraft, airlift
aircraft, naval vessels, tanks, helicopters, missiles, and
vehicles.
Department of Transportation.—The budget requests
$2.4 billion in budget authority for the Department of
Transportation, which includes $2.1 billion to modernize the air traffic control system and $0.3 billion for
the Coast Guard to acquire vessels and other equipment. Requests for advance appropriations for the air
traffic control system in the Federal Aviation Administration are discussed with Table 6–5.
Department of the Treasury.—The budget requests
$1.0 billion in budget authority for 1999 for major
equipment, primarily information technology investments for the Internal Revenue Service.. These efforts
and proposed advance appropriations for 2000 will help
the IRS improve customer service by providing alternative means of filing returns and paying taxes, improve telephone service for taxpayers; and give employees immediate access to complete information and modern tools to do their jobs. These investments are also
discussed in the text that accompanies Table 6–5, which
displays advance appropriations for capital acquisitions.
National Aeronautics and Space Administration
(NASA).—The budget requests $0.7 billion in budget
authority to procure major equipment for programs in
human space flight, science, aeronautics, and technology. Most of the equipment is to be acquired for
Space Shuttle upgrades, such as orbiter improvements,
Space Shuttle main engines, solid rocket booster improvements, and launch site equipment.
Other agencies.—This budget requests $5.4 billion for
major equipment for other agencies. The largest part
of this is for the Postal Service ($1.3 billion in 1999).
Other agencies include the Department of Energy ($0.7
billion), for science and other projects; the Department
of Justice ($0.7 billion), primarily for the FBI; and the
Department of Veterans Affairs ($0.6 billion), for hospital equipment.
Purchase and Sale of Land and Structures
This budget includes $0.5 billion for 1999 for the
purchase of land and structures. This is primarily $0.2
billion for the purchase of buildings by the General
Services Administration. The budget also includes $4.4
billion in 1998 for proceeds from the sale of the United
States Enrichment Corporation ($1.6 billion), the Privatization of Elk Hills ($2.4 billion), and other assets.
Full Funding of Major Projects
This budget proposes full funding for new capital
projects and for many projects formerly funded incrementally. This funding is shown in Table 6–5.
The importance of full funding was discussed earlier
in this Part and is also explained in the ‘‘Principles

of Budgeting for Capital Asset Acquisitions,’’ which appears as an Appendix to this Part. This budget proposes
to use this principle more consistently than in past
years. This budget requests $5.3 billion in budget authority for 1999, $14.8 billion in advance appropriations
for 2000–2003, and $2.1 billion in advance appropriations for later years, for a total request of $22.1 billion
for these projects for these years.
Department of Commerce
This budget requests $590 million in regular appropriations and $2.9 billion in advance appropriations for
the Department of Commerce for projects in the National Oceanic and Atmospheric Administration (NOAA)
and the National Institute of Standards and Technology
(NIST).
NOAA.—This budget requests $550 million for 1999
and $1,462 million in advance appropriations for
1999–2003 for capital asset acquisitions in NOAA. An
additional $1,336 million is requested for 2004–2011.
These acquisitions support the largest modernization
in the history of the National Weather Service. The
modernization is well underway and demonstrating improvements in weather forecasts and warnings that
lead to lives and property saved. The budget supports
this multi-year effort to develop and deploy advanced
technology, including advanced radar equipment, other
ground observing systems, and geostationary and polarorbiting satellites that will greatly improve the timeliness and accuracy of severe weather and flood warnings
while reducing staffing requirements.
NIST.—The request includes $40 million in 1999 and
$115 million in 2000–2002 in advance appropriations
to complete funding for construction of a $218 million
Advanced Measurement Laboratory in Gaithersburg,
Maryland. This facility will provide stringent controls
for particulate matter, temperature, vibration, and humidity that are unattainable in current NIST buildings.
Such conditions are vital for NIST to keep pace with
rapid developments in semiconductors, precision instruments, industrial robots, computers, chemicals, pharmaceuticals, building materials, and emerging technologies
requiring molecular and atomic-level precision.
Department of Defense
This budget requests $569 million in advance appropriations for 2000–2002 to fully fund selected military
construction projects in the Army and Navy. The budget
requests $225 million for these projects in 1999.
Department of Energy
The budget proposes $2,304 million in advance appropriations for 2000–2003 and an additional $213 million
for 2004–2006 for design and construction of facilities
for defense and science activities in the Department
of Energy. The budget requests $717 million for these
projects for 1999.
Weapons activities.—The budget requests $482 million in regular appropriations for 1999, $974 million
in advance appropriation for 2000–2003, and an additional $38 million for 2004–2006 in advance appropria-

6.

137

FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING

Table 6–5.

PROPOSED SPENDING TO FULLY FUND SELECTED CAPITAL ASSET ACQUISITIONS
(Budget authority in millions of dollars)
Regular
appropriations
1999

DEPARTMENT OF COMMERCE
National Oceanic and Atmospheric Administration: 1 Procurement, acquisition and construction ..............................
National Institute of Standards and Technology: Construction of research activities ..................................................

Advance appropriations
2000

2001

2002

Sum
2000–2003

2003

550
40

451
40

419
40

307
35

285
............

1,462
115

590

491

459

342

285

1,577

32
193

14
293

............
190

............
72

............
............

14
555

225

307

190

72

............

569

482
66
169

519
58
318

251
13
353

146
5
333

58
............
250

974
76
1,254

Subtotal, Department of Energy .......................................................................................................................................
DEPARTMENT OF HEALTH AND HUMAN SERVICES
Indian health facilities .........................................................................................................................................................
National Institutes of Health ..............................................................................................................................................

717

895

617

484

308

2,304

39
90

28
40

28
............

............
............

............
............

56
40

Subtotal, Department of Health and Human Services ....................................................................................................
DEPARTMENT OF THE INTERIOR
Bureau of Reclamation: Water and related resources ......................................................................................................
National Park Service: Construction ...................................................................................................................................

129

68

28

............

............

96

7
14

9
40

6
12

8
............

1
............

24
52

Subtotal, Department of the Interior .................................................................................................................................
DEPARTMENT OF TRANSPORTATION
Federal Aviation Administration: Facilities and equipment 1 ...........................................................................................
DEPARTMENT OF THE TREASURY
Internal Revenue Service: Information technology investments .......................................................................................
CORPS OF ENGINEERS
Construction .........................................................................................................................................................................
ENVIRONMENTAL PROTECTION AGENCY
Buildings and facilities: Research Triangle Park ..............................................................................................................
NATIONAL AERONAUTICS AND SPACE ADMINISTRATION
Human space flight 1 ...........................................................................................................................................................
NATIONAL SCIENCE FOUNDATION
Major research equipment .................................................................................................................................................
SMITHSONIAN INSTITUTION
Construction .........................................................................................................................................................................

21

49

18

8

1

76

775

700

475

329

248

1,752

323

323

............

............

............

323

184

244

163

92

32

531

32

41

............

............

............

41

2,270

2,134

1,933

1,766

1,546

7,379

44

38

30

17

10

95

16

19

............

............

............

19

5,325

5,309

3,913

3,110

2,430

14,762

Subtotal, Department of Commerce .................................................................................................................................
DEPARTMENT OF DEFENSE
Military construction, Navy ................................................................................................................................................
Military construction, Army ................................................................................................................................................
Subtotal, Department of Defense .....................................................................................................................................
DEPARTMENT OF ENERGY
Weapons activities 1 ............................................................................................................................................................
Other defense activities ......................................................................................................................................................
Science 1 ...............................................................................................................................................................................

Total ..................................................................................................................................................................................

Note: For these capital projects, budget authority for the entire project is requested partly in the budget year and partly in future years in advance appropriations.
1
This budget also requests advance appropriations for years beyond 2003.

tions to complete useful segments of all new and ongoing construction projects supporting the nuclear weapons Stockpile Stewardship and Management Program.
Advance appropriations are requested for twenty two
projects that support this program. The largest project
is the National Ignition Facility (NIF), which will be
used to perform experiments, including inertial confinement fusion experiments, at high pressures and temperatures. The budget requests $284 million in 1999
for NIF and $394 million in advance appropriations
for 2000–2003 to complete the project, which is under
construction at the Lawrence Livermore National Laboratory. Other major projects include the Dual Axis
Radiographic Hydrodynamic Facility at the Los Alamos

National Laboratory; a computing laboratory, a systems
testing center, and a processing laboratory at the
Sandia National Laboratory; and major reconstruction
projects at the Pantex, Kansas City, and Y–12 facilities.
Other defense activities.—The budget requests $66
million in 1999 and an additional $76 million in advance appropriations to complete useful segments of
all new and ongoing construction projects in support
of the Fissile Materials Disposition and Naval Reactors
programs. For Fissile Materials Disposition, the budget
requests $25 million in 1999 and $22 million in 2000
to design a facility to take apart plutonium pits from
nuclear weapons and convert the material to a nonclassified form and requests $28 million in 1999 and

138
$22 million in 2000 to design a facility to fabricate
excess plutonium into mixed-oxide fuel for commercial
nuclear reactors. For Naval Reactors, the budget requests $13 million in 1999 and $32 million in advance
appropriations to upgrade laboratory facilities and expand a facility for storage of spent nuclear fuel from
naval vessels.
Science.— The budget requests $169 million in 1999,
$1,254 million in advance appropriation for 2000–2003,
and an additional $175 million in advance appropriations for 2004–2005 for various science-related projects.
The largest project is the Spallation Neutron Source
(SNS), for which $157 million is requested in 1999 and
a total of $814 million in advance appropriations in
subsequent years. The SNS will be a world-class facility
enabling researchers in academia, industry, and government to conduct cutting-edge research into new materials, semiconductors, and structural biology.
Department of Health and Human Services
This budget requests $129 million for 1999 in regular
appropriations and $96 million in advance appropriations for projects in the Department of Health and
Human Services. Funds for National Institutes of
Health (NIH) support an advanced clinical research facility that will house laboratories and hospital beds
under one roof. This will allow the continuation of the
best possible clinical research at NIH.
Funds for Indian health facilities will allow for needed improvements in these facilities.
Department of the Interior
This budget requests $21 million in budget authority
for 1999 and $76 million in advance appropriations for
2000–2003 to fully fund projects in the Bureau of Reclamation and the National Park Service.
Bureau of Reclamation.—This budget requests $7
million in regular appropriations for 1999 for the Bureau of Reclamation and $24 million over the years
2000–2003 in advance appropriations to fully fund
three water resources projects. These funds will finance
the modification of an existing dam to meet current
safety criteria, a project to reduce flood damage on the
Upper Colorado River, and one to prevent further degradation of an aquifer in eastern Idaho.
National Park Service.—The National Park Service
needs to build or restore its buildings and other structures over the next few years. Funding stability is particularly needed for the National Park Service (NPS)
to restore the Elwha River in Olympic National Park,
Washington, by acquiring and removing two dams. Before NPS can acquire the dams, the Secretary of the
Interior must determine that funds to complete restoration are available. In addition to $11 million already
appropriated and $86 million in 1998 from priority Federal land acquisitions and exchanges, advance appropriations of $16 million in 2000 would fully fund the
$113 million project and provide the funding stability
needed for the Secretary to proceed with acquisition.
Advance appropriations are also requested for four
other parks that have an ongoing project requiring

ANALYTICAL PERSPECTIVES

funding for later years: Sequoia National Park ($13
million); Riis Park in Gateway National Recreation
Area ($5.5 million); Shiloh National Military Park ($10
million); and Lake Mead National Recreation Area ($7.5
million). For 1999 the budget requests $14 million in
regular appropriations for these projects.
Department of Transportation
Federal Aviation Administration.—This Budget requests $775 million in 1999, an additional $1,752 million for 2000–2003, with additional requests of $160
million for 2004–2006, for 11 multi-year capital projects
to improve and modernize the FAA’s air traffic control,
communications, and aviation weather information systems. These projects are: Aviation Weather Services Improvements, Terminal Digital Radar, Terminal Automation (STARS), Wide Area Augmentation System for
GPS, Display System Replacement, Weather and Radar
Processor, Voice Switching and Control System, Oceanic
Automation, Aeronautical Data Link, Operational and
Supportability Implementation System (OASIS), and
Beacon Interrogation Replacement.
Department of the Treasury
Internal Revenue Service (IRS).—This budget requests $323 million in budget authority for 1999 and
$323 million in advance appropriations for 2000 to finance information technology investments. The IRS and
the Treasury Department are significantly modifying
the business plans for modernizing the IRS tax administration and systems by focusing on reengineering
work processes and exploring private sector technology
opportunities. These efforts will ensure that future capital investments by the IRS will improve customer service by providing alternative means of filing returns and
paying taxes, improve telephone service for taxpayers;
and give employees immediate access to complete information and modern tools to do their jobs.
Corps of Engineers
This budget requests $184 million in 1999 and $531
million for 2000–2003 to fully fund ongoing projects
that can be completed in 2003 or earlier. These funds
finance construction, rehabilitation, and related activity
for water resources development projects that provide
navigation, flood control, environmental restoration,
and other benefits.
Environmental Protection Agency
This budget requests $32 million in 1999 and $41
million in advance appropriations in 2000 for construction of the EPA’s new research and office facility in
Research Triangle Park in North Carolina. The total
cost of the facility is $273 million. This state-of-theart facility will consolidate nine leased spaces spread
across three metropolitan areas. This project has been
the Agency’s top laboratory construction project for
many years and will prove instrumental in achieving
many national environmental goals.

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FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING

National Aeronautics and Space Administration
(NASA)
Human Space Flight (International Space Station).—
This budget requests $2,270 million in budget authority
for 1999, $7,379 million in advance appropriations over
the years 1999–2003, and an additional $350 million
in 2004 to fully fund the remaining costs of the International Space Station. This will be an international
laboratory in low earth orbit on which American, Russian, Canadian, European, and Japanese astronauts
will conduct unique scientific and technological investigations in a microgravity environment. During 1993
the program underwent a major redesign to reduce program costs. The first launch to begin construction of
the Station is scheduled for mid-1998 and final assembly will be complete by 2004. Advance appropriations
will enable NASA to complete the development program
on schedule and at minimal total cost. Since the redesign, Congress has already appropriated $11.1 billion
through 1998.
National Science Foundation (NSF)
This budget requests $44 million in 1999 and $95
million in advance appropriations for 2000–2003 to

139

complete the redevelopment of the U.S. station at the
South Pole in Antarctica and to complete NSF’s contribution to the International Large Hadron Collider.
These amounts include $22 million in 1999 and $36
million for 2000–2001 to complete the redevelopment
of the South Pole station. This will provide a platform
for scientific activities, provide a safe working and living environment, and maintain a U.S. presence in the
Antarctica in accordance with national policy.
The Large Hadron Collider will be the largest particle
accelerator in the world, and will be owned and operated by the European Laboratory for Particle Physics
(CERN). NSF is collaborating with the Department of
Energy in the development of detectors for the project.
The budget requests $22 million in 1999 and $59 million in 2000–2003 to complete NSF’s contribution.
Smithsonian Institution
This budget requests $16 million in budget authority
for regular appropriations in 1999 and $19 million in
advance appropriations for 2000 to complete construction of the National Museum of the American Indian.
Congress has already appropriated $38 million through
1998.

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Appendix to Part II: PRINCIPLES OF BUDGETING FOR CAPITAL ASSET ACQUISITIONS
Introduction and Summary
The Administration plans to use the following principles in budgeting for capital asset acquisitions. These
principles address planning, costs and benefits, financing, and risk management requirements that should
be satisfied before a proposal for the acquisition of capital assets can be included in the Administration’s
budget. A Glossary describes key terms. A Capital
Programming Guide has been published that provides
detailed information on planning and acquisition of capital assets.
The principles are organized in the following four
sections:
A. Planning. This section focuses on the need to ensure that capital assets support core/priority missions
of the agency; the assets have demonstrated a projected
return on investment that is clearly equal to or better
than alternative uses of available public resources; the
risk associated with the assets is understood and managed at all stages; and the acquisition is implemented
in phased, successive segments, unless it can be demonstrated there are significant economies of scale at
acceptable risk from funding more than one segment
or there are multiple units that need to be acquired
at the same time.
B. Costs and Benefits. This section emphasizes that
the asset should be justified primarily by benefit-cost
analysis, including life-cycle costs; that all costs are
understood in advance; and that cost, schedule, and
performance goals are identified that can be measured
using an earned value management system or similar
system.
C. Principles of Financing. This section stresses that
useful segments are to be fully funded with regular
or advance appropriations; that as a general rule, planning segments should be financed separately from procurement of the asset; and that agencies are encouraged
to aggregate assets in capital acquisition accounts and
take other steps to accommodate lumpiness or ‘‘spikes’’
in funding for justified acquisitions.
D. Risk Management. This section is to help ensure
that risk is analyzed and managed carefully in the acquisition of the asset. Strategies can include separate
accounts for capital asset acquisitions, the use of apportionment to encourage sound management, and the selection of efficient types of contracts and pricing mechanisms in order to allocate risk appropriately between
the contractor and the Government. In addition cost,
schedule, and performance goals are to be controlled
and monitored by using an earned value management
system or a similar system; and if progress toward
these goals is not met there is a formal review process
to evaluate whether the acquisition should continue or
be terminated.
A Glossary defines key terms, including capital assets. As defined here, capital assets are land, structures, equipment, and intellectual property (including
software) that are used by the Federal Government,

including weapon systems. Not included are grants to
States or others for their acquisition of capital assets.
A. Planning
Investments in major capital assets proposed for
funding in the Administration’s budget should:
1. support core/priority mission functions that need
to be performed by the Federal Government;
2. be undertaken by the requesting agency because
no alternative private sector or governmental
source can support the function more efficiently;
3. support work processes that have been simplified
or otherwise redesigned to reduce costs, improve
effectiveness, and make maximum use of commercial, off-the-shelf technology;
4. demonstrate a projected return on the investment
that is clearly equal to or better than alternative
uses of available public resources. Return may
include: improved mission performance in accordance with measures developed pursuant to the
Government Performance and Results Act; reduced cost; increased quality, speed, or flexibility;
and increased customer and employee satisfaction. Return should be adjusted for such risk factors as the project’s technical complexity, the
agency’s management capacity, the likelihood of
cost overruns, and the consequences of under- or
non-performance;
5. for information technology investments, be consistent with Federal, agency, and bureau information architectures which: integrate agency work
processes and information flows with technology
to achieve the agency’s strategic goals; reflect the
agency’s technology vision and year 2000 compliance plan; and specify standards that enable information exchange and resource sharing, while
retaining flexibility in the choice of suppliers and
in the design of local work processes;
6. reduce risk by: avoiding or isolating custom-designed components to minimize the potential adverse consequences on the overall project; using
fully tested pilots, simulations, or prototype implementations when necessary before going to
production; establishing clear measures and accountability for project progress; and, securing
substantial involvement and buy-in throughout
the project from the program officials who will
use the system;
7. be implemented in phased, successive segments
as narrow in scope and brief in duration as practicable, each of which solves a specific part of
an overall mission problem and delivers a measurable net benefit independent of future segments, unless it can be demonstrated that there
are significant economies of scale at acceptable
risk from funding more than one segment or
there are multiple units that need to be acquired
at the same time; and

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FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING

8.

employ an acquisition strategy that appropriately
allocates risk between the Government and the
contractor, effectively uses competition, ties contract payments to accomplishments, and takes
maximum advantage of commercial technology.
Prototypes require the same justification as other
capital assets.
As a general presumption, the Administration will
recommend new or continued funding only for those
capital asset investments that satisfy good capital programming policies. Funding for those projects will be
recommended on a phased basis by segment, unless
it can be demonstrated that there are significant economies of scale at acceptable risk from funding more than
one segment or there are multiple units that need to
be acquired at the same time. (For more information,
see the Glossary entry, ‘‘capital project and useful segments of a capital project.’’)
The Administration recognizes that many agencies
are in the middle of ongoing projects, and they may
not be able immediately to satisfy the criteria. For
those projects that do not satisfy the criteria, OMB
will consider requests to use 1998 and 1999 funds to
finance additional planning, as necessary, to support
the establishment of realistic cost, schedule, and performance goals for the completion of the project. This
planning could include: the redesign of work processes,
the evaluation of alternative solutions, the development
of information system architectures, and, if necessary,
the purchase and evaluation of prototypes. Realistic
goals are necessary for agency portfolio analysis to determine the viability of the project, to provide the basis
for fully funding the project to completion, and setting
the baseline for management accountability to deliver
the project within goals.
Because the Administration considers this information essential to agencies’ long-term success, the Administration will use this information both in preparing
its budget and, in conjunction with cost, schedule, and
performance data, as apportionments are made. Agencies are encouraged to work with their OMB representative to arrive at a mutually satisfactory process, format, and timetable for providing the requested information.
B. Costs and Benefits
The justification of the project should evaluate and
discuss the extent to which the project meets the above
criteria and should also include:
1. an analysis of the project’s total life-cycle costs
and benefits, including the total budget authority
required for the asset, consistent with policies described in OMB Circular A–94: ‘‘Guidelines and
Discount Rates for Benefit-Cost Analysis of Federal Programs’’ (October 1992);
2. an analysis of the risk of the project including
how risks will be isolated, minimized, monitored,
and controlled, and, for major programs, an evaluation and estimate by the Chief Financial Offi-

3.

4.

cer of the probability of achieving the proposed
goals;
if, after the planning phase, the procurement is
proposed for funding in segments, an analysis
showing that the proposed segment is economically and programmatically justified—that is, it
is programmatically useful if no further investments are funded, and in this application its benefits exceed its costs; and
show cost, schedule, and performance goals for
the project (or the useful segment being proposed)
that can be measured throughout the acquisition
process using an earned value management system or similar system. Earned value is described
in OMB Circular A–11, Part 3, ‘‘Planning, Budgeting and Acquisition of Capital Assets,’’ (June
1997), Appendix 300C.
C. Principles of Financing

Principle 1: Full Funding
Budget authority sufficient to complete a useful segment of a capital project (or the entire capital project,
if it is not divisible into useful segments) must be appropriated before any obligations for the useful segment
(or project) may be incurred.
Explanation: Good budgeting requires that appropriations for the full costs of asset acquisition be enacted in advance to help ensure that all costs and benefits are fully taken into account at the time decisions
are made to provide resources. Full funding with regular appropriations in the budget year also leads to
tradeoffs within the budget year with spending for
other capital assets and with spending for purposes
other than capital assets. Full funding increases the
opportunity to use performance-based fixed price contracts, allows for more efficient work planning and
management of the capital project, and increases the
accountability for the achievement of the baseline goals.
When full funding is not followed and capital projects
or useful segments are funded in increments, without
certainty if or when future funding will be available,
the result is sometimes poor planning, acquisition of
assets not fully justified, higher acquisition costs, cancellation of major projects, the loss of sunk costs, or
inadequate funding to maintain and operate the assets.
Principle 2: Regular and Advance Appropriations
Regular appropriations for the full funding of a capital project or a useful segment of a capital project in
the budget year are preferred. If this results in spikes
that, in the judgment of OMB, cannot be accommodated
by the agency or the Congress, a combination of regular
and advance appropriations that together provide full
funding for a capital project or a useful segment should
be proposed in the budget.
Explanation: Principle 1 (Full Funding) is met as
long as a combination of regular and advance appropriations provide budget authority sufficient to complete the capital project or useful segment. Full funding

142
in the budget year with regular appropriations alone
is preferred because it leads to tradeoffs within the
budget year with spending for other capital assets and
with spending for purposes other than capital assets.
In contrast, full funding for a capital project over several years with regular appropriations for the first year
and advance appropriations for subsequent years may
bias tradeoffs in the budget year in favor of the proposed asset because with advance appropriations the
full cost of the asset is not included in the budget
year. Advance appropriations, because they are scored
in the year they become available for obligation, may
constrain the budget authority and outlays available
for regular appropriations of that year.
If, however, the lumpiness caused by regular appropriations cannot be accommodated within an agency
or Appropriations Subcommittee, advance appropriations can ameliorate that problem while still providing
that all of the budget authority is enacted in advance
for the capital project or useful segment. The latter
helps ensure that agencies develop appropriate plans
and budgets and that all costs and benefits are identified prior to providing resources. In addition, amounts
of advance appropriations can be matched to funding
requirements for completing natural components of the
useful segment. Advance appropriations have the same
benefits as regular appropriations for improved planning, management, and accountability of the project.
Principle 3: Separate Funding of Planning Segments
As a general rule, planning segments of a capital
project should be financed separately from the procurement of a useful asset.
Explanation: The agency must have information
that allows it to plan the capital project, develop the
design, and assess the benefits, costs, and risks before
proceeding to procurement of the useful asset. This is
especially important for high risk acquisitions. This information comes from activities, or planning segments,
that include but are not limited to market research
of available solutions, architectural drawings, geological
studies, engineering and design studies, and prototypes.
The construction of a prototype that is a capital asset,
because of its cost and risk, should be justified and
planned as carefully as the project itself. The process
of gathering information for a capital project may consist of one or more planning segments, depending on
the nature of the asset. Funding these segments separately will help ensure that the necessary information
is available to establish cost, schedule, and performance
goals before proceeding to procurement.
If budget authority for planning segments and procurement of the useful asset are enacted together, the
Administration may wish to apportion budget authority
for one or several planning segments separately from
procurement of the useful asset.

ANALYTICAL PERSPECTIVES

Principle 4: Accommodation of Lumpiness or
‘‘Spikes’’ and Separate Capital Acquisition Accounts
To accommodate lumpiness or ‘‘spikes’’ in funding justified capital acquisitions, agencies, working with OMB,
are encouraged to aggregate financing for capital asset
acquisitions in one or several separate capital acquisition budget accounts within the agency, to the extent
possible within the agency’s total budget request.
Explanation: Large, temporary, year-to-year increases in budget authority, sometimes called lumps
or spikes, may create a bias against the acquisition
of justified capital assets. Agencies, working with OMB,
should seek ways to avoid this bias and accommodate
such spikes for justified acquisitions. Aggregation of
capital acquisitions in separate accounts may:
• reduce spikes within an agency or bureau by providing roughly the same level of spending for acquisitions each year;
• help to identify the source of spikes and to explain
them. Capital acquisitions are more lumpy than
operating expenses; and with a capital acquisition
account, it can be seen that an increase in operating expenses is not being hidden and attributed
to one-time asset purchases;
• reduce the pressure for capital spikes to crowd
out operating expenses; and
• improve justification and make proposals easier
to evaluate, since capital acquisitions are generally analyzed in a different manner than operating expenses (e.g., capital acquisitions have a
longer time horizon of benefits and life-cycle
costs).
D. Risk Management
Risk management should be central to the planning,
budgeting, and acquisition process. Failure to analyze
and manage the inherent risk in all capital asset acquisitions may contribute to cost overruns, schedule shortfalls, and acquisitions that fail to perform as expected.
For each major capital project a risk analysis that includes how risks will be isolated, minimized, monitored,
and controlled may help prevent these problems.
The project cost, schedule and performance goals established through the planning phase of the project
are the basis for approval to procure the asset and
the basis for assessing risk. During the procurement
phase performance-based management systems (earned
value or similar system) must be used to provide contractor and Government management visibility on the
achievement of, or deviation from, goals until the asset
is accepted and operational. If goals are not being met,
performance-based management systems allow for early
identification of problems, potential corrective actions,
and changes to the original goals needed to complete
the project and necessary for agency portfolio analysis
decisions. These systems also allow for Administration
decisions to recommend meaningful modifications for
increased funding to the Congress, or termination of

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FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING

the project, based on its revised expected return on
investment in comparison to alternative uses of the
funds. Agencies must ensure that the necessary acquisition strategies are implemented to reduce the risk of
cost escalation and the risk of failure to achieve schedule and performance goals. These strategies may include:
1. having budget authority appropriated in separate
capital asset acquisition accounts;
2. apportioning budget authority for a useful segment;
3. establishing thresholds for cost, schedule, and
performance goals of the acquisition, including return on investment, which if not met may result
in cancellation of the acquisition;
4. selecting types of contracts and pricing mechanisms that are efficient and that provide incentives to contractors in order to allocate risk appropriately between the contractor and the Government;
5. monitoring cost, schedule, and performance goals
for the project (or the useful segment being proposed) using an earned value management system or similar system. Earned value is described
in OMB Circular A–11, Part 3, ‘‘Planning, Budgeting and Acquisition of Capital Assets’’ (June
1997), Appendix 300C; and
6. if progress is not within 90 percent of goals, or
if new information is available that would indicate a greater return on investment from alternative uses of funds, institute senior management
review of the project through portfolio analysis
to determine the continued viability of the project
with modifications, or the termination of the
project, and the start of exploration for alternative solutions if it is necessary to fill a gap
in agency strategic goals and objectives.
E. Glossary
Appropriations
An appropriation provides budget authority that permits Government officials to incur obligations that result in immediate or future outlays of Government
funds.
Regular annual appropriations: These appropriations are:
• enacted normally in the current year;
• scored entirely in the budget year; and
• available for obligation in the budget year and
subsequent years if specified in the language. (See
‘‘Availability,’’ below.)
Advance appropriations: Advance appropriations
may be accompanied by regular annual appropriations
to provide funds available for obligation in the budget
year as well as subsequent years. Advance appropriations are:
• enacted normally in the current year;

143
• scored after the budget year (e.g., in each of one,
two, or more later years, depending on the language); and
• available for obligation in the year scored and subsequent years if specified in the language. (See
‘‘Availability,’’ below.)
• Availability: Appropriations made in appropriations acts are available for obligation only in the
budget year unless the language specifies that an
appropriation is available for a longer period. If
the language specifies that the funds are to remain available until the end of a certain year
beyond the budget year, the availability is said
to be ‘‘multi-year.’’ If the language specifies that
the funds are to remain available until expended,
the availability is said to be ‘‘no-year.’’ Appropriations for major procurements and construction
projects are typically made available for multiple
years or until expended.

Capital Assets
Capital assets are land, structures, equipment, and
intellectual property (including software) that are used
by the Federal Government and have an estimated useful life of two years or more. Capital assets exclude
items acquired for resale in the ordinary course of operations or held for the purpose of physical consumption
such as operating materials and supplies. The cost of
a capital asset includes both its purchase price and
all other costs incurred to bring it to a form and location suitable for its intended use.
Capital assets may be acquired in different ways:
through purchase, construction, or manufacture;
through a lease-purchase or other capital lease, regardless of whether title has passed to the Federal Government; through an operating lease for an asset with
an estimated useful life of two years or more; or
through exchange. Capital assets include leasehold improvements and land rights; assets owned by the Federal Government but located in a foreign country or
held by others (such as Federal contractors, state and
local governments, or colleges and universities); and
assets whose ownership is shared by the Federal Government with other entities. Capital assets include not
only the assets as initially acquired but also additions;
improvements; replacements; rearrangements and reinstallations; and major repairs but not ordinary repairs and maintenance.
Examples of capital assets include the following, but
are not limited to them:
• office buildings, hospitals, laboratories, schools,
and prisons;
• dams, power plants, and water resources projects;
• furniture, elevators, and printing presses;
• motor vehicles, airplanes, and ships;
• satellites and space exploration equipment;
• information technology hardware and software;
and
• Department of Defense weapons systems.
Capital assets may or may not be capitalized (i.e.,
recorded in an entity’s balance sheet) under Federal

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ANALYTICAL PERSPECTIVES

accounting standards. Examples of capital assets not
capitalized are Department of Defense weapons systems, heritage assets, stewardship land, and some software.
Capital assets do not include grants for acquiring
capital assets made to state and local governments or
other entities (such as National Science Foundation
grants to universities or Department of Transportation
grants to AMTRAK). Capital assets also do not include
intangible assets such as the knowledge resulting from
research and development or the human capital resulting from education and training, although capital assets
do include land, structures, equipment, and intellectual
property (including software) that the Federal Government uses in research and development and education
and training.

of whether the other buildings are constructed, even
though that building may not be at its maximum use.
Illustration 2: If the full acquisition is for several
items (e.g., aircraft), the useful segment would be the
number of complete aircraft required to achieve benefits
that exceed costs even if no further funding becomes
available. In contrast, some portion of several aircraft
(e.g., engines for five aircraft) would not be a useful
segment if no further funding is available, nor would
one aircraft be a useful segment if two or more are
required for benefits to exceed costs.
Illustration 3: For information technology, a module
(the information technology equivalent of ‘‘useful segment’’) is separable if it is useful in itself without subsequent modules. The module should be designed so that
it can be enhanced or integrated with subsequent modules if future funding becomes available.

Capital Project and Useful Segments of a Capital
Project
The total capital project, or acquisition of a capital
asset, includes useful segments that are either planning
segments or useful assets.

Earned Value
Earned value refers to a performance-based management system for establishing baseline cost, schedule,
and performance goals for a capital project and measuring progress against the goals. Earned value is described in OMB Circular A–11, Part 3, ‘‘Planning, Budgeting and Acquisition of Capital Assets’’ (June 1997),
Appendix 300C.

Planning segments: A planning segment of a capital
project provides information that allows the agency to
develop the design; assess the benefits, costs, and risks;
and establish realistic baseline cost, schedule, and performance goals before proceeding to full acquisition of
the useful asset (or canceling the acquisition). This information comes from activities, or planning segments,
that include but are not limited to market research
of available solutions, architectural drawings, geological
studies, engineering and design studies, and prototypes.
The process of gathering information for a capital
project may consist of one or more planning segments,
depending on the nature of the asset. If the project
includes a prototype that is a capital asset, the prototype may itself be one segment or may be divisible
into more than one segment. Because of uncertainty
regarding the identification of separate planning segments for research and development activities, the application of full funding concepts to research and development planning will need more study.
Useful asset: A useful asset is an economically and
programmatically separate segment of the asset procurement stage of the capital project that provides an
asset for which the benefits exceed the costs, even if
no further funding is appropriated. The total capital
asset procurement may include one or more useful assets, although it may not be possible to divide all procurements in this way. Illustrations follow:
Illustration 1: If the construction of a building meets
the justification criteria and has benefits greater than
its costs without further investment, then the construction of that building is a ‘‘useful segment.’’ Excavation
is not a useful segment because no useful asset results
from the excavation alone if no further funding becomes
available. For a campus of several buildings, a useful
segment is one complete building if that building has
programmatic benefits that exceed its costs regardless

Funding
Full funding: Full funding means that appropriations—regular appropriations or advance appropriations—are enacted that are sufficient in total to complete a useful segment of a capital project before any
obligations may be incurred for that segment. Full
funding for an entire capital project is required if the
project cannot be divided into more than one useful
segment. If the asset can be divided into more than
one useful segment, full funding for a project may be
desirable, but is not required to constitute full funding.
Incremental (partial) funding: Incremental (partial)
funding means that appropriations—regular appropriations or advance appropriations—are enacted for just
part of a useful segment of a capital project, if the
project has useful segments, or for part of the capital
project as a whole, if it is not divisible into useful
segments. Under incremental funding for a capital
asset, which is not permitted under these principles,
the funds could be obligated to start the segment (or
project) despite the fact that they are insufficient to
complete a useful segment or project.
Risk Management
Risk management is an organized method of identifying and measuring risk and developing, selecting, and
managing options for handling these risks. Before beginning any procurement, managers should review and
revise as needed the acquisition plan to ensure that
risk management techniques considered in the planning
phase are still appropriate.
There are three key principles for managing risk
when procuring capital assets: (1) avoiding or limiting
the amount of development work; (2) making effective

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FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING

use of competition and financial incentives; and (3) establishing a performance-based acquisition management system that provides for accountability for program successes and failures, such as an earned value
system or similar system.
There are several types of risk an agency should consider as part of risk management. The types of risk
include:

•
•
•
•
•

schedule risk;
cost risk;
technical feasibility;
risk of technical obsolescence;
dependencies between a new project and other
projects or systems (e.g., closed architectures); and
• risk of creating a monopoly for future procurement.

146

ANALYTICAL PERSPECTIVES

Part III: FEDERALLY FINANCED CAPITAL STOCKS
Federal investment spending creates a ‘‘stock’’ of capital that is available in the future for productive use.
Each year, Federal investment outlays add to the stock
of capital. At the same time, however, wear and tear
and obsolescence reduce it. This section presents very
rough measures over time of three different kinds of
capital stocks financed by the Federal Government:
public physical capital, research and development
(R&D), and education.
Federal spending for physical assets adds to the Nation’s capital stock of tangible assets, such as roads,
buildings, and aircraft carriers. These assets deliver
a flow of services over their lifetime. The capital depreciates as the asset ages, wears out, is accidentally damaged, or becomes obsolete.
Federal spending for the conduct of research, development, and education adds to an ‘‘intangible’’ asset, the
Nation’s stock of knowledge. Although financed by the
Federal Government, the research and development or
education can be performed by Federal or State government laboratories, universities and other nonprofit organizations, or private industry. Research and development covers a wide range of activities, from the investigation of subatomic particles to the exploration of
outer space; it can be ‘‘basic’’ research without particular applications in mind, or it can have a highly specific
practical use. Similarly, education includes a wide variety of programs, assisting people of all ages beginning
with pre-school education and extending through graduate studies and adult education. Like physical assets,
the capital stocks of R&D and education provide services over a number of years and depreciate as they
become outdated.
For this analysis, physical and R&D capital stocks
are estimated using the perpetual inventory method.
In this method, the estimates are based on the sum
of net investment in prior years. Each year’s Federal
outlays are treated as gross investment, adding to the
capital stock; depreciation reduces the capital stock.
Gross investment less depreciation is net investment.
A limitation of the perpetual inventory method is that
investment spending is not necessarily an accurate
measure of the value of the asset created. However,
alternative methods for measuring asset value, such
as direct surveys of current market worth or indirect
estimation based on an expected rate of return, are
especially difficult to apply to assets that do not have
a private market, such as highways or weapons systems.
In contrast to physical and R&D stocks, the estimate
of the education stock is based on the replacement cost
method. Data on the total years of education of the
U.S. population are combined with data on the cost
of education and the Federal share of education spending to yield the cost of replacing the Federal share
of the Nation’s stock of education.
Additional detail about the methods used to estimate
capital stocks appears in a methodological note at the

end of this section. It should be stressed that these
estimates are rough approximations, and provide a
basis only for making broad generalizations. Errors may
arise from uncertainty about the useful lives and depreciation rates of different types of assets, incomplete
data for historical outlays, and imprecision in the
deflators used to express costs in constant dollars. The
substantial upward revisions in the estimates of physical capital stocks this year, discussed below, provide
an example of the impact of changes in underlying assumptions.
The Stock of Physical Capital
This section presents data on stocks of physical capital assets and estimates of the depreciation on these
assets.
Trends.—Table 6–6 shows the value of the net federally financed physical capital stock since 1960, in constant fiscal year 1992 dollars.3 After rising in the
1960s, the total stock held constant through the 1970s
and began rising again in the early 1980s. The stock
amounted to $1,827 billion in 1997 and is estimated
to increase slightly to $1,839 billion by 1999. In 1997,
the national defense capital stock accounted for $657
billion, or 36 percent of the total, and nondefense stocks
for $1,170 billion, or 64 percent of the total.
The stock data shown here are revised significantly
from the figures reported in the budget last year, because of changes in estimating techniques to conform
to the changes in depreciation methods in the recent
revision of the National Income and Product Accounts.
As described in the technical note at the end of this
section, the new methods result in reduced depreciation
estimates and therefore larger stocks. The total physical
capital stock reported last year for 1996 was $1,491
billion, compared to $1,820 billion now estimated for
that year, an increase of 22 percent. The largest revisions were in the stocks for grant-financed capital,
which increased 43 percent relative to the earlier figures. Direct stocks increased by 31 percent for nondefense and only 1 percent for defense capital. Stocks
of direct defense and nondefense equipment fell from
the previous estimate, by 24 percent and 42 percent
respectively.
Real stocks of defense and nondefense capital show
very different trends. Nondefense stocks have grown
consistently since 1970, increasing from $476 billion
in 1970 to $1,170 billion in 1997. With the investments
proposed in the budget, nondefense stocks are estimated to grow to $1,224 billion in 1999. During the
1970s, the nondefense capital stock grew at an average
annual rate of 4.5 percent. In the 1980s, however, the
growth rate slowed to 2.8 percent annually, with growth
continuing at about that rate since then.
3
Constant dollar stock estimates are expressed in chained 1992 dollars, consistent with
the revisions to the National Income and Product Accounts (NIPAs) released in January
1996.

6.

147

FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING

Table 6–6.

NET STOCK OF FEDERALLY FINANCED PHYSICAL CAPITAL
(In billions of 1992 dollars)
Nondefense

Fiscal Year

Total

National
Defense

Total

Five year intervals:
1960 ...............................................
1965 ...............................................
1970 ...............................................
1975 ...............................................
1980 ...............................................
1985 ...............................................
Annual data:
1990 ...............................................
1991 ...............................................
1992 ...............................................
1993 ...............................................
1994 ...............................................
1995 ...............................................
1996 ...............................................
1997 ...............................................
1998 est. ........................................
1999 est. ........................................

Capital Financed by Federal Grants

Direct Federal Capital
Total Nondefense

Water and
Power

Total

Other

Transportation

Community
and
Regional

Natural
Resources

Other

895
964
1,098
1,142
1,237
1,442

633
599
621
553
498
587

262
365
476
589
738
855

128
160
182
203
230
256

78
96
109
124
145
157

50
64
72
79
85
99

134
205
295
386
508
599

82
145
211
260
313
365

24
29
42
67
104
126

19
20
24
37
68
86

9
11
18
22
23
22

1,692
1,729
1,760
1,783
1,797
1,810
1,820
1,827
1,831
1,839

719
733
736
733
719
700
679
657
634
615

973
996
1,024
1,051
1,078
1,109
1,141
1,170
1,196
1,224

288
295
304
312
318
325
333
340
342
346

166
168
171
172
173
174
175
174
174
174

121
127
134
140
145
151
159
165
167
172

685
702
719
738
760
784
807
831
855
878

426
438
451
464
478
493
508
522
537
552

136
138
139
141
142
145
148
150
153
155

98
100
102
103
105
106
108
109
110
111

24
26
28
30
34
39
44
49
55
60

Real national defense stocks began in 1970 at a relatively high level, and declined steadily throughout the
decade, as depreciation from the Vietnam era exceeded
new investment in military construction and weapons
procurement. Starting in the early 1980s, however, a
large defense buildup began to increase the stock of
defense capital. By 1987, the defense stock had exceeded its size at the height of the Vietnam War. In
the last few years, depreciation on this increased stock
and a slower pace of defense investment have begun
to reduce the stock from its recent levels. The stock
is estimated to fall from $657 billion in 1997 to $615
billion in 1999.
Another trend in the Federal physical capital stocks
is the shift from direct Federal assets to grant-financed
assets. In 1960, 49 percent of federally financed nondefense capital was owned by the Federal Government,
and 51 percent was owned by State and local governments but financed by Federal grants. Expansion in
Federal grants for highways and other state and local
capital, coupled with relatively slow growth in direct
Federal investments by agencies such as the Bureau
of Reclamation and Corps of Engineers, shifted the composition of the stock substantially. In 1997, 29 percent
of the nondefense stock was owned by the Federal Government and 71 percent by State and local governments.
The growth in the stock of physical capital financed
by grants has come in several areas. The growth in
the stock for transportation is largely grants for highways, including the Interstate Highway System. The
growth in community and regional development stocks
occurred largely with the enactment of the community
development block grant in the early 1970s. The value
of this capital stock has grown only slowly in the past
few years. The growth in the natural resources area
occurred primarily because of construction grants for

sewage treatment facilities. The value of this federally
financed stock has also been relatively stable since the
mid-1980s.
Table 6–7 shows nondefense physical capital outlays
both gross and net of depreciation since 1960. Total
nondefense net investment has been consistently positive over the period covered by the table, indicating
that new investment has exceeded depreciation on the
existing stock. The reduced amount of net investment
in 1998 reflects the sale of the United States Enrichment Corporation and the privatization of Elk Hills.
For some categories in the table, such as water and
power programs, net investment has been negative in
some years, indicating that new investment has not
been sufficient to offset estimated depreciation. The net
investment in this table is the change in the net nondefense physical capital stock displayed in Table 6–6.
The Stock of Research and Development Capital
This section presents data on the stock of research
and development, taking into account adjustments for
its depreciation.
Trends.—As shown in Table 6–8, the R&D capital
stock financed by Federal outlays is estimated to be
$801 billion in 1997 in constant 1992 dollars. About
two–fifths is the stock of basic research knowledge;
about three-fifths is the stock of applied research and
development.
The total federally financed R&D stock in 1997 was
about evenly divided between defense and nondefense.
Although investment in defense R&D has exceeded that
of nondefense R&D in every year since 1979, the nondefense R&D stock is actually the larger of the two,
because of the different emphasis on basic research and
applied research and development. Defense R&D spending is heavily concentrated in applied research and de-

148

ANALYTICAL PERSPECTIVES

Table 6–7.

COMPOSITION OF GROSS AND NET FEDERAL AND FEDERALLY FINANCED NONDEFENSE PUBLIC PHYSICAL
INVESTMENT
(In billions of 1992 dollars)
Total nondefense investment

Direct Federal investment

Investment financed by Federal grants

Composition of net
investment
Fiscal Year
Gross

Five year intervals:
1960 ........................
1965 ........................
1970 ........................
1975 ........................
1980 ........................
1985 ........................
Annual data:
1990 ........................
1991 ........................
1992 ........................
1993 ........................
1994 ........................
1995 ........................
1996 ........................
1997 ........................
1998 est. .................
1999 est. .................

Depreciation

Net

Gross

Depreciation

Net

Water
and
power

Composition of net investment
Gross

Depreciation

Net

Other

Transportation
(mainly
highways)

Community and
regional
development

Natural
resources and
environment

Other

23.7
31.6
30.6
31.9
45.0
43.2

5.0
7.0
9.1
11.0
13.5
16.4

18.7
24.6
21.5
20.8
31.5
26.7

8.7
10.4
6.9
9.6
11.5
13.8

2.9
3.8
4.4
4.9
5.4
6.9

5.8
6.6
2.4
4.8
6.0
6.9

3.0
3.1
2.0
3.7
3.9
2.3

2.7
3.5
0.5
1.1
2.1
4.6

15.0
21.2
23.7
22.2
33.5
29.4

2.1
3.2
4.7
6.2
8.1
9.6

12.9
18.0
19.1
16.1
25.5
19.8

12.3
15.2
11.9
7.3
12.3
13.1

0.1
2.0
4.8
4.0
7.0
3.8

0.1
0.4
0.9
4.1
6.3
3.0

0.5
0.4
1.5
0.6
–0.2
–0.1

43.5
45.3
49.3
49.6
50.7
55.5
56.7
55.4
52.4
54.4

20.6
21.3
22.0
22.8
23.5
24.1
24.9
25.8
26.4
26.9

22.9
24.0
27.3
26.8
27.2
31.4
31.7
29.6
26.1
27.5

15.7
16.9
20.3
19.0
16.9
18.8
20.2
18.8
14.4
17.0

9.6
10.0
10.5
11.0
11.3
11.6
12.0
12.4
12.6
12.8

6.1
6.9
9.8
8.1
5.6
7.3
8.2
6.4
1.7
4.2

2.0
1.5
2.9
1.6
0.5
1.5
0.6
–0.5
–*
–0.6

4.1
5.4
6.9
6.5
5.0
5.8
7.6
6.9
1.8
4.9

27.8
28.3
29.1
30.6
33.8
36.7
36.5
36.6
38.1
37.4

11.0
11.3
11.6
11.9
12.2
12.6
13.0
13.3
13.7
14.1

16.8
17.1
17.5
18.7
21.6
24.1
23.5
23.2
24.3
23.3

12.1
12.1
12.3
13.4
14.1
15.0
14.6
14.7
14.8
14.6

1.5
1.4
1.5
1.3
1.9
2.5
2.7
2.5
2.8
2.6

1.9
2.0
1.9
1.6
1.4
1.8
1.4
1.3
1.2
1.0

1.3
1.5
1.9
2.4
4.3
4.9
4.9
4.8
5.5
5.1

* $50 million or less.

velopment, which depreciates much more quickly than
basic research. The stock of applied research and development is assumed to depreciate at a ten percent geometric rate, while basic research is assumed not to
depreciate at all.
The defense R&D stock rose slowly during the 1970s,
as gross outlays for R&D trended down in constant
dollars and the stock created in the 1960s depreciated.
A renewed emphasis on defense R&D spending from
1980 through 1989 led to a more rapid growth of the
R&D stock. Since then, defense R&D outlays have tapered off, depreciation has grown, and, as a result,
the net defense R&D stock has stabilized.
The growth of the nondefense R&D stock slowed from
the 1970s to the late 1980s, from an annual rate of
3.8 percent in the 1970s to a rate of 1.7 percent from
1980 to 1988. Gross investment in real terms fell during much of the 1980s, and about three-fourths of new
outlays went to replacing depreciated R&D. Since 1988,
however, nondefense R&D outlays have been on an upward trend while depreciation has edged down. As a
result, the net nondefense R&D capital stock has grown
more rapidly.
The Stock of Education Capital
This section presents estimates of the stock of education capital financed by the Federal government.
As shown in Table 6–9, the federally financed education stock is estimated at $842 billion in 1997 in
constant 1992 dollars, rising to $920 billion in 1999.
The vast majority of the Nation’s education stock is
financed by State and local governments, and by students and their families themselves. This federally financed portion of the stock represents about 3 percent

of the Nation’s total education stock.4 Nearly threequarters is for elementary and secondary education,
while the remaining one quarter is for higher education.
Despite a slowdown in growth during the early 1980s,
the stock grew at an average annual rate of 5.0 percent
from 1970 to 1997, and the expansion of the education
stock is projected to continue under this budget.
Note on Estimating Methods
This note provides further technical detail about the
estimation of the capital stock series presented in Tables 6–6 through 6–9.
As stated previously, the capital stock estimates are
very rough approximations. Sources of possible error
include:
The historical outlay series.—The historical outlay
series for physical capital was based on budget records
since 1940 and was extended back to 1915 using data
from selected sources. There are no consistent outlay
data on physical capital for this earlier period, and
the estimates are approximations. In addition, the historical outlay series in the budget for physical capital
extending back to 1940 may be incomplete. The historical outlay series for the conduct of research and development began in the early 1950s and required selected
sources to be extended back to 1940. In addition, separate outlay data for basic research and applied R&D
were not available for any years and had to be estimated from obligations and budget authority. For education, data for Federal outlays from the budget were
combined with data for non-Federal spending from the
4
For estimates of the total education stock, see Table 2–4 in Chapter 2, ‘‘Stewardship:
Toward a Federal Balance Sheet.’’

6.

149

FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING

Table 6–8.

NET STOCK OF FEDERALLY FINANCED RESEARCH AND DEVELOPMENT 1
(In billions of 1992 dollars)
National Defense

Fiscal Year

Basic
Research

Total

Five year intervals:
1970 .............................................................................
1975 .............................................................................
1980 .............................................................................
1985 .............................................................................
Annual data:
1990 .............................................................................
1991 .............................................................................
1992 .............................................................................
1993 .............................................................................
1994 .............................................................................
1995 .............................................................................
1996 .............................................................................
1997 .............................................................................
1998 est. ......................................................................
1999 est. ......................................................................
1

Nondefense
Applied
Research and
Development

Basic
Research

Total

Total Federal
Applied
Research and
Development

Basic
Research

Total

Applied
Research and
Development

235
249
252
288

14
19
22
27

221
231
229
260

194
237
280
304

60
88
118
156

133
149
162
148

429
486
532
592

74
106
141
184

354
380
391
408

357
361
365
368
371
370
370
368
365
362

32
33
34
36
37
38
39
40
41
42

325
328
331
333
334
333
331
328
324
320

341
354
366
380
393
407
420
433
446
461

205
216
227
238
249
261
272
283
295
308

137
138
140
142
144
146
148
149
151
153

699
715
732
748
764
777
790
801
811
823

237
249
261
274
286
298
311
323
336
349

462
466
471
474
477
479
479
477
475
473

Excludes outlays for physical capital for research and development, which are included in Table 6–6.

Table 6–9.

NET STOCK OF FEDERALLY FINANCED EDUCATION
CAPITAL
(In billions of 1992 dollars)

Five year intervals:
1960 ...............................................................................
1965 ...............................................................................
1970 ...............................................................................
1975 ...............................................................................
1980 ...............................................................................
1985 ...............................................................................
Annual data:
1990 ...............................................................................
1991 ...............................................................................
1992 ...............................................................................
1993 ...............................................................................
1994 ...............................................................................
1995 ...............................................................................
1996 ...............................................................................
1997 ...............................................................................
1998 est. ........................................................................
1999 est. ........................................................................

institution or jurisdiction receiving Federal funds,
which may introduce error because of differing fiscal
years and confusion about whether the Federal Government was the original source of funding.
Price adjustments.—The prices for the components
of the Federal stock of physical, R&D, and education
capital have increased through time, but the rates of
increase are not accurately known. Estimates of costs
in fiscal year 1992 prices were made through the application of price deflators from the National Income and
Product Accounts (NIPAs), but these should be considered only approximations of the costs of these assets
in 1992 prices.
Depreciation.—The useful lives of physical, R&D,
and education capital, as well as the pattern by which

Elementary
and Secondary Education

Higher Education

70
100
225
308
414
510

52
73
179
251
326
383

18
27
46
57
88
126

662
682
701
727
749
780
809
842
878
920

490
504
515
528
544
559
577
595
617
647

171
179
186
199
205
220
232
247
260
273

Total Education Stock

Fiscal Year

they depreciate, are very uncertain. This is compounded
by using depreciation rates for broad classes of assets,
which do not apply uniformly to all the components
of each group. As a result, the depreciation estimates
should also be considered approximations. This limitation is especially important in capital financed by
grants, where the specific asset financed with the grant
is often subject to the discretion of the recipient jurisdiction.
Research continues on the best methods to estimate
these capital stocks. The estimates presented in the
text could change as better information becomes available on the underlying investment data and as improved methods are developed for estimating the stocks
based on those data.

150
Physical Capital Stocks
For many years, current and constant-cost data on
the stock of most forms of public and private physical
capital—e.g., roads, factories, and housing—have been
estimated annually by the Bureau of Economic Analysis
(BEA) in the Department of Commerce. With the January 1996 comprehensive revision of the NIPAs, government investment has taken increased prominence. Government investment in physical capital is now reported
separately from government consumption expenditures,
and government consumption expenditures include a
measure of depreciation as the consumption of the existing capital stock. In addition, estimates of depreciation are improved based on recent empirical research.5
The BEA data are not directly linked to the Federal
budget, do not extend to the years covered by the budget, and do not separately identify the capital financed
but not owned by the Federal Government. For budgetary purposes, OMB prepares separate estimates,
using techniques that roughly follow the BEA methods.
Method of estimation.—The estimates were developed from the OMB historical data base for physical
capital outlays and grants to State and local governments for physical capital. These are the same major
public physical capital outlays presented in Part I. This
data base extends back to 1940 and was supplemented
by rough estimates for 1915–1939.
The deflators used to convert historical outlays to
constant 1992 dollars were based on composite NIPA
deflators for Federal, State, and local consumption of
durables and gross investment. For 1915 through 1929,
deflators were estimated from Census Bureau historical
statistics on constant price public capital formation.
The resulting capital stocks were aggregated into
nine categories and depreciated using geometric rates
roughly following those of BEA, which estimates depreciation using much more detailed categories. The geometric rates were 1.9 percent for water and power
projects; 2.4 percent for other direct non-defense construction and rehabilitation; 20.3 percent for non-defense equipment; 14.0 percent for defense equipment;
2.1 percent for defense structures; 1.6 percent for transportation grants; 1.7 percent for community and regional development grants; 1.5 percent for natural resources and environment grants; and 1.8 percent for
other nondefense grants. In previous estimates of physical capital stocks, OMB used straight-line depreciation
with useful lives roughly based on BEA’s methods prior
to its comprehensive revision.6 The new rates result
in slower depreciation and hence larger stocks over
time for all categories except equipment, where the
rates result in smaller stocks than before.
5
BEA explained its new methods and presented its revised estimates of capital stocks
in ‘‘Improved Estimates of Fixed Reproducible Tangible Wealth, 1929–95’’, Survey of Current
Business, May 1997, pp. 69–92. Updated estimates incorporating BEA’s annual revision
appear in ‘‘Fixed Reproducible Tangible Wealth in the United States: Revised Estimates
for 1993–95 and Summary Estimates for 1925–96’’, Survey of Current Business, September
1997, pp. 37–47.
6
The straight-line depreciation estimates were based on the following assumed useful
lives: 46 years for water and power projects; 40 years for other direct Federal construction
and all grant-financed capital; and 16 years for defense procurement and major nondefense
equipment.

ANALYTICAL PERSPECTIVES

Research and Development Capital Stocks
Method of estimation.—The estimates were developed from a data base for the conduct of research and
development largely consistent with the data in the
Historical Tables. Although there is no consistent time
series on basic and applied R&D for defense and nondefense outlays back to 1940, it was possible to estimate the data using obligations and budget authority.
The data are for the conduct of R&D only and exclude
outlays for physical capital for research and development, because those are included in the estimates of
physical capital. Nominal outlays were deflated by the
chained price index for gross domestic product (GDP)
in fiscal year 1992 dollars to obtain estimates of constant dollar R&D spending.
The appropriate depreciation rate of intangible R&D
capital is even more uncertain than that of physical
capital. Empirical evidence is inconclusive. It was assumed that basic research capital does not depreciate
and that applied research and development capital has
a ten percent geometric depreciation rate. These are
the same assumptions used in a study published by
the Bureau of Labor Statistics estimating the R&D
stock financed by private industry.7 More recent experimental work at BEA, extending estimates of tangible
capital stocks to R&D, used slightly different assumptions. This work assumed straight-line depreciation for
all R&D over a useful life of 18 years, which is roughly
equivalent to a geometric depreciation rate of 11 percent. The slightly higher depreciation rate and its extension to basic research would result in smaller stocks
than the method used here.8
Education Capital Stocks
Method of estimation.—The estimates of the federally financed education capital stock in Table 6–9 were
calculated by first estimating the Nation’s total stock
of education capital, based on the current replacement
cost of the total years of education of the population.
To derive the Federal share of this total stock, the
Federal share of total educational expenditures was applied to the total amount. The percent in any year
was estimated by averaging the prior years’ share of
Federal education outlays in total education costs. For
more information, refer to the technical note in Chapter
2, ‘‘Stewardship: Toward a Federal Balance Sheet.’’
The stock of capital estimated in Table 6–9 is based
only on spending for education. Stocks created by other
human capital investment outlays included in Table
6–1, such as job training and vocational rehabilitation,
were not calculated because of the lack of historical
data prior to 1962 and the absence of estimates of
depreciation rates.
7
See U.S. Department of Labor, Bureau of Labor Statistics, The Impact of Research
and Development on Productivity Growth, Bulletin 2331, September 1989.
8
See ‘‘A Satellite Account for Research and Development’’, Survey of Current Business,
November 1994, pp. 37–71.

6.

151

FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING

Part IV: ALTERNATIVE CAPITAL BUDGET AND CAPITAL EXPENDITURE PRESENTATIONS
A capital budget would separate Federal expenditures
into two categories: spending for investment and all
other spending. In this sense, Part I of the present
chapter provides a capital budget for the Federal Government, distinguishing outlays that yield long-term
benefits from all others. But alternative capital budget
presentations have also been suggested. The subject is
currently being examined by the President’s Commission to Study Capital Budgeting.
The Federal budget mainly finances investment for
two quite different types of reasons. It invests in capital—such as office buildings, computers, and weapons
systems—that primarily contributes to its ability to provide governmental services to the public; some of these
services, in turn, are designed to increase economic
growth. And it invests in capital—such as highways,
education, and research—that contributes more directly
to the economic growth of the Nation. Most of the capital in the second category, unlike the first, is not
Table 6–10.

owned or controlled by the Federal Government. In the
discussion that follows, the first is called ‘‘Federal capital’’ and the second is called ‘‘national capital.’’ Table
6–10 compares total Federal investment as defined in
this chapter with investment in Federal capital, which
was defined as ‘‘capital assets’’ in Part II of this chapter, and with investment in national capital. Some Federal investment is not classified as either Federal or
national capital, and a relatively small part is included
in both categories.
Capital budgets and other changes in Federal budgeting have been suggested from time to time for the Government’s investment in both Federal and national capital. These proposals differ widely in coverage, depending on the rationale for the suggestion. Some would
include all the investment shown in Table 6–1, or more,
whereas others would be narrower in various ways.
These proposals also differ in other respects, such as
whether investment would be financed by borrowing

ALTERNATIVE DEFINITIONS OF INVESTMENT OUTLAYS, 1999 1
(In millions of dollars)
Total
investment
outlays

Federal
capital

National
capital

27,649
2,357
6,185
6,841
134

................
................
................
................
................

27,649
2,355
1,152
................
52

4,605
506
3,976
1,005
576
1,663
1,355
885
2,044

4,605
413
2,465
1,005
117
1,663
1,355
885
1,593

................
506
3,666
1,005
576
1,663
1,355
................
972

Total construction and rehabilitation .....................................................
Acquisition of major equipment (direct):
National defense ............................................................................................
Postal Service ................................................................................................
Air transportation ............................................................................................
Other ...............................................................................................................

59,781

14,101

40,951

45,730
617
1,838
4,093

45,730
617
1,838
3,913

................
617
1,838
2,311

Total major equipment ...............................................................................
Purchase or sale of land and structures ...........................................................
Other physical assets (grants) ...........................................................................

52,278
–89
1,220

52,098
–89
................

4,766
................
................

Total physical investment ..............................................................................
Research and development:
Defense ..........................................................................................................
Nondefense ....................................................................................................

113,190

66,110

45,793

39,417
34,287

................
................

1,121
33,728

Total research and development ..............................................................
Education and training .......................................................................................

73,704
49,958

................
................

34,849
49,628

Total investment outlays ....................................................................................

236,852

66,110

130,270

Construction and rehabilitation:
Grants:
Transportation ............................................................................................
Natural resources and environment ..........................................................
Community and regional development .....................................................
Housing assistance ....................................................................................
Other grants ...............................................................................................
Direct Federal:
National defense ........................................................................................
General science, space, and technology ..................................................
Natural resources and environment ..........................................................
Energy ........................................................................................................
Transportation ............................................................................................
Veterans and other health facilities ..........................................................
Postal Service ............................................................................................
GSA real property activities ......................................................................
Other construction ......................................................................................

1

Total Federal investment is the same as ‘‘total, major Federal investment outlays’’ in Table 6–1. Some Federal investment is not classified as
either Federal or national capital, and a relatively small part is included in both categories.

152

ANALYTICAL PERSPECTIVES

and whether the non-investment budget would necessarily be balanced. Some of these proposals are discussed below and illustrated by alternative capital
budget and other capital expenditure presentations, although the discussion does not address matters of implementation such as the effect on the Budget Enforcement Act. The planning and budgeting process for capital assets, which is a different subject, is discussed
in Part II of this chapter together with the steps this
Administration is taking to improve it.
Investment in Federal Capital
The goal of investment in Federal capital is to deliver
the right amount of Government services as efficiently
and effectively as possible. The Congress allocates resources to Federal agencies to accomplish a wide variety of programmatic goals. Because these goals are diverse and most are not measured in dollars, they are
difficult to compare with each other. Policy judgments
must be made as to their relative importance.
Once amounts have been allocated for one of these
goals, however, analysis may be able to assist in choosing the most efficient and effective means of delivering
service. This is the context in which decisions are made
on the amount of investment in Federal capital. For
example, budget proposals for the Department of Justice must consider whether to increase the number of
FBI agents, the amount of justice assistance grants
to State and local governments, or the number of Federal prisons in order to accomplish the department’s
objectives. The optimal amount of investment in Federal capital derives from these decisions. There is no
efficient target for total investment in Federal capital
as such.
The universe of Federal capital encompasses federally
owned capital assets. It excludes Federal grants to
States for infrastructure, such as highways, and it excludes intangible investment, such as education and
research. Investment in Federal capital in 1999 is estimated to be $66 billion, or 28 percent of the total Federal investment outlays shown in Table 6–1. Of the
investment in Federal capital, 76 percent is for defense
and 24 percent for nondefense purposes.
A Capital Budget for Capital Assets
Discussion of a capital budget has often centered on
Federal capital, called ‘‘capital assets’’ in Part II of this
chapter—buildings, other construction, and equipment
that support the delivery of Federal services. This includes capital commonly available from the commercial
sector, such as office buildings, computers, military
family housing, veterans hospitals, research and development facilities, and associated equipment; it also includes special purpose capital such as weapons systems,
military bases, the space station, and dams. This definition excludes capital that the Federal Government has
financed but does not own.8
8
This definition of ‘‘capital assets’’ is the same as used in last year’s budget. Narrower
definitions of ‘‘fixed assets’’ were used in earlier budgets.

Some capital budget proposals would partition the
unified budget into a capital budget, an operating budget, and a total budget. Table 6–11 illustrates such a
capital budget for capital assets as defined above. It
is accompanied by an operating budget and a total
budget. The operating budget consists of all expenditures except those included in the capital budget, plus
depreciation on the stock of assets of the type purchased through the capital budget. The capital budget
consists of expenditures for capital assets and, on the
income side of the account, depreciation. The total
budget is the present unified budget, largely based on
cash for its measure of transactions, which records all
outlays and receipts of the Federal Government. It consolidates the operating and capital budgets by adding
them together and netting out depreciation as an
intragovernmental transaction. The operating budget
has a small deficit, compared to a small surplus in
the unified budget. This reflects both the relatively
small Federal investment in new capital assets and
the offsetting effect of depreciation on the existing
stock. The figures in Table 6–11 and the subsequent
tables of this section are rough estimates, intended only
to be illustrative and to provide a basis for broad generalizations.
Table 6–11.

CAPITAL, OPERATING, AND UNIFIED BUDGETS:
FEDERAL CAPITAL, 1999 1, 2
(In billions of dollars)

Operating Budget
Receipts ..................................................................................................
Expenses:
Depreciation .......................................................................................
Other ..................................................................................................

1,743
85
1,667

Subtotal, expenses ........................................................................
Surplus or deficit (–) ..........................................................................
Capital Budget
Income: depreciation ..............................................................................
Capital expenditures ...............................................................................

1,752
–10

Surplus or deficit (–) ..........................................................................
Unified Budget
Receipts ..................................................................................................
Outlays ....................................................................................................

19
1,743
1,733

Surplus or deficit (–) ..........................................................................

10

85
66

1

Historical data to estimate the capital stocks and calculate depreciation are not readily available for Federal
capital. Depreciation estimates were based on the assumption that outlays for Federal capital were a constant
percentage of the larger categories in which such outlays were classified. They are also subject to the limitations explained in Part III of this chapter. Depreciation is measured in terms of current cost, not historical cost.
2
The method of estimating depreciation was revised in this year’s budget, as explained in the previous
section of this chapter.

Some proposals for a capital budget would exclude
defense capital (other than military family housing).
These exclusions—weapons systems, military bases,
and so forth—would comprise three-fourths of the expenditures shown in the capital budget of Table 6–11.
If they were excluded, the operating budget would have
a surplus that was essentially the same size as the
unified budget surplus: a surplus $2 billion higher than
the unified budget surplus, instead of a deficit that

6.

FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING

was $20 billion lower as shown above for the complete
coverage of Federal capital. Excluding defense makes
such a large difference because of its large relative
size and the recent pattern of capital asset purchases.
The large defense buildup that began in the early 1980s
raised the capital stock and depreciation; the buildup
was followed by a sharp decline in purchases, while
the capital stock and depreciation have declined more
slowly. (See the previous section of this chapter.)
Budget Discipline and a Capital Budget
Many proposals for a capital budget, though not all,
would effectively dispense with the unified budget and
make expenditure decisions on capital asset acquisitions in terms of the operating budget instead. When
the Government proposed to purchase a capital asset,
the operating budget would include only the estimated
depreciation. For example, suppose that an agency proposed to buy a $50 million building at the beginning
of the year with an estimated life of 25 years and
with depreciation calculated by the straightline method.
Operating expense in the budget year would increase
by $2 million, or only 4 percent of the asset cost. The
same amount of depreciation would be recorded as an
increase in operating expense for each year of the asset’s life.9
Recording the annual depreciation in the operating
budget each year would provide little control over the
decision about whether to invest in the first place. Most
Federal investments are sunk costs and as a practical
matter cannot be recovered by selling or renting the
asset. At the same time, there is a significant risk
that the need for a capital asset may change over a
period of years, because either the need was not permanent, it was initially misjudged, or other needs become
more important. Since the cost is sunk, however, control
cannot be exercised later on by comparing the annual
benefit of the asset services with depreciation and interest and then selling the asset if its annual services
are not worth this expense. Control can only be exercised up front when the Government commits itself to
the full sunk cost. By spreading the real cost of the
project over time, however, use of the operating budget
for expenditure decisions would make the budgetary
cost of the capital asset appear very cheap when decisions were being made that compared it to alternative
expenditures. As a result, there would be an incentive
to purchase capital assets with little regard for need,
and also with little regard for the least-cost method
of acquisition.
A budget is a financial plan for allocating resources—
deciding how much the Federal Government should
spend in total, program by program, and for the parts
of each program. The budgetary system provides a process for proposing policies, making decisions, implementing them, and reporting the results. The budget needs
9
The amount of depreciation recorded as an expense in the budget year might be overstated by this illustration. First, most assets are purchased after the beginning of the
year, in which case less than a full year’s depreciation would be recorded. Second, assets
may be constructed or built to order, in which case no depreciation would be recorded
until the work was completed and the asset put into service. This could be several years
after the initial expenditure.

153

to measure costs accurately so that decision makers
can compare the cost of a program with its benefit,
the cost of one program with another, and the cost
of alternative methods of reaching a specified goal.
These costs need to be fully included in the budget
up front, when the spending decision is made, so that
executive and congressional decision makers have the
information and the incentive to take the total costs
into account.
The unified budget does this for investment. By recording investment on a cash basis, it causes the total
cost to be compared up front in a rough and ready
way with the total expected future net benefits. Since
the budget measures only cost, the benefits with which
these costs are compared, based on policy makers’ judgment, must be presented in supplementary materials.
Such a comparison of total cost with benefits is consistent with the formal method of cost-benefit analysis of
capital projects in government, in which the full cost
of a capital asset as the cash is paid out is compared
with the full stream of future benefits (all in terms
of present values).10 This comparison is also consistent
with common business practice, in which capital budgeting decisions for the most part are made by comparing cash flows. The cash outflow for the full purchase
price is compared with expected future cash inflows,
either through a relatively sophisticated technique of
discounted cash flows—such as net present value or
internal rate of return—or through cruder methods
such as payback periods.11 Regardless of the specific
technique adopted, it usually requires comparing future
returns with the entire cost of the asset up front—
not spread over time through annual depreciation.12
Practice Outside the Federal Government
The proponents of making investment decisions on
the basis of an operating budget with depreciation have
sometimes claimed that this is the common practice
outside the Federal Government. However, while the
practice of others may differ from the Federal budget
and the terms ‘‘capital budget’’ and ‘‘capital budgeting’’
are often used, these terms do not normally mean that
capital asset acquisitions are decided on the basis of
annual depreciation cost. The use of these terms in
10
For example, see Edward M. Gramlich, A Guide to Benefit-Cost Analysis (2nd ed.;
Englewood Cliffs: Prentice Hall, 1990), chap. 6; or Joseph E. Stiglitz, Economics of the
Public Sector (2nd ed.; New York: Norton, 1988), chap. 10. This theory is applied in formal
OMB instructions to Federal agencies in OMB Circular No. A–94, Guidelines and Discount
Rates for Benefit-Cost Analysis of Federal Programs (October 29, 1992). General Accounting
Office, Discount Rate Policy, GAO/OCE–17.1.1 (May 1991), discusses the appropriate discount
rate for such analysis but not the foundation of the analysis itself, which is implicitly
assumed.
11
For a full textbook analysis of capital budgeting techniques in business, see Harold
Bierman, Jr., and Seymour Smidt, The Capital Budgeting Decision (8th ed.; Saddle River,
N.J.: Prentice-Hall, 1993). Shorter analyses from the standpoints of corporate finance and
cost accounting may be found, for example, in Richard A. Brealey and Stewart C. Myers,
Principles of Corporate Finance (5th ed.; New York: McGraw-Hill, 1996), chap. 2, 5, and
6; Charles T. Horngren et al., Cost Accounting (9th ed.; Upper Saddle River, N.J.: PrenticeHall, 1997), chap. 22 and 23; Jerold L. Zimmerman, Accounting for Decision Making and
Control (Chicago: Irwin, 1995), chap. 3; and Surendra S. Singhvi, ‘‘The Capital Budgeting
Process’’ and ‘‘The Capital Expenditure Evaluation Methods,’’ chap. 19 and 20 in Robert
Rachlin and H.W. Allen Sweeny, Handbook of Budgeting (3rd ed.; New York: Wiley, 1993).
12
Two surveys of business practice conducted a few years ago found that such techniques
are predominant. See Thomas Klammer et al., ‘‘Capital Budgeting Practices—A Survey
of Corporate Use,’’ Journal of Management and Accounting Research, vol. 3 (Fall 1991),
pp. 113–30; and Glenn H. Petry and James Sprow, ‘‘The Theory and Practice of Finance
in the 1990s,’’ The Quarterly Review of Economics and Finance, vol. 33 (Winter 1993),
pp. 359–82. Petry and Sprow also found that discounted cash flow techniques are recommended by the most widely used textbooks in managerial finance.

154
business and State government also does not mean that
businesses and States finance all their investment by
borrowing. Nor does it mean that under a capital budget the extent of borrowing by the Federal Government
to finance investment would be limited by the same
forces that constrain business and State borrowing for
investment.
Private business firms call their investment decision making process ‘‘capital budgeting,’’ and they
record the resulting planned expenditures in a ‘‘capital
budget.’’ However, decisions are normally based on upfront comparisons of the cash outflows needed to make
the investment with the resulting cash inflows expected
in the future, as explained above, and the capital budget records the period-by-period cash outflows proposed
for capital projects.13 This supports the business’s goal
of deciding upon and controlling the use of its resources.
The cash-based focus of business budgeting for capital
is in contrast to business financial statements—the income statement and balance sheet—which use accrual
accounting for a different purpose, namely to record
how well the business is meeting its objectives of earning profit and accumulating wealth for its owners. For
this purpose, the income statement shows the profit
in a year from earning revenue net of the expenses
incurred. These expenses include depreciation, which
is an allocation of the cost of capital assets over their
estimated useful life. With similar objectives in mind,
the Office of Management and Budget, the Treasury
Department, and the General Accounting Office have
adopted the use of depreciation on general property,
plant, and equipment owned by the Federal Government as a measure of expense in financial statements
and cost accounting for Federal agencies.14
Businesses finance investment from net income as
well as borrowing. When they borrow to finance investment, they are constrained in ways that Federal borrowing is not. The amount that a business borrows
is limited by its own profit motive and the market’s
assessment of its capacity to repay. The greater a
business’s indebtedness, other things equal, the more
risky is any additional borrowing and the higher is
the cost of funds it must pay. Since the profit motive
ensures that a business will not want to borrow unless
the expected return is at least as high as the cost
of funds, the amount of investment that a business
will want to finance is limited; it has an incentive to
borrow only for projects where the expected return is
as high or higher than the cost of funds. Furthermore,
if the risk is great enough, a business may not be
able to find a lender.
13
A business capital budget is depicted in Glenn A. Welsch et al., Budgeting: Profit
Planning and Control (5th ed.; Englewood Cliffs: Prentice Hall, 1988), pp. 396–99.
14
Office of Management and Budget, Statement of Federal Financial Accounting Standards
No. 6, Accounting for Property, Plant, and Equipment (November 30, 1995), pp. 5–14 and
34–35. Depreciation is not used as a measure of expense for weapons systems, space exploration equipment, and other ‘‘Federal mission property’’ or for heritage assets. Depreciation
also is not used as a measure of expense for physical property financed by the Federal
Government but owned by State and local governments, or for investment that the Federal
Government finances in human capital and research and development.

ANALYTICAL PERSPECTIVES

No such constraint limits the Federal Government—
either in the total amount of its borrowing for investment, or in its choice of which assets to buy—because
of its sovereign power to tax and the wide economic
base that it taxes. It can tax to pay for investment;
and, if it borrows, its power to tax ensures that the
credit market will judge U.S. Treasury securities free
from any risk of default even if it borrows ‘‘excessively’’
or for projects that do not seem worthwhile.
Most States also have a ‘‘capital budget,’’ but the
operating budget is not like the operating budget envisaged by proponents of making Federal investment decisions on the basis of depreciation. State capital budgets
differ widely in many respects but generally relate some
of the State’s purchases of capital assets to borrowing
and other earmarked means of financing. For the debtfinanced portion of investment, the interest and repayment of principal are usually recorded in the operating
budget. For the portion of investment purchased in the
capital budget but financed by Federal grants or by
taxes, which may be substantial, State operating budgets do not record any amount. No State operating budget is charged for depreciation.15
States also do not record depreciation expense in the
financial accounting statements for governmental
funds. They record depreciation expense only in their
proprietary (commercial-type) funds and in those trust
funds where net income, expense, or capital maintenance is measured.16 Under a proposed change in financial reporting standards, however, depreciation on general capital assets would be recognized as an expense
in entity-wide financial statements.17
State borrowing to finance investment, like business
borrowing, is subject to limitations that do not apply
to Federal borrowing. Like business borrowing, it is
constrained by the credit market’s assessment of the
State’s capacity to repay. Furthermore, it is usually
designated for specified investments, and it is almost
always subject to constitutional limits or referendum
requirements.
Other developed nations tend to show a more systematic breakdown between investment and operating
expenditures within their budgets than does the United
States, even while they record capital expenditures on
a cash basis within the same budget totals. For example, the United Kingdom shows the capital spending
within each agency total and displays the sum of capital spending for the government as a whole. However,
a recent study of European countries found only four
15
The characteristics of State capital budgets were examined in a survey of State budget
officers for all 50 States in 1986. See Lawrence W. Hush and Kathleen Peroff, ‘‘The Variety
of State Capital Budgets: A Survey,’’ Public Budgeting and Finance (Summer 1988), pp.
67–79. More detailed results are available in an unpublished OMB document, ‘‘State Capital
Budgets’’ (July 7, 1987). Two GAO reports examined State capital budgets and reached
similar conclusions on the issues in question. See Budget Issues: Capital Budgeting Practices
in the States, GAO/AFMD–86–63FS (July 1986), and Budget Issues: State Practices for
Financing Capital Projects, GAO/AFMD–89–64 (July 1989). For further information about
state capital budgeting, see National Association of State Budget Officers, Capital Budgeting
in the States (September 1997).
16
Governmental Accounting Standards Board (GASB), Codification of Governmental Accounting and Financial Reporting Standards as of June 30, 1996, sections 1100.107 and
1400.114–1400.118.
17
Governmental Accounting Standard Board, Exposure Draft, Basic Financial Statements—and Management’s Discussion and Analysis—for State and Local Governments (January 31, 1997), paragraphs 33–37 and 273–81.

6.

155

FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING

that had a real difference between a current budget
and a capital budget (Greece, Ireland, Luxembourg, and
Portugal); 18 and a survey by the Congressional Budget
Office in 1993 found only two developed nations, Chile
and New Zealand, that recognize depreciation in their
budgets.19 New Zealand, moreover, while budgeting on
an accrual basis that generally includes depreciation,
requires the equivalent of appropriations for the full
cost up front before a department can make net additions to its capital assets; and it budgets for infrastructure assets that it owns on the basis of cash expenditure rather than depreciation.20 Some countries—including Sweden, Denmark, Finland, and the Netherlands—formerly had separate capital budgets but abandoned them a number of years ago.21
Conclusions
It is for reasons such as these that the General Accounting Office issued a report in 1993 that criticized
budgeting for capital in terms of depreciation. Although
the criticisms were in the context of what is termed
‘‘national capital’’ in this chapter, they apply equally
to ‘‘Federal capital.’’
‘‘Depreciation is not a practical alternative
for the Congress and the administration to use
in making decisions on the appropriate level of
spending intended to enhance the nation’s
long-term economic growth for several reasons.
Currently, the law requires agencies to have
budget authority before they can obligate or
spend funds. Unless the full amount of budget
authority is appropriated up front, the ability
to control decisions when total resources are
committed to a particular use is reduced. Appropriating only annual depreciation, which is
only a fraction of the total cost of an investment, raises this control issue.’’ 22
After further study of the role of depreciation in
budgeting for national capital, GAO reiterated that conclusion in another study in 1995.23 ‘‘The greatest disadvantage . . . was that depreciation would result in
a loss of budgetary control under an obligation-based
18
M. Peter van der Hoek, ‘‘Fund Accounting and Capital Budgeting: European Experience,’’
Public Budgeting and Financial Management, vol. 8 (Spring 1996), pp. 39– 40.
19
Robert W. Hartman, Statement before the Subcommittee on Economic Development,
Committee on Public Works and Transportation, U.S. House of Representatives (May 26,
1993). Hartman stated: ‘‘to our knowledge, only two developed countries, Chile and New
Zealand, recognize depreciation in their budgets.’’ The United Kingdom has announced plans
to budget on an accrual basis, including the depreciation for capital assets, beginning with
its budget for 2001–02.
20
New Zealand’s use of depreciation in its budget is discussed in GAO, Budget Issues:
The Role of Depreciation in Budgeting for Certain Federal Investments, GAO/AIMD–95–34
(February 1995), pp. 13 and 16–17.
21
The budgets in Sweden, Great Britain, Germany, and France are described in GAO,
Budget Issues: Budgeting Practices in West Germany, France, Sweden, and Great Britain,
GAO/AFMD–87–8FS (November 1986). Sweden had separate capital and operating budgets
from 1937 to 1981, together with a total consolidated budget from 1956 onwards. The
reasons for abandoning the capital budget are discussed briefly in the GAO report and
more extensively by a government commission established to recommend changes in the
Swedish budget system. One reason was that borrowing was no longer based on the distinction between current and capital budgets. See Sweden, Ministry of Finance, Proposal for
a Reform of the Swedish Budget System: A Summary of the Report of the Budget Commission
Published by the Ministry of Finance (Stockholm, 1974), chapter 10.
22
GAO, Budget Issues: Incorporating an Investment Component in the Federal Budget,
GAO/AIMD–94–40 (November 1993), p. 11. GAO had made the same recommendation in
earlier reports but with less extensive analysis.
23
GAO, Budget Issues: The Role of Depreciation in Budgeting for Certain Federal Investments, GAO/AIMD–95–34 (February 1995), pp. 1 and 19–20.

budgeting system.’’ 24 Although that study also focused
primarily on what is termed ‘‘national capital’’ in this
chapter, its analysis applies equally to ‘‘Federal capital.’’ In 1996 GAO extended its conclusions to Federal
capital as well. ‘‘If depreciation were recorded in the
federal budget in place of cash requirements for capital
spending, this would undermine Congress’ ability to
control expenditures because only a small fraction of
an asset’s cost would be included in the year when
a decision was made to acquire it.’’ 25
Investment in National Capital
A Target for National Investment
The Federal Government’s investment in national
capital has a much broader and more varied form than
its investment in Federal capital. The Government’s
goal is to support and accelerate sustainable economic
growth for the Nation as a whole and in some instances
for specific regions or groups of people. The Government’s investment concerns for the Nation are two-fold:
• The effect of its own investment in national capital
on the output and income that the economy can
produce. Reducing expenditure on consumption
and increasing expenditure on investment that
supports economic growth is a major priority for
the Administration. It has reordered priorities in
its budgets by proposing increases in selected investments.
• The effect of Federal taxation, borrowing, and
other policies on private investment. The Administration’s deficit reduction policy has brought about
an expansion of private investment, most notably
in producers’ durable equipment.
In its 1993 report, Incorporating an Investment Component in the Federal Budget, the General Accounting
Office (GAO) recommended establishing an investment
component within the unified budget—but not a separate capital budget or the use of depreciation—for this
type of investment.26 GAO defined this investment as
‘‘federal spending, either direct or through grants, that
is directly intended to enhance the private sector’s longterm productivity.’’ 27 To increase investment—both
public and private—GAO recommended establishing
targets for the level of Federal investment and for a
declining path of unified budget deficits over time.28
Such a target for investment in national capital would
focus attention on policies for growth, encourage a conscious decision about the overall level of growth-enhancing investment, and make it easier to set spending
priorities in terms of policy goals for aggregate formation of national capital. GAO reiterated its recommendation in another report in 1995.29
24

Ibid., p. 17. Also see pp. 1–2 and 16–19.
GAO, Budget Issues: Budgeting for Federal Capital, GAO/AIMD–97–5 (November 1996),
p. 28. Also see p. 4.
26
Incorporating an Investment Component in the Federal Budget, pp. 1–2, 9–10, and
15.
27
Ibid., pp. 1 and 5.
28
Ibid., pp. 2 and 13–16.
29
The Role of Depreciation in Budgeting for Certain Investments, pp. 2 and 19–20.
25

156
Table 6–12.

ANALYTICAL PERSPECTIVES

UNIFIED BUDGET WITH NATIONAL INVESTMENT
COMPONENT, 1999

Table 6–13.

(In billions of dollars)

CAPITAL, OPERATING, AND UNIFIED BUDGETS:
NATIONAL CAPITAL, 1999 1, 2
(In billions of dollars)

Receipts ....................................................................................................
Outlays:
National investment .............................................................................
Other ....................................................................................................

1,743
130
1,603

Subtotal, outlays ..............................................................................

1,733

Surplus or deficit (–) ............................................................................

10

Table 6–12 illustrates the unified budget reorganized
as GAO recommends to have a separate component for
investment in national capital. This component is
roughly estimated to be $130 billion in 1999. It includes
infrastructure outlays financed by Federal grants to
State and local governments, such as highways and
sewer projects, as well as direct Federal purchases of
infrastructure, such as electric power generation equipment. It also includes intangible investment for nondefense research and development, for basic research
financed through defense, and for education and training. Much of this expenditure consists of grants and
credit assistance to State and local governments, nonprofit organizations, or individuals. Only 9 percent of
national investment consists of assets to be owned by
the Federal Government. Military investment and some
other ‘‘capital assets’’ as defined previously are excluded, because that investment does not primarily enhance economic growth.
A Capital Budget for National Investment
Table 6–13 roughly illustrates what a capital budget
and operating budget would look like under this definition of investment—although it must be emphasized
that this is not GAO’s recommendation. Some proponents of a capital budget would make spending decisions within the framework of such a capital budget
and operating budget. But the limitations that apply
to the use of depreciation in deciding on investment
decisions for Federal capital apply even more strongly
in deciding on investment decisions for national capital.
Most national capital is neither owned nor controlled
by the Federal Government. Such investments are sunk
costs completely and can be controlled only by decisions
made up front when the Government commits itself
to the expenditure.30
In addition to these basic limitations, the definition
of investment is more malleable for national capital
than Federal capital. Many programs promise long-term
intangible benefits to the Nation, and depreciation rates
are much more difficult to determine for intangible investment such as research and education than they
are for physical investment such as highways and office
buildings. These and other definitional questions are
hard to resolve. The answers could significantly affect
30
GAO’s conclusions about the loss of budgetary control that were quoted at the end
of the section on Federal capital came from studies that predominantly considered ‘‘national
capital.’’

Operating Budget
Receipts ..................................................................................................
Expenses:
Depreciation 3 .....................................................................................
Other ..................................................................................................

1,697
72
1,603

Subtotal, expenses ........................................................................
Surplus or deficit (–) ..........................................................................
Capital Budget
Income:
Depreciation 3 .....................................................................................
Earmarked tax receipts 4 ...................................................................

1,675
22

Subtotal, income ............................................................................
Capital expenditures ...............................................................................

118
130

Surplus or deficit (–) ..........................................................................
Unified Budget
Receipts ..................................................................................................
Outlays ....................................................................................................

–12
1,743
1,733

Surplus or deficit (–) .....................................................................

10

72
46

1

For the purpose of this illustrative table only, education and training outlays are arbitrarily depreciated over
30 years by the straight-line method. This differs from the treatment of education and training elsewhere in this
chapter and in Chapter 2. All depreciation estimates are subject to the limitations explained in Part III of this
chapter. Depreciation is measured in terms of current cost, not historical cost.
2
The method of estimating depreciation was revised in this year’s budget, as explained in the previous section of this chapter.
3
Excludes depreciation on capital financed by earmarked tax receipts allocated to the capital budget.
4
Consists of tax receipts of the highway and airport and airways trust funds, less trust fund outlays for operating expenditures. These are user charges earmarked for financing capital expenditures.

budget decisions, because they would determine whether the budget would record all or only a small part
of the cost of a decision when policy makers were comparing the budgetary cost of a project with their judgment of its benefits. The process of reaching an answer
with a capital budget would open the door to manipulation, because there would be an incentive to make the
operating expenses and deficit look smaller by
classifying outlays as investment and using low depreciation rates. This would ‘‘justify’’ more spending by
the program or the Government overall.31
A Capital Budget and the Analysis of Saving
and Investment
Data from the Federal budget may be classified in
many different ways, including analyses of the Government’s direct effects on saving and investment. As Parts
I and III of this chapter have shown, the unified budget
provides data that can be used to calculate Federal
investment outlays and federally financed capital
stocks. However, the budget totals themselves do not
make this distinction. In particular, the budget surplus
or deficit does not measure the Government’s contribution to the nation’s net saving (i.e., saving net of depre31
These problems are also pointed out in GAO, Incorporating an Investment Component
in the Federal Budget, pp. 11–12. They are discussed more extensively with respect to
highway grants, research and development, and human capital in GAO, The Role of Depreciation in Budgeting for Certain Federal Investments, pp. 11–14. GAO found no government
that budgets for the depreciation of infrastructure (whether or not owned by that government), human capital, or research and development (except that New Zealand budgets
for the depreciation of research and development if it results in a product that is intended
to be used or marketed).

6.

157

FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING

ciation). A capital budget, it is sometimes contended,
is needed for this purpose.
This purpose, however, is now fulfilled by the Federal
sector of the national income and product accounts
(NIPAs) according to one definition of investment. The
NIPA Federal sector measures the impact of Federal
receipts, expenditures, and deficit on the national economy. It is part of an integrated set of measures of
aggregate U.S. economic activity that is prepared by
the Bureau of Economic Analysis in the Department
of Commerce in order to measure gross domestic product (GDP), the income generated in its production, and
many other variables used in macroeconomic analysis.
The NIPA Federal sector for recent periods is published
monthly in the Survey of Current Business with separate releases for historical data. Estimates for the
President’s proposed budget through the budget year
are normally published in the budget documents. The
NIPA translation of the budget, rather than the budget
itself, is ordinarily used by economists to analyze the
effect of Government fiscal policy on the aggregate economy.32
Until two years ago the NIPA Federal sector did not
divide government purchases of goods and services between consumption and investment. With the comprehensive revision of the national income and product
accounts in early 1996, it now makes that distinction.33
The revised NIPA Federal Government account for receipts and expenditures is a current account or an operating account for the Federal Government. The current
account excludes expenditures for structures and equipment owned by the Federal Government; it includes
depreciation on the federally owned stock of structures
and equipment as a measure of the cost of using capital
assets and thus as part of the Federal Government’s
current expenditures. It applies this treatment to a
comprehensive definition of federally owned structures
and equipment, both defense and nondefense, similar
to the definition of ‘‘capital assets’’ in this chapter.34
The NIPA ‘‘current surplus or deficit’’ of the Federal
Government thus measures the Government’s direct
contribution to the Nation’s net saving (given the definition of investment that is employed). The 1997 Federal
Government current account deficit was increased $10
billion by including depreciation rather than gross investment, because depreciation of federally owned
structures and equipment was more than gross invest32
See chapter 18 of this volume, ‘‘National Income and Product Accounts,’’ for the NIPA
current account of the Federal Government based on the budget estimates for 1998 and
1999, and for a discussion of the NIPA Federal sector and its relationship to the budget.
33
This distinction is also made in the national accounts of most other countries and
in the System of National Accounts (SNA), which is guidance prepared by the United
Nations and other international organizations. Definitions of investment may vary. Other
countries and the SNA do not include the purchase of military equipment as investment.
34
The revised NIPA Federal sector is explained in Survey of Current Business, ‘‘Preview
of the Comprehensive Revision of the National Income and Product Accounts: Recognition
of Government Investment and Incorporation of a New Methodology for Calculating Depreciation’’ (September 1995), pp. 33–39. As is the case of private sector investment, government
investment does not include expenditures on research and development or on education
and training. Government purchases of structures and equipment remain a part of gross
domestic product (GDP) as a separate component. The NIPA State and local government
account has been revised in the same way and includes depreciation on structures and
equipment owned by State and local governments that were financed by Federal grants
as well as by their own resources. Depreciation is not displayed as a separate line item
in the Federal sector: depreciation on general government capital assets is included in
government ‘‘consumption expenditures’’; and depreciation on the capital assets of government enterprises is subtracted in calculating the ‘‘current surplus of government enterprises.’’

ment. The 1999 Federal current account deficit is estimated to be increased $14 billion. This is unlike a
few years earlier, when the Federal current account
deficit was reduced, in some years substantially.35 A
capital budget is not needed to capture this effect.
Borrowing to Finance a Capital Budget
A further issue raised by a capital budget is the
financing of capital expenditures. Some have argued
that the Government ought to balance the operating
budget and borrow to finance the capital budget—capital expenditures less depreciation. The rationale is that
if the Government borrows for net investment and the
rate of return exceeds the interest rate, the additional
debt does not add a burden onto future generations.
Instead, the burden of paying interest on the debt and
repaying its principal is spread over the generations
that will benefit from the investment. The additional
debt is ‘‘justified’’ by the additional assets.
This argument is at best a justification to borrow
to finance net investment, after depreciation is subtracted from gross outlays, not to borrow to finance
gross investment. To the extent that capital is used
up during the year, there are no additional assets to
justify additional debt. If the Government borrows to
finance gross investment, the additional debt exceeds
the additional capital assets. The Government is thus
adding onto the amount of future debt service without
providing the additional capital that would produce the
additional income needed to service that debt.
This justification, furthermore, requires that depreciation be measured in terms of current cost, not historical cost. When prices change, historical cost depreciation does not measure the extent to which the capital
stock is used up each year.
As a broad generalization, Tables 6–11 and 6–13 suggest that this rationale would not currently justify
much Federal borrowing, if any at all, under the two
capital budgets roughly illustrated in this chapter. For
Federal capital, Table 6–11 indicates that current cost
depreciation is more than gross investment for Federal
capital—the capital budget surplus is $19 billion. The
rationale of borrowing to finance net investment would
not justify the Federal Government borrowing at all
to finance its investment in Federal capital; instead,
it would have to repay this amount of debt ($19 billion).
For national capital, Table 6–13 indicates that current
cost depreciation (plus the excise taxes earmarked to
finance capital expenditures for highways and airports
and airways 36) is less than gross investment but almost
as large—the capital budget deficit is $12 billion. The
rationale of borrowing to finance net investment would
justify the Federal Government borrowing this amount
($12 billion) and no more to finance its investment in
national capital.37
35
See actuals and estimates for 1988–99 in table 18–2 of chapter 18 of this volume,
‘‘National Income and Product Accounts.’’
36
The capital budget deficit would be about $35 billion larger if current cost depreciation
were used instead of earmarked excise taxes for investment in highways and airports
and airways.
37
This discussion abstracts from non-budgetary transactions that affect Federal borrowing
requirements, such as changes in the Treasury operating cash balance and the net financing

158

ANALYTICAL PERSPECTIVES

Even with depreciation calculated in current cost, the
rationale for borrowing to finance net investment is
not persuasive. The Federal Government, unlike a business or household, is responsible not only for its own
affairs but also for the general welfare of the Nation.
To maintain and accelerate national economic growth
and development, the Government needs to sustain private investment as well as its own national investment.
For more than a decade, however, net national saving
has been low, both by historical standards and in comparison to the amounts needed to meet the challenges
expected in the decades ahead.
To the extent that the Government finances its own
investment in a way that results in lower private investment, the net increase of total investment in the
economy is less than the increase from the additional
Federal capital outlays alone. The net increase in total
investment is significantly less if the Federal investment is financed by borrowing than if it is financed
by taxation, because borrowing primarily draws upon
the saving available for private (and State and local)
investment whereas much of taxation instead comes
out of private consumption. Therefore, the net effect

of Federal investment on economic growth would be
reduced if it were financed by borrowing. This would
be the result even if the rate of return on Federal
investment was higher than the rate of return on private investment. For example, if a Federal investment
that yielded a 15 percent rate of return crowded out
private investment that yielded 10 percent, the net social return would still be positive but it would only
be 5 percent.38
The first budget of this Administration was a bold
step to increase the saving available for private investment while also increasing Federal investment for national capital. The deficit has been cut by over ninetenths during the past five years, and available resources have been shifted to investment in education
and training and in science and technology. The present
budget goes further, proposing budget balance by 1999
while protecting high priority investments. A capital
budget is not a justification to relax current and proposed budget constraints. Any easing would undo the
gains from the deficit reduction already achieved and
the further gains from balancing the budget.

disbursements of the direct loan and guaranteed loan financing accounts. See chapter 13
of this volume, ‘‘Federal Borrowing and Debt,’’ and the explanation of Table 13–2.

38
GAO considered deficit financing of investment but did not recommend it. See Incorporating an Investment Component in the Federal Budget, pp. 12–13.

6.

159

FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING

Part V: SUPPLEMENTAL PHYSICAL CAPITAL INFORMATION
The Federal Capital Investment Program Information
Act of 1984 (Title II of Public Law 98–501; hereafter
referred to as the Act) requires that the budget include
projections of Federal physical capital spending and information regarding recent assessments of public civilian physical capital needs. This section is submitted
to fulfill that requirement.
This part is organized in two major sections. The
first section projects Federal outlays for public physical
capital and the second section presents information regarding public civilian physical capital needs.
Projections of Federal Outlays For Public
Physical Capital
Federal public physical capital spending is defined
here to be the same as the ‘‘major public physical capital investment’’ category in Part I of this chapter. It
covers spending for construction and rehabilitation, acquisition of major equipment, and other physical assets.
This section excludes outlays for human capital, such
as the conduct of education and training, and outlays
for the conduct of research and development.
The projections are done generally on a current services basis, which means they are based on 1998 enacted
appropriations and adjusted for inflation in later years.

Table 6–14.

The current services concept is discussed in Chapter
16, ‘‘Current Services Estimates.’’
Federal public physical capital spending was $113.6
billion in 1997 and is projected to increase to $132.4
billion by 2007 on a current services basis. The largest
components are for national defense and for roadways
and bridges, which together accounted for almost twothirds of Federal public physical capital spending in
1997.
Table 6–14 shows projected current services outlays
for Federal physical capital by the major categories
specified in the Act. Total Federal outlays for transportation-related physical capital were $29.1 billion in
1997, and current services outlays are estimated to increase to $36.1 billion by 2007. Outlays for nondefense
housing and buildings were $12.1 billion in 1997 and
are estimated to be $13.3 billion in 2007. Physical capital outlays for other nondefense categories were $20.0
billion in 1997 and are projected to be $25.7 billion
by 2007. For national defense, this spending was $52.4
billion in 1997 and is estimated on a current services
basis to be $57.4 billion in 2007.
Table 6–15 shows current services projections on a
constant dollar basis, using fiscal year 1992 as the base
year.

CURRENT SERVICES OUTLAY PROJECTIONS FOR FEDERAL PHYSICAL CAPITAL SPENDING
(In billions of dollars)
1997
Actual

Nondefense:
Transportation-related categories:
Roadways and bridges ......................................................................................
Airports and airway facilities .............................................................................
Mass transportation systems ............................................................................
Railroads ............................................................................................................

Estimate
1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

20.5
3.9
4.0
0.7

21.7
3.4
3.8
0.4

22.7
3.5
3.6
0.4

23.2
3.5
4.0
0.4

23.6
3.6
4.2
0.4

23.9
3.7
4.5
0.4

24.3
3.9
4.6
0.4

24.7
4.0
4.7
0.4

25.3
4.1
4.8
0.4

25.8
4.2
4.9
0.4

26.3
4.3
5.0
0.4

Subtotal, transportation .................................................................................
Housing and buildings categories:
Federally assisted housing ................................................................................
Hospitals ............................................................................................................
Public buildings 1 ...............................................................................................

29.1

29.3

30.2

31.0

31.7

32.4

33.2

33.9

34.6

35.3

36.1

7.2
1.8
3.1

7.3
2.6
2.9

7.3
2.3
2.6

7.4
2.4
2.7

7.3
2.4
2.8

7.2
2.5
2.8

7.4
2.6
2.8

7.0
2.6
2.8

7.2
2.7
2.8

7.3
2.8
2.9

7.5
2.9
2.9

Subtotal, housing and buildings ...................................................................
Other nondefense categories:
Wastewater treatment and related facilities .....................................................
Water resources projects ..................................................................................
Space and communications facilities ................................................................
Energy programs ...............................................................................................
Community development programs ..................................................................
Other nondefense ..............................................................................................

12.1

12.8

12.2

12.4

12.6

12.5

12.8

12.4

12.7

13.0

13.3

2.1
2.0
3.3
1.3
5.9
5.3

1.9
2.7
2.9
1.2
6.5
2.1

2.1
2.4
3.2
1.1
6.2
5.8

2.4
2.5
4.0
1.3
6.3
6.8

2.6
2.5
3.9
1.2
6.4
7.0

2.5
2.5
3.1
1.2
6.4
6.7

2.6
2.7
2.7
1.3
6.5
7.5

2.7
2.7
2.8
1.4
6.6
7.7

2.7
2.8
2.8
1.4
6.8
7.9

2.8
2.8
2.9
1.5
6.9
8.1

2.8
2.9
3.0
1.5
7.1
8.3

Subtotal, other nondefense ...........................................................................

20.0

17.4

20.8

23.3

23.6

22.5

23.3

23.9

24.5

25.1

25.7

Subtotal, nondefense .........................................................................................
National defense ....................................................................................................

61.2
52.4

59.4
48.7

63.2
49.4

66.7
49.2

67.9
49.8

67.4
50.3

69.3
52.3

70.1
53.7

71.7
55.0

73.4
56.1

75.0
57.4

Total ............................................................................................................................

113.6

108.2

112.6

116.0

117.7

117.7

121.6

123.8

126.7

129.6

132.4

1

Excludes outlays for public buildings that are included in other categories in this table.

160

ANALYTICAL PERSPECTIVES

Table 6–15.

CURRENT SERVICES OUTLAY PROJECTIONS FOR FEDERAL PHYSICAL CAPITAL
SPENDING
(In billions of constant 1992 dollars)
1997
Actual

Nondefense:
Transportation-related categories:
Roadways and bridges ....................................................................................................
Airports and airway facilities ...........................................................................................
Mass transportation systems ...........................................................................................
Railroads ..........................................................................................................................

Estimate
1998

1999

2000

2001

2002

18.1
3.6
3.6
0.6

18.8
3.1
3.2
0.4

19.2
3.0
3.0
0.4

19.1
3.0
3.3
0.3

18.9
3.0
3.3
0.3

18.7
3.0
3.5
0.3

Subtotal, transportation ....................................................................................................
Housing and buildings categories:
Federally assisted housing ..............................................................................................
Hospitals ...........................................................................................................................
Public buildings 1 ..............................................................................................................

25.8

25.4

25.6

25.7

25.6

25.6

6.5
1.7
2.9

6.3
2.5
2.7

6.2
2.1
2.4

6.1
2.1
2.4

5.9
2.1
2.5

5.7
2.1
2.4

Subtotal, housing and buildings ......................................................................................
Other nondefense categories:
Wastewater treatment and related facilities ....................................................................
Water resources projects ................................................................................................
Space and communications facilities ..............................................................................
Energy programs .............................................................................................................
Community development programs ................................................................................
Other nondefense ............................................................................................................

11.1

11.5

10.7

10.6

10.6

10.3

1.9
1.9
3.2
1.3
5.2
5.0

1.6
2.5
2.7
1.1
5.7
1.9

1.8
2.2
3.0
1.0
5.3
5.2

2.0
2.3
3.6
1.1
5.2
6.0

2.1
2.2
3.4
1.1
5.1
6.0

2.0
2.1
2.7
1.0
5.0
5.7

Subtotal, other nondefense .............................................................................................

18.4

15.5

18.4

20.2

20.0

18.5

Subtotal, nondefense .......................................................................................................
National defense ..................................................................................................................

55.4
47.0

52.4
42.9

54.7
42.7

56.5
41.6

56.1
41.2

54.4
40.7

Total ..........................................................................................................................................

102.5

95.4

97.4

98.1

97.4

95.1

1

Excludes outlays for public buildings that are included in other categories in this this table.

For budget authority and outlay details for most programs on a policy basis, see the items included in major
public physical capital in tables 6–2 and 6–3.
Public Civilian Capital Needs Assessments
The Act requires information regarding the state of
major Federal infrastructure programs, including highways and bridges, airports and airway facilities, mass
transit, railroads, federally assisted housing, hospitals,
water resources projects, and space and communications investments. Funding levels, long-term projections, policy issues, needs assessments, and critiques,
are required for each category.
Capital needs assessments change little from year
to year, in part due to the long-term nature of the
facilities themselves, and in part due to the consistency
of the analytical techniques used to develop the assessments and the comparatively steady but slow changes
in underlying demographics. As a result, the practice
has arisen in reports in previous years to refer to earlier discussions, where the relevant information had
been carefully presented and changes had been minimal.

The needs assessment material in reports of earlier
years is incorporated this year largely by reference to
earlier editions and by reference to other needs assessments. The needs analyses, their major components,
and their critical evaluations have been fully covered
in past Supplements, such as the 1990 Supplement to
Special Analysis D.
It should be noted that the needs assessment data
referenced here have not been determined on the basis
of cost-benefit analysis. Rather, the data reflect the
level of investment necessary to meet a predefined
standard (such as maintenance of existing highway conditions). The estimates do not address whether the benefits of each investment would actually be greater than
its cost or whether there are more cost-effective alternatives to capital investment, such as initiatives to reduce demand or use existing assets more efficiently.
Before investing in physical capital, it is necessary to
compare the cost of each project with its estimated
benefits, within the overall constraints on Federal
spending.

6.

161

FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING

Significant Factors Affecting Infrastructure Needs Assessments
Highways
1. Projected annual growth in travel to the year 2011 ..................................................................................................
2. Annual cost to maintain overall 1993 conditions and performance on highways eligible for Federal-aid ............
3. Annual cost to maintain overall 1994 conditions on bridges ....................................................................................

2.15 percent
$42.8 billion (1993 dollars)
$5.1 billion (1993 dollars)

Airports and Airway Facilities
1. Airports in the National Plan of Integrated Airport Systems with scheduled passenger traffic ...........................
2. Air traffic control towers ..............................................................................................................................................
3. Airport development eligible under airport improvement program for period 1993–1997 .....................................

540
476
$29.7 billion ($9.4 billion for
capacity) (1992 dollars)

Mass Transportation Systems
1. Yearly cost to maintain condition and performance of rail facilities over a period of 20 years .............................
2. Yearly cost to replace and maintain the urban, rural, and special services bus fleet and facilities .....................

$4.2 billion (1993 dollars)
$3.7 billion (1993 dollars)

Wastewater Treatment
1. Total remaining needs of sewage treatment facilities ...............................................................................................
2. Total Federal expenditures under the Clean Water Act of 1972 through 1998 ......................................................
3. The population served by centralized treatment facilities: percentage that benefits from at least secondary
sewage treatment systems (1996) ................................................................................................................................
4. States and territories served by State Revolving Funds ...........................................................................................

$128 billion (1996 dollars)
$68 billion
91 percent
51

Housing
1. Total unsubsidized very low income renter households with worst case needs (5.3 million*)
A. In severely substandard units .................................................................................................................................
B. With a rent burden greater than 50 percent ..........................................................................................................
* The total is less than the sum because some renter families have both problems.

0.4 million
5.0 million

Indian Health (IHS) Care Facilities
1.
2.
3.
4.
5.

IHS hospital occupancy rates (1997) ...........................................................................................................................
Average length of stay, IHS hospitals (days) (1997) ..................................................................................................
Hospital admissions (1997) ..........................................................................................................................................
Outpatient visits (1996) ...............................................................................................................................................
Eligible population (1998) ............................................................................................................................................

45.3 percent
4.2
56,219
4,118,800
1,463,938

1.
2.
3.
4.
5.

Department of Veterans Affairs (VA) Hospitals (1996)
Hospitals ........................................................................................................................................................................
Outpatient clinics ..........................................................................................................................................................
Domiciliaries .................................................................................................................................................................
Centers for veterans .....................................................................................................................................................
Nursing homes ..............................................................................................................................................................

172
439
40
206
131

Water Resources
Water resources projects include navigation (deepwater ports and inland waterways); flood and storm damage protection; irrigation; hydropower; municipal and industrial water supply; recreation; fish and wildlife mitigation, enhancement, and restoration; and soil conservation.
Potential water resources investment needs typically consist of the set of projects that pass both a benefit-cost test for economic feasibility
and a test for environmental acceptability. In the case of fish and wildlife mitigation or restoration projects, the set of eligible projects
includes those that pass a cost-effectiveness test.

Investment Needs Assessment References
General
U.S. Advisory Commission on Intergovernmental Relations (ACIR). High Performance Public Works: A New
Federal Infrastructure Investment Strategy for America,
Washington, D.C., 1993.
U.S. Advisory Commission on Intergovernmental Relations (ACIR). Toward a Federal Infrastructure Strategy: Issues and Options, A–120, Washington, D.C.,
1992.

U.S. Army Corps of Engineers, Living Within Constraints: An Emerging Vision for High Performance
Public Works. Concluding Report of the Federal Infrastructure Strategy Programs. Institute for Water Resources, Alexandria, VA, 1995
U.S. Army Corps of Engineers, A Consolidated
Performance Report on the Nation’s Public Works: An
Update. Report of the Federal Infrastructure Strategy
Program. Institute for Water Resources, Alexandria,
VA, 1995.

162
Surface Transportation
Department of Transportation. 1995 Status of the Nation’s Surface Transportation System: Conditions and
Performance: Report to Congress. 1995. This report discusses roads, bridges, mass transit, and maritime transportation.
Airports and Airways Facilities
Federal Aviation Administration. The National Plan
of Integrated Airport Systems Report, April 1995.
Federally Assisted Housing
U.S. Department of Housing and Urban Development, Office of Policy Planning and Development, Tabulations of 1993 American Housing Survey.
Indian Health Care Facilities
Indian Health Service. Priority System for Health Facility Construction (Document Number 0820B or
2046T). September 19, 1981.
Indian Health Service. Trends in Indian Health—
1995. 1995.
Office of Audit, Office of Inspector General, U.S. Department of Health and Human Services. Review of
Health Facilities Construction Program. Indian Health
Service Proposed Replacement Hospital at Shiprock,
New Mexico (CIN A–09–88–00008). June, 1989.

ANALYTICAL PERSPECTIVES

Office of Audit, Office of Inspector General, U.S. Department of Health and Human Services. Review of
Health Facilities Construction Program. Indian Health
Service Proposed Construction Project for the Alaska
Native Medical Center at Anchorage Alaska (CIN
A–09–89–00096). July, 1989.
Office of Technology Assessment. Indian Health Care
(OTA 09H 09290). April, 1986.
Wastewater Treatment
Environmental Protection Agency, Office of Water.
1996 Needs Survey Report to Congress. (EPA
832–R–87–003).
Water Resources
National Council on Public Works Improvement. The
Nation’s Public Works, Washington, D.C., May, 1987.
See ‘‘Defining the Issues—Needs Studies,’’ Chapter II;
Report on Water Resources, Shilling et al., and Report
on Water Supply, Miller Associates.
Frederick, Kenneth D., Balancing Water Demands
with Supplies: The Role of Demand Management in a
World of Increasing Scarcity, Report for the International Bank of Reconstruction and Development,
Washington, D.C. 1992.

7. RESEARCH AND DEVELOPMENT EXPENDITURES
Scientific and technological advances have left few
facets of life untouched. Great leaps in the speed and
economy of transportation, enormous increases in farm
productivity, global flows of information and services,
advances in health treatment and prevention and in
environmental protection—all these changes have created a world at the dawn of the 21st Century that
is vastly different from the world our grandparents
knew. As numerous studies show, technological innovation and scientific discovery have been responsible for
at least half of the Nation’s productivity growth in the
last 50 years, generated millions of high-skill, highwage jobs, and substantially improved the quality of
life in America.
The Federal government has played an important
role in spurring and sustaining this scientific and technological advance. Among other feats, Governmentsponsored research and development (R&D) has put
Americans on the moon, explored the oceans, harnessed
the atom, devised more effective treatments for cancers,
found the remains of lost civilizations, tracked weather
Table 7–1.

patterns and earthquake faults, and discovered the
chemistry of life. No other country in history can match
the United States’ record of achievement in science and
technology. Because these investments have paid such
rich dividends, and because the next century will bring
new challenges, opportunities and problems that science
and technology can help address, continued U.S. leadership in science and technology is a cornerstone of the
President’s vision for America. The Administration is
proposing $76.4 billion in outlays for R&D activities
in 1999, including $36.4 billion for civilian R&D—a sixpercent increase over 1998. University-based research
will increase to roughly $13.5 billion, an eight-percent
increase over 1998. The ‘‘Federal Science and Technology’’ (FS&T) budget is an alternative measure of
the Federal investment in science and technology proposed by the National Academy of Sciences. By this
alternative accounting method the FS&T budget total
would be approximately $45 billion in 1999. Chapter
Six of the Budget includes a lengthier discussion of
R&D activities and shows budget authority data.

FEDERAL RESEARCH AND DEVELOPMENT EXPENDITURES
(Outlays, dollar amounts in millions)
1997 Actual

1998 Estimate

1999 Proposed

Dollar Change:
1998 to 1999

Percent Change:
1998 to 1999

By Agency
Defense .....................................................................................................................
Health and Human Services .....................................................................................
National Aeronautics and Space Administration ......................................................
Energy .......................................................................................................................
National Science Foundation ....................................................................................
Agriculture ..................................................................................................................
Commerce .................................................................................................................
Interior ........................................................................................................................
Transportation ............................................................................................................
Veterans Affairs .........................................................................................................
Environmental Protection Agency .............................................................................
Other ..........................................................................................................................

37,844
11,407
9,811
6,572
2,343
1,478
792
572
561
563
537
1,050

36,592
13,096
9,769
6,289
2,370
1,561
820
622
517
608
596
1,007

36,714
14,127
9,618
7,002
2,607
1,599
837
632
908
664
617
1,108

122
1,031
–151
713
237
38
17
10
391
56
21
101

0%
8%
–2%
11%
10%
2%
2%
2%
76%
9%
4%
10%

TOTAL ..................................................................................................................

73,530

73,847

76,433

2,586

4%

By R&D Type
Basic Research .........................................................................................................
Applied Research ......................................................................................................
Development ..............................................................................................................
Equipment ..................................................................................................................
Facilities .....................................................................................................................

14,113
13,898
43,062
731
1,726

14,549
15,030
41,800
698
1,770

15,805
15,787
42,112
828
1,901

1,256
757
312
130
131

9%
5%
1%
19%
7%

TOTAL ..................................................................................................................

73,530

73,847

76,433

2,586

4%

By Civilian Theme
Basic Research .........................................................................................................
Applied Research ......................................................................................................
Development ..............................................................................................................
Equipment ..................................................................................................................
Facilities .....................................................................................................................

12,981
9,785
8,118
582
1,411

13,456
10,733
8,166
552
1,336

14,684
11,219
8,384
684
1,423

1,228
486
218
132
87

9%
5%
3%
24%
7%

SUBTOTAL ...........................................................................................................

32,877

34,243

36,394

2,151

6%

163

164

ANALYTICAL PERSPECTIVES

Table 7–1.

FEDERAL RESEARCH AND DEVELOPMENT EXPENDITURES—Continued
(Outlays, dollar amounts in millions)
1997 Actual

1998 Estimate

1999 Proposed

Dollar Change:
1998 to 1999

Percent Change:
1998 to 1999

By Defense Theme
Basic Research .........................................................................................................
Applied Research ......................................................................................................
Development ..............................................................................................................
Equipment ..................................................................................................................
Facilities .....................................................................................................................

1,132
4,113
34,944
149
315

1,093
4,297
33,634
146
434

1,121
4,568
33,72
144
478

28
271
894
–2
44

3%
6%
0%
–1%
10%

SUBTOTAL ...........................................................................................................

40,653

39,604

40,039

435

1%

R&D Support to Universities .........................................................................................

11,748

12,458

13,455

997

8%

8. UNDERWRITING FEDERAL CREDIT AND INSURANCE
The Federal Government continues to be the largest
financial institution in the United States, with a face
value of $6.2 trillion outstanding at the end of 1997.
Of this, $181 billion is direct loans, $822 billion is loan
guarantees, and $5.2 trillion is insurance. Including
Government-sponsored enterprises (GSEs), the total
Federal and federally assisted credit and insurance outstanding is $7.9 trillion.
These diverse financial programs offer credit for
housing, education, business, and exports, and insurance for deposits, pensions, and other risks. They face
two challenges. Like other programs, they are operating
under tight budgetary constraints. And they are seeking to redefine their purpose and improve their effectiveness in the context of rapidly evolving private financial markets that are making some of their functions
less necessary while generating both new risks and new
opportunities.
The introduction to this chapter summarizes key
changes in financial markets and their effects on Federal programs.
• Its first section is a cross-cutting assessment of
the rationale for a continued Federal role in providing credit and insurance, performance measures for credit programs, and criteria for re-engineering credit programs so as to enhance their
benefits in relation to costs. This section also describes the recent simplification of credit reform
and the intent to increase loan sales.
• The second section reviews Federal credit programs and GSEs in four sectors: housing, education, business and community development, and
exports, noting the rationale and goals of these
programs. It highlights a new housing consortium
to help program managers integrate with evolving
private sector practices, and efforts to improve the
effectiveness of student, business, and international credit programs.
• The final section assesses recent developments in
Federal deposit insurance, pension guarantees,
and disaster insurance.
Evolving Financial Markets
Financial markets have been evolving rapidly in recent years. Both intermediaries—banks and the many
non-bank firms engaged in financial services—and capital markets have been reaching out to new clients that
they did not serve a few years ago. Competition for
business within and across industry lines has become
more intense as legal and regulatory restrictions segmenting financial markets have eased. Massive databanks and increasingly sophisticated analytical methods are being used to find creditworthy borrowers

among people and businesses previously thought ineligible for private credit.
Moreover, funds are flowing more readily to their
most productive uses across the country and around
the world. Interstate banking and branching are almost
nationwide. Capital market financing is available to
smaller companies and for a broader range of purposes
than before. Secondary markets are the main source
of financing for mortgages, and a rapidly growing
source of financing for household durables, consumer
credit, and small business loans. Nonbanks and nonfinancial firms are helping to funnel funds from capital
markets to small clients in cities and in rural areas.
Faster and cheaper information and communications
systems have revolutionized ‘‘back office’’ functions.
These can be consolidated to achieve economies of scale
and located anywhere in the world where capable help
is available and economical. From these locations, communications can bring the ‘‘back office’’ to the front
line on a computer terminal in the office of any realtor
or supplier or in any storefront or kiosk. From a timely
information base, credit servicing and workout have become much more efficient.
Impact on Federal Programs
These changes are affecting the roles, risks, and operations of Federal credit and insurance programs.
• In some cases, private credit and insurance markets may evolve sufficiently to take over functions
previously left to Federal programs. More likely,
they may take away the best risks among those
who have been borrowing from the Government
or with its guarantee, leaving the Federal program
facing a smaller pool of riskier clients. If the Government is aware of this in time, the result may
be new benefit/cost calculations that might help
to redesign—or to end—the program. If the Government is caught unaware, the result may be
greater cost for the taxpayers.
• At the same time, Federal programs can take advantage of the growing private capability. They
can leverage it to provide additional assistance
to their clients. With careful attention to the incentives faced by the private sector, they can develop a variety of partnerships with private entities. And they can contract with the private sector
wherever it can provide specific credit servicing,
collection, or asset disposition services more efficiently.
Insurance programs, too, are affected by the evolution
of the financial marketplace. That is most obvious for
deposit insurance, which now backs a recovered, consolidating industry, but one that has assumed the risks
inherent in providing a growing array of increasingly

165

166

ANALYTICAL PERSPECTIVES

sophisticated services, including many off-balance sheet
activities, often on a world-wide basis. Depository institutions have become increasingly vulnerable to adverse
shocks in foreign financial markets through loans, investments, foreign exchange transactions, and off-balance-sheet activities. In pensions, the Government
guarantees defined benefit plans, but defined contribution plans play an increasing role—attracting the support of younger workers in an aging workforce. This
trend may accelerate as the retirement of the baby
boom generation nears. In disaster insurance, private
firms are gaining a better understanding of their risks
I.

and exploring ways to diversify them in capital markets.
In this changing environment for Federal credit and
insurance programs, this chapter asks three questions.
First, what is our current understanding of the roles
of these programs? Second, how well they are achieving
their goals? And finally, could they be re-engineered
to achieve greater benefits in relation to costs? A new
consortium of housing program managers, and managers of student, business, and international credit programs will be working intensively on this third question
next year.

A CROSS-CUTTING ASSESSMENT

The Federal Role
In most lines of credit and insurance, the private
market efficiently allocates resources to meet societal
demands, and Federal intervention is unnecessary.
However, Federal intervention may improve on the
market outcome in some situations. The following are
six standard situations where this may be the case,1
together with some examples of Federal programs that
address them.
• Information failures occur when there is an asymmetry in the information available to different
agents in the marketplace. A common Federal
intervention in such cases is to require the more
knowledgeable agent, such as a financial institution, to provide certain information to the other
party, for example, the borrower or investor. A
different sort of information failure occurs when
the private market deems it too risky to develop
a new financial instrument or market. This is rare
nowadays, but it is worth remembering that the
Federal Government developed the market for amortized, fixed-rate mortgages and other innovations in housing finance.
• Externalities occur when people or entities either
do not pay the full cost of their activities (e.g.,
pollution) or do not receive the full return. Federal
credit assistance for students is justified in part
because, although people with more education are
likely to have higher income and even better
health, they do not receive the full benefits of
their education. Their colleagues at work, the residents of their community, and the citizens of the
Nation also benefit from their greater knowledge
and productivity.
• Economic disequilibrium is a third rationale for
Federal intervention. This is one rationale for deposit insurance. If many banks and thrifts are
hurt simultaneously by an economic shock, such
as accelerating inflation in the 1970s, and depositors have a hard time knowing which ones may
become insolvent, deposit insurance prevents a
1
Economics textbooks also list pure public goods,like national defense, where it is difficult
or impossible to exclude people from sharing the full benefits of the goods or services
once they have been produced. It is hard to imagine credit or insurance examples in this
category.

contagious rush to withdraw deposits that could
harm the whole economy.
• Failure of competition, resulting from barriers to
entry, economies of scale, or foreign government
intervention, may also argue for Federal intervention—for example, by reducing barriers to entry,
as has often been done recently, by negotiating
to eliminate or reduce foreign government subsidies, or by providing countervailing Federal credit assistance to American exporters.
• Incomplete markets occur if producers do not provide credit or insurance even though customers
might be willing to pay for it. One example would
be catastrophic insurance, where there is a small
risk of a very large loss; a disaster that occurred
sooner rather than later could bankrupt the insurer even if premiums were set at an appropriate
level to cover long-term cost. Another example is
caused by ‘‘moral hazard’’ problems, where the
borrower or insured could behave so as to take
advantage of the lender or insurer. This is the
case for pension guarantees, where sponsors might
underfund plans, and for deposit insurance, where
banks might take more risk to earn a higher return. In these cases, the Government’s legal and
regulatory powers provide an advantage in comparison with a private insurer.
• In addition to correcting market failures, Federal
credit programs are often used to redistribute resources by providing subsidies from the general
taxpayer to disadvantaged regions or segments of
the population.
In reviewing its credit and insurance programs, the
Federal Government must continually reassess whether
the direct and indirect benefits to the economy exceed
the direct and indirect costs. This assessment should
include the costs associated with redirecting scarce resources away from other investments. In some situations, the market may have recently become capable
of providing financial services, and older Federal programs may need to be modified or ended to make room
for private markets to develop. Private providers in
similar circumstances might go bankrupt, merge, or
change their line of business; for Federal programs,
a policy decision and usually a change in law are need-

8. UNDERWRITING FEDERAL CREDIT AND INSURANCE

ed to eliminate overcapacity. In other instances, Federal
programs may be redesigned to encourage the development of private credit market institutions or to target
Federal assistance more efficiently to groups still unable to obtain credit and insurance in the private market.
What Are We Trying to Achieve?
If the main Federal role is to provide credit and insurance that private markets would not provide—to
stretch the boundaries in providing credit and insurance—the Federal goal is to achieve a net impact that
benefits society. Together, these objectives make the
standard for success of a Federal credit or insurance
program more daunting than for a private credit or
insurance firm.
For credit and insurance, as for all other programs,
implementation of the Government Performance and
Results Act (GPRA) will help to assess whether programs are achieving their intended results in practice—
and will improve the odds for success. GPRA requires
agencies to develop strategic plans in consultation with
the Executive Branch, the Congress, and interested parties; this process should refine and focus agency missions. The strategic plans set long-range goals, annual
performance plans set milestones to be reached in the
coming year, and annual performance reports will
measure agency progress toward achieving their goals.
GPRA defines four kinds of measures for assessing
programs: inputs (the resources used), outputs (the
goods or services produced), outcomes (the gross effects
on society achieved by the program), and net impacts
(the effects net of those that would have occurred in
the absence of the program, e.g., with private financing). For credit and insurance programs, interesting
interrelationships among these measures provide the
keys to program success.
Net impacts assess the net effect of the program
on intended outcomes compared with what would have
occurred in the absence of the program. They exclude,
for example, effects that would have been achieved with
private credit in the absence of the program. Among
the net impacts toward which Federal credit programs
strive are: a net increase in home ownership, a net
increase in higher education graduates, a net increase
in small businesses, a net increase in exports, and a
net increase in jobs.
For credit programs, the first key to achieving any
of these net impacts is outreach. In the spirit of the
Federal role, programs need to identify borrowers who
would not get private credit. They need to reach out
to under-served populations (e.g., low-income or minority people) and neighborhoods (urban and rural). They
need to encourage the start-up of new activities (e.g.,
beginning farmers, new businesses, new exporters).
They need to reach their legislatively targeted populations (e.g., students, veterans). Federal lending is
often to higher-risk borrowers, or for higher-risk purposes. In order to assist certain target groups or encour-

167
age certain activities, credit may be extended for longer
periods or at a lower cost to the borrower.
Achieving program objectives, however, also means
finding ways to assist those borrowers at the boundary
of private credit markets to repay their loans. This
is not just a financial goal; it is necessary to achieve
the program’s social purpose. Home ownership requires
mortgage repayment. Education that enhances income
is associated with repayment of student loans. Remaining in business with a good credit rating requires repayment of small business, farm, and export loans. And
loan repayment is inherent in program cost-effectiveness. Moreover, when the Federal Government bears
risk for less creditworthy borrowers and does so in a
way that fails to assist them to repay, they struggle
with high debt burdens and are left with poor credit
records.
With implementation of the Federal Credit Reform
Act of 1990, Federal credit programs began to reconcile
the tension between helping certain groups or purposes
and ‘‘business-like’’ financial management. With the implementation of GPRA, they may begin to see program
success and financial success as two facets of the same
goal. The challenge is usually to identify ‘‘boundary’’
borrowers and to structure the loan and its servicing
(including technical assistance) so as to pull those borrowers toward financial and programmatic success. In
some cases, savings from improved credit program management may be reinvested to pull more borrowers
across that boundary.
Outputs and outcomes, therefore, have an interrelationship which is crucial to the performance of credit programs. The most obvious output of Federal credit
programs is the number and value of direct loans originated or loans guaranteed. But volume alone does not
achieve the objectives of Federal credit programs; indeed, large volume or market share may mean that
private lenders are displaced. Loans must have certain
characteristics in order to achieve the desired outcomes
and net impacts; these characteristics are therefore part
of the desired program output.
Because of the Federal role, output measures should
include an estimate of the percent of loans or guarantees originated going to borrowers who would otherwise
not have access to private credit, and the percent of
loans or guarantees originated going to specific target
groups (e.g., veterans) or for specific purposes. Because
of the Federal goal, output measures should include
the percent of loans or guarantees that are current.
This should be compared with the percent that were
expected to be current at this point in the repayment
cycle.
To assess the latter, program data should be analyzed
to determine whether repayment prospects are enhanced by particular characteristics of loan structure
(such as higher initial borrower equity), of loan origination (such as verifying borrower financial status), of
loan servicing (such as prompt counseling), or of guarantee conditions (such as lender risk-sharing). When
such characteristics help to control the cost of credit

168

ANALYTICAL PERSPECTIVES

programs and to achieve desired outcomes, then these
characteristics should be measured as part of the program’s output.
The linkage between such output characteristics and
the outcomes of Federal credit programs is not always
fully recognized. For example, one desired outcome is
to reach under-served populations or neighborhoods. To
achieve this outcome, it would be useful to monitor
whether loans are going to borrowers who would not
otherwise have access to credit, or to specific target
groups. Other desired outcomes include supporting investment important to the economy, encouraging startup of new activities, or contributing to sustained economic development. To achieve these outcomes, it would
be useful to monitor whether the program’s loans and
operating procedures have characteristics that would
enhance borrower repayment.
Inputs. Program cost is also a performance measure.
For credit and insurance programs, it is a continuing
challenge to understand and control the risks that the
Government assumes and to measure the inherent cost.
This is especially important in view of the rapid
changes in financial markets discussed above and the
increasingly complex financial instruments.
The subsidy cost of Federal credit programs, cumulated over time for each cohort of the program’s loans
or loan guarantees, is the main input. Another is the
administrative cost of the program, including the cost
of credit extension, direct loan servicing and guaranteed
loan monitoring, collecting on delinquent loans and collateral, and other administrative costs such as policy
making or systems development.
The relationship between these inputs is also crucial
for credit programs. Careful servicing of loans, for example, can reduce default costs, and perhaps total program costs. So good servicing is good financial management for the taxpayer. But good servicing is also an
art, which can—by assisting borrowers to repay—help
to achieve the program’s performance objectives. Private servicing of loans offers many examples of the
gains from matching repayment to the borrower’s flow
of income, treating borrowers in different circumstances
differently, and in other ways maximizing the borrower’s chances to make good.
In sum, there are three relationships that seem to
hold the key to excellence in credit program perform-

ance: the relationship between repayment and the
achievement of program objectives, the relationship between the characteristics of credit program outputs and
desired outcomes, and the relationship between subsidy
cost and good servicing and program administration.
Another important key to success is the speed with
which the program adapts to market changes, including
its ability to provoke or harness private markets into
meeting Federal goals.
Principles for Re-engineering
In order to improve the effectiveness of Federal credit
programs, OMB will be working with agencies to identify ways to re-engineer credit management. This effort
will focus on improving servicing, will consider consolidation of functions such as data collection and asset
disposition, will rely on the private sector when that
would improve efficiency, will devise incentives to improve management and reduce cost, and will ensure
the development of data for management and subsidy
estimation.
The focus will be on managing the servicing, workout,
and sale of any collateral efficiently. For example, why
does the Federal Government pay claims on guaranteed
loans and handle the workout, instead of leaving this
to the originating lender? Why does the Government
take over collateral? How do the timing and results
of our asset disposition compare with private practice?
Why do we make loans to finance purchases of collateral? What incentives and penalties would be useful
for programs and program staff? For guaranteed loan
originators? For contractors who service Federal loans
or dispose of collateral?
OMB has developed a tentative set of principles for
re-engineering credit programs that builds on OMB Circular A-129 and initial research. These will be modified
by lessons learned as they are put into practice. The
resulting principles are intended to improve the performance of Federal credit programs in the years ahead.
Because private markets are extending credit where
it was formerly unavailable, and because there is little
purpose to re-engineering programs which are not justified, these principles start with basic questions of program justification. But their main focus is on how programs should be carried out.

Program Justification
1.

Credit assistance should be provided only when it has been demonstrated that private credit markets cannot
achieve clearly defined Federal objectives. What is the objective? Is access to private credit available? If
not, why not? If so, why and to what extent should private terms and conditions be supplemented or subsidized?

2.

Credit assistance should be provided only when it is the best means to achieve Federal objectives. Can private credit markets be developed? Can market imperfections be overcome by information, regulatory
changes, or other means? Would small grants for downpayments, capitalization for State, local, or nonprofit revolving funds, or other approaches be more efficient?

8. UNDERWRITING FEDERAL CREDIT AND INSURANCE

3.

169

Credit assistance should be provided only when its benefits exceed its cost. Analyze benefits and costs in accordance with OMB Circular A–94.

Program Design
4.

Credit programs should minimize substitution for private credit. What features of program design minimize
displacement? Encourage and supplement private lending? To what extent is credit for this objective expanded by this program compared with what would be available in the absence of the program? What is
the economic cost of the lending bumped from the credit queue?

5.

Credit programs should stretch their resources and better meet their objectives by controlling the risk of default. What features of program design minimize risk? Are there incentives and penalties for loan originators and servicers to minimize risk? What features of the loan contract, the process of origination, the
quality of servicing, and the workout procedures minimize risk? Do borrowers have an equity interest? Is
maturity shorter than the economic life of the asset financed? Are the timing and amount of payment
matched with availability of resources? Is timely reminder and technical assistance provided? How well
is risk understood, measured, and monitored?

6.

Credit programs should stretch their resources to better meet their objectives by minimizing cost; most
should be self-sustaining. Do fees and interest cover the Government’s cost, including administration?
Are interest rates specified as a percent of market rates on comparable maturity Treasury securities?
Are charges for riskier borrowers proportional to their higher cost?

Program Operations
7.

Credit programs should take advantage of the capacity, flexibility, and expertise available in competitive
private markets unless the benefits of direct Federal operations can be shown to exceed the cost. Private financial institutions may offer convenient access for borrowers, potential for graduation to private credit,
economies of scale, ready adjustment to changing volume or location of loans, and knowledge of current
credit conditions and techniques.

8.

The lender (in the case of a loan guarantee), the servicer, and the providers of workout and asset disposition
services should have a stake in the successful and timely repayment of the loan or collections on claims
and collateral. Originators of guaranteed loans should bear a share of each dollar of default loss, and—
unless other arrangements can be shown to be more cost-effective—should be responsible for handling
workout. Each contract should include incentives for good performance, and penalties, including loss of
business, for poor performance. The duration and scope of each contract or agreement should be limited
so as to maximize specialization and competition, unless those are offset by economies of scale in operations and monitoring.

9.

Criteria should be established for participation in Federal loan guarantee programs by lenders, servicers,
and providers of workout and asset disposition services. These criteria should include financial and capital requirements for lenders and servicers not regulated by a Federal financial institution regulatory
agency, and may include fidelity/surety bonding and/or errors and omissions insurance, qualification requirements for officers and staff, and requirements of good standing and performance in relation to other
contracts and debts. Lenders transferring and/or assigning servicing, and lenders or servicers transferring and/or assigning workout or asset disposition, must use only entities which have qualified under the
Federal participation criteria.

10.

When there are economies of scope or scale, the data gathering and analysis, servicing, workout, asset disposition, or other functions of specific credit programs should be combined or coordinated. The sequence
of operations should be streamlined, and accountability for each step clearly defined.

Program Monitoring
11.

Each program should maintain or receive monthly loan-by-loan transaction data and a system whereby this
information triggers servicing, workout, and follow-up actions. These data shall be linked by loan number
to an analytical database showing characteristics of loans, borrowers, projects financed, financial information, credit ratings, and other data in a form suitable for use in subsidy estimation and loan pricing.

170
12.

ANALYTICAL PERSPECTIVES

Each program should design and carry out steps to foresee problems, and to inspect, audit, and assess the
program’s operations. Methods should be benchmarked against the best practices used elsewhere. The
program and its lenders, servicers, and other contractors should experiment with and assess ways in
which the effectiveness or efficiency of the program might be improved or costs reduced.

Simplification of Credit Reform
The Balanced Budget Act of 1997 amended the Federal Credit Reform Act of 1990 (FCRA) to make several
technical changes, some of which codified OMB guidance. Among the provisions were:
• Requiring agencies to use the same discount rate
to calculate the subsidy when they obligate budget
authority for direct loans and loan guarantees as
when they prepare the President’s Budget. Previously, agencies switched at obligation to interest
rates during the preceding calendar quarter. Analysis showed that quarterly rates predicted actual
annual average rates slightly better than the
President’s Budget assumptions from the previous
year. However, the increased accuracy was not
great enough to justify the additional complexity
and the change in loan volume from what Congress had assumed when it appropriated subsidy
budget authority for the program.
• Requiring agencies to use the same forecast assumptions (e.g., default and recovery rates) to calculate subsidy rates when they obligate for direct
loans and loan guarantees as when they prepare
the President’s Budget. This provision also was
enacted in response to the Budget and Appropriations Committees’ desire for loan volumes consistent with Congressional intent in appropriations
acts. While agencies must use the same forecast
assumptions, they will continue to calculate subsidy estimates at obligation using cash flows that
have been adjusted to reflect the actual terms and
conditions (explicit technical assumptions) of the
direct loan and loan guarantee contracts, rather
than the estimated terms and conditions assumed
in the President’s Budget.
• Strengthening the requirement that agencies to
transfer end-of-year unobligated balances in liquidating accounts (revolving funds for direct loans
and loan guarantees made prior to the effective
date of the FCRA) to the general fund as soon
as practicable after the close of the fiscal year.
Because permanent appropriations are available
to pay claims in excess of the liquidating account
balance, these unobligated balances do not need
to be carried forward between fiscal years.
• Requiring the interest rate paid on financing account debt to Treasury, and earned on financing
account balances, to be identical to the discount
rate used to calculate subsidy costs. These interest
rates must be equal in order for the financing
accounts to have exactly enough resources to pay
default claims or repay debt to Treasury.
OMB also has simplified the reestimate process by
requiring only one reestimate for differences between

the interest rate assumptions in the President’s Budget
and the actual interest rate when the loan is disbursed.
This reestimate is to be made when at least 90 percent
of the dollar volume of loans in a cohort has been
disbursed. Previously, agencies were required to perform interest rate reestimates after the close of each
fiscal year in which disbursements occurred. For programs disbursing over multiple years, the true discount
rate for a cohort is not known for several years; meanwhile, calculations using a combination of estimated
and actual rates resulted in wide fluctuations in reestimates that provided no useful information.
Debt Collection and Loan Asset Sales
The Federal Government’s inventory of delinquent
loans and loan receivables was $37 billion at the end
of 1997. Usually, this debt is worked by the agency
that made the direct loans or loan guarantees. Little
progress has been made in reducing this debt, whereas
the private sector has developed sophisticated tools for
collecting delinquent debt and quickly disposing of assets acquired through default. A major theme of credit
program re-engineering will be to work delinquent debt
more aggressively and take advantage of private sector
efficiencies by:
• Fully implementing the Debt Collection Improvement Act of 1996. Agencies must send debt that
is over 180 days overdue to Treasury for offset
against Federal payments to the delinquent borrower and to a debt collection center designated
by the Secretary of the Treasury.
• Requiring private lenders to liquidate collateralized defaulted loan assets. The Rural Housing
Service of USDA, and its farm and business loan
guarantee programs, require lenders to dispose of
defaulted assets. This better aligns private lenders’ incentives with the Federal Government’s
interest in maximizing collections, and takes advantage of private sector efficiencies to maximize
collections and reduce the net cost of credit programs. The Government avoids acquiring delinquent debt and having to dispose of the collateral.
• Requiring agencies to sell delinquent debt over one
year overdue. Government policy will presume that
sales of delinquent debt over one year overdue
will be in the best financial interest of the Government unless demonstrated otherwise. Exemptions
will be made for debt that is producing collections,
owned by foreign Governments or entities, is in
structured forbearance, or is in adjudication or
bankruptcy. HUD’s aggressive program of selling
delinquent assets over the past three years has
demonstrated that agencies can significantly reduce their delinquent debt in a way that furthers
program objectives and increases the return to the

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8. UNDERWRITING FEDERAL CREDIT AND INSURANCE

Government. SBA also will sell delinquent assets
in 1998, 1999, and 2000.
The Federal Credit Policy Working Group, together
with the General Services Administration, is developing
a government-wide Financial Advisor Request for Proposal, which by June 1998 will make available to all
agencies a list of financial advisors through a basic
II.

ordering agreement. Each credit agency will be expected to contract with a financial advisor to conduct
a valuation of their loan asset portfolio. For all agencies, the results of the asset valuation study will be
used to adjust baseline subsidy rates in the FY 2000
Budget. These rates will also reflect estimated proceeds
from the sale of delinquent assets.

CREDIT IN FOUR SECTORS

Housing Credit Programs and GSEs
The Federal Government provides loans and loan
guarantees to expand access to home ownership to people who lack the savings, income, or credit history to
qualify for a conventional home mortgage and to finance rental housing for low-income persons. The Departments of Housing and Urban Development (HUD),
Veterans Affairs (VA), and Agriculture (USDA) made
$102 billion of loan and loan guarantee commitments
in 1997, helping 1.3 million households.
Each Department has a program to guarantee singlefamily mortgages; together, they guaranteed [XX] percent of the single-family mortgages originated in the
United States last year.
• HUD’s Federal Housing Administration (FHA)
runs a Mutual Mortgage Insurance Fund that
guaranteed $61 billion in mortgages for 740,000
households in 1997. Over three-fourths of these
went to first-time homebuyers.
• The VA assists veterans, members of the Selected
Reserve, and active duty personnel to purchase
homes as a recognition of their service to the Nation. The program substitutes the Federal guarantee for the borrower’s down payment. In 1997,
VA provided $24 billion in guarantees to 239,000
borrowers.
• USDA’s Rural Housing Service (RHS) guarantees
up to 90 percent of an unsubsidized home loan.
The program’s emphasis is on reducing the number of rural residents living in substandard housing. In 1997, nearly $2 billion of guarantees went
to 40,000 households.
In addition, RHS has direct loan programs for singlefamily and multi-family mortgages, and FHA guarantees mortgages for multi-family housing and other specialized properties. The VA makes vendee loans when
it sells collateral from defaults.
The Housing Consortium
Private banks, thrifts, and mortgage bankers, which
originate the mortgages that FHA, VA, and RHS guarantee, may deal with all three programs, as well as
with the Government National Mortgage Association
(Ginnie Mae), which guarantees timely payment on securities based on pools of these mortgages. In addition,
the same private firms originate conventional mortgages, many of which are securitized by Governmentsponsored enterprises—the Federal National Mortgage
Association (Fannie Mae) and the Federal Home Loan
Mortgage Corporation (Freddie Mac).

Many of these firms already use or are planning to
use electronic loan origination and are moving toward
electronic underwriting. Behind such underwriting are
data warehouses showing default experience by type
of loan, borrower characteristics, home location, originator, and servicer, and models relating these factors to
default cost. ‘‘Web lending’’ is also on the horizon.
These changes offer both challenges and opportunities
to the Federal mortgage guarantors and Ginnie Mae.
They are challenged to make themselves electronically
accessible to their clients and loan originators. They
are challenged to assess and monitor their risks closely,
now that private firms are reaching out to the better
risks among their potential clients. They also have an
opportunity to provide better service, and to improve
the effectiveness and efficiency of their programs.
The FHA, VA, and RHS housing guarantee programs
and Ginnie Mae are forming a Housing Consortium
to adapt to the rapid shift to electronic underwriting
in the private sector. This Consortium will become the
focus of agency efforts to keep abreast of changes in
the housing credit market, accelerate adoption of best
practices, establish common standards where possible,
and make government systems compatible with the private sector. The Consortium will become the ‘‘board
of directors’’ for a common data warehouse and analysis
center on housing loan performance—using it to monitor the changing risk and cost of guarantees and the
performance of guaranteed loan originators and
servicers. Learning from each other and from the private sector, the Housing Consortium will seek to improve loan origination, data systems, performance
measurement, risk sharing and pricing, and asset disposition.
Loan Origination. Electronic underwriting provides
convenient, faster service at a lower cost to both lenders
and borrowers. Freddie Mac and Fannie Mae are among
the leaders in developing such systems and encouraging
their use.
The VA recently entered into a ‘‘memorandum of understanding’’ with Freddie Mac to use its ‘‘Loan Prospector’’ electronic underwriting system. VA customized
the scoring for its applicants based upon the actual
profile of its veteran borrowers. As a result, VA will
improve its risk management capability by focusing
servicing on its high-risk borrowers to reduce losses
to the government, lenders, and borrowers. VA expects
that less required lender documentation, faster processing, and fewer errors will improve efficiency of loan

172
origination. In 1999, VA will propose legislation to
charge lenders a fee that will be used to develop Electronic Data Interchange (EDI) capability with lenders
to automate loan processing and servicing.
The FHA is also collaborating with Freddie Mac to
pilot Loan Prospector, adapting it to FHA’s clients. The
RHS is examining the potential benefits of electronic
underwriting for its guaranteed loan program. Meanwhile, RHS will develop the ability to offer electronic
origination using off-the-shelf software. Building on new
systems for both its direct and guarantee programs,
RHS will introduce electronic origination into its 502
Guarantee program by 1999.
Data Systems. Ginnie Mae guarantees timely payment of principal and interest on securities based on
pools of mortgages guaranteed by FHA and VA. The
issuers of these securities are almost always FHA and
VA servicers. To track experience on these loans and
issuers, Ginnie Mae created two data bases starting
in 1990 that draw monthly input from issuers based
on private standards.
The Issuer Portfolio Analysis Database System
(IPADS) and the Correspondence Portfolio Analysis
Database System (CPADS) monitor current performance by loan, originator, servicer, mortgage pool, security, and security issuer. Performance can be tracked
and compared, taking account of differences between
region, economic conditions, size and type of business,
and age of portfolio.
The current analytical system is designed fill Ginnie
Mae’s needs. IPADS allows quick access to information,
such as yearly changes in the size of business an issuer
has with Ginnie Mae, delinquency ratio, twelve-month
collection history, portfolio age, and average mortgage
rate. IPADS will generate twenty-four month trend
analyses of key performance indicators and compare
an issuer’s portfolio data against established Ginnie
Mae norms.
But the same data and much the same system could
be very useful to the loan guarantee programs. For
example, CPADS is similar to IPADS but organizes
the data by loan servicer and can compare performance
by loan originator regardless of how often a loan is
sold. Thus, CPADS could enable FHA and VA to monitor and assess how well the firms that originate and
service the loans they guarantee are doing their jobs.
These systems can also report promptly on the payment status of individual loans, enabling quick followup to late payments. If federally guaranteed loans were
originated electronically, useful data on the loan, borrower, and home characteristics could be ‘‘warehoused’’
in conjunction with information on the monthly payment history. This could be the basis for models that
determine which loans are most likely to become delinquent or default. Servicer attention could focus on those
borrowers.
FHA is currently a participant in Ginnie Mae’s data
monitoring systems. VA and RHS will soon become participants. RHS will require all of its lenders to file
reports electronically in IPADS before FY 1999, and

ANALYTICAL PERSPECTIVES

will become a full user of that system to track its guaranteed loans.
Performance Measurement. Measuring loan servicing performance establishes a baseline for assessing
changes to servicing practice. Monthly data will not
only give housing programs a better understanding of
how their guarantee portfolio behaves, but also how
the federally guaranteed housing market as a whole
performs. This information is critical for developing
good performance standards.
HUD has begun to rank servicers based on a combination of loan default rates and the ratio of actual
to potential losses on defaults. The rankings are adjusted for each state. Bonus points are given for
servicers with portfolios emphasizing social objectives.
Servicers are divided into categories based on their size.
Those in the top 25 percent of their category receive
higher reimbursement rates for certain servicing-related activities.
The rankings move FHA away from reviewing compliance with procedures and toward evaluating servicing
performance. Ranking criteria can be refined as more
experience is gained with the system. For example, the
system could include the effects of proactive servicing
techniques that would prevent delinquency. The most
effective use of performance-based incentives to encourage better servicing could also be analyzed. Aggressive
use of such measures would allow FHA to identify best
practices of top servicers and to sanction poorly-performing servicers.
RHS reviews at least 10 percent of the loans serviced
by a lender every two years. If deficiencies in loan
servicing or underwriting are noted, the lender is requested to take corrective action; its eligibility will be
terminated if it does not comply. RHS is now instituting
an annual external audit of servicing at a representative sample of lenders for compliance with requirements
and to pinpoint weaknesses contributing to loan delinquencies.
RHS is re-writing program regulation to enhance program delivery, and is considering a legislative proposal
to augment the guarantee fee structure in order to reward or penalize lenders based on performance.
Risk Sharing and Pricing. Risk-based pricing is
emerging in the conventional mortgage market as an
important means by which lenders can take on more
risk. Technology is giving lenders much more precise
ability to assess the initial default risk associated with
making a particular loan. This increasingly precise underwriting technology, in turn, allows lenders and insurers to adjust fees or loan rates and/or raise insurance premiums to reflect risk and loan cost accurately.
If, as expected, risk-based pricing becomes common
in the private sector in the next few years, Federal
loan guarantee programs will need to assess the impact
on their loan portfolios. They may need to adopt a
similar pricing structure or face adverse selection and
larger losses. Currently, premiums are fixed in statute
and vary only slightly with one dimension of risk, the

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8. UNDERWRITING FEDERAL CREDIT AND INSURANCE

initial loan-to-value ratio. New risk-based pricing might
help maintain the actuarial soundness of these programs in the context of adverse selection. On the other
hand, risk-based pricing might reduce the effectiveness
of these programs in serving the needs of lower-income,
minority, and traditionally underserved borrowers. Further study of these competing concerns in light of actual
market developments is required.
Under its current limited risk-sharing demonstration
authority, FHA may assess risk-sharing proposals to
test a scheme that partners a housing credit program
with a private guarantor. The purpose is to lower the
government’s share of risk while, under a pre-arranged
contract, the private guarantor picks up the remainder.
The private guarantor, perhaps a large private mortgage insurer with experience and superior skills, would
have an incentive to help loan programs push loan
servicers to manage risks efficiently. FHA and a partner assume a large majority of the risk while holding
the lender accountable for a small portion, so the lender’s willingness to underwrite high-risk borrowers is
not significantly reduced compared with current practice.
Asset Disposition. Common wisdom in the mortgage
industry is to avoid foreclosure because that is when
significant losses pile up, including costs for maintenance and marketing. Federal guarantee programs
have found that the best practice is to avoid taking
the property into possession, and instead make it the
responsibility of the lender.
Of the three Federal mortgage guarantee programs,
RHS is the only one that currently operates under the
‘‘best practice’’ for asset disposition. The lender is paid
the loss claim, which includes costs incurred for up
to six months from the time of the default. After the
loss claim is paid, RHS has no involvement in the loan,
and it becomes the sole responsibility of the lender.
RHS will shorten the loss claim period from six months
to three months through regulation changes to encourage lenders to dispose of properties as efficiently as
possible.
VA and FHA will also be making improvements in
asset disposition. VA will propose legislation to eliminate the vendee loan program, which provides public
financing on foreclosed properties. In addition, VA will
explore initiatives that outsource its asset disposition.
RHS Direct Housing Loans
RHS also provides subsidized single-family direct
loans to very-low and low-income borrowers unable to
get credit elsewhere to purchase, rehabilitate, or repair
homes. In October 1997, RHS completed implementation of the Dedicated Loan Origination Service System
(DLOS), which centralized servicing of the whole loan
portfolio. Whereas all origination and servicing had
been done in over 2,000 field offices, these now only
handle origination and some specific liquidation duties.
Everything else is handled at the centralized servicing
center.

DLOS has been a major improvement. Along with
two major regulations in 1996 and 1997, it reduced
RHS’ direct loan subsidy rate by 40 percent. RHS is
also exploring what economies of scale could be realized
in the area of asset disposition. Legislative proposals
for 1999 would allow single-family direct loans to be
refinanced using guarantees, thus helping borrowers to
graduate to private credit. The refinanced loans would
be relatively low-risk because the borrowers would have
built up equity in their homes.
Fannie Mae and Freddie Mac
Because Fannie Mae and Freddie Mac, the largest
Government-sponsored enterprises (GSEs), are the
dominant firms in the secondary mortgage market,
changes in their business practices can have a significant impact on the housing finance sector of the U.S.
economy. As of September 1997, Fannie Mae and
Freddie Mac had $1.5 trillion outstanding in mortgages
purchased or guaranteed. These GSEs engage in two
main lines of business: they issue and guarantee mortgage-backed securities (MBS), and they hold portfolios
of mortgages, MBS, and other mortgage-related securities that they finance by borrowing.
The Federal Housing Enterprises Safety and Soundness Act of 1992 reformed Federal regulation of Fannie
Mae and Freddie Mac. This Act created the Office of
Federal Housing Enterprise Oversight (OFHEO) to
manage the Government’s exposure to risk by conducting examinations and enforcing minimum and riskbased capital requirements. The risk-based capital requirements will be based on a stress-test model.
OFHEO has solicited public comment on a variety of
issues related to a risk-based capital regulation and,
in June 1996, published the first of two Notices of Proposed Rulemaking (NPR) on risk-based capital. OFHEO
expects to publish its second NPR in early 1999.
As required by the 1992 Act, the Secretary of Housing
and Urban Development issued a final regulation at
the end of 1995 that established new goals for Fannie
Mae and Freddie Mac to foster housing credit for lowerincome families and under-served communities. For
1997 through 1999, the regulation requires each GSE
to devote:
• 42 percent of its mortgage purchases to finance
dwelling units that are affordable by low- and
moderate-income families;
• 24 percent of its purchases to finance units in
central cities, rural areas, and other metropolitan
areas with low and moderate median family income and high concentrations of minority residents; and
• 14 percent of its purchases to finance units that
are special affordable housing for very-low-income
families and low-income families living in low-income areas.
During 1993–95, the GSEs were subject to transitional goals, and in 1996, they were subject to interim
goals that were slightly lower than the goals for

174
1997–99. Fannie Mae and Freddie Mac each achieved
all three goals in 1996.
The growth of the GSEs’ core mortgage businesses
has slowed, but they have maintained the growth in
their earnings by expanding the range of their activities
and increasing their on-balance sheet holdings of mortgages and MBS. These changes may, however, increase
their risk. The GSEs’ exposure to changes in interest
rates increases as their on-balance sheet holdings of
mortgages and MBS grow.
By contrast, some of the GSEs’ new business activities and innovations may improve their risk profiles.
The GSEs’ use of credit scores and automated underwriting may improve risk measurement and therefore
mitigate the credit risks inherent in purchasing and
securitizing mortgages. Similarly, the advent of riskbased pricing may mitigate risk by pricing more precisely for expected losses. For holders of mortgage credit
risk, sophisticated risk measurement and pricing tools
are leading to shifts in the distribution of risk among
the GSEs, private mortgage insurers, lenders, and
mortgage investors.
Federal Home Loan Bank System
The Federal Home Loan Bank System (FHLBS) was
established in 1932 to provide liquidity to home mortgage lenders. The FHLBS carries out this mission by
issuing debt and using the proceeds to make secured
loans, called advances, to its members. Member institutions primarily use advances to finance residential
mortgages and other housing related assets. Federally
chartered thrifts are required to be FHLBS members,
but membership is open to state-chartered thrifts, commercial banks, credit unions, and insurance companies
on a voluntary basis. As of September 30, 1997, 6,418
financial institutions were FHLBS members, an increase of 395 over September 1996. About 69 percent
of members are commercial banks, 28 percent are
thrifts, and the remaining 3 percent are credit unions
and insurance companies; however, almost 70 percent
of outstanding FHLBS advances were held by thrifts
as of September 30.
The FHLBS reported net income of $1.5 billion for
the year ending September 30, 1997, up from $1.3 billion in the previous 12 months. Total System capital
rose from $16.5 billion to $18.4 billion, and the ratio
of capital to assets fell from 5.8 percent to 5.7 percent.
Average return on equity was about 6.8 percent, after
adjustment for payment of interest to the Resolution
Funding Corporation (REFCorp). Outstanding advances
to members reached $182 billion at September 30, 1997,
a 19 percent increase over the $153 billion outstanding
a year earlier. System investments other than advances
stood at $138 billion, or about 42 percent of total assets,
as of September 30, 1997; compared to a year earlier,
investments have increased in dollar terms but declined
as a percentage of assets.
The Federal Home Loan Banks are required by law
to pay $300 million annually toward the cost of interest
on bonds issued by the Resolution Funding Corporation

ANALYTICAL PERSPECTIVES

and the greater of 10 percent of net income or $100
million to the Affordable Housing Program (AHP). In
addition, the FHLBanks are required by law to provide
discounted advances for targeted housing and community investment lending through a Community Investment Program (CIP). The need to generate income to
meet the REFCorp and AHP obligations and still provide a competitive return on members’ investment was
a driving force behind the substantial increase in the
System’s investment activity in recent years. The System also needs to service a capital requirement which
is based on members’ asset size, mortgage holdings,
and advances, rather than the amount of risk in the
System.
In the past, the FHLBS’ exposure to credit risk was
virtually nonexistent. All advances to member institutions are collateralized, and the FHLBanks can call
for additional or substitute collateral during the life
of an advance. No FHLBank has ever experienced a
loss on an advance. While the System’s expanding investment activities have created new sources of risk,
the FHLBanks have taken measures to manage these
risks. Indeed, the FHLBS’ investment activities also
pose important public policy issues as to the degree
to which the composition of assets on the FHLBS’ balance sheet adequately reflects the mission of the System. New pilot programs allowing the FHLBanks to
underwrite mortgages jointly with their members have
been approved by the Federal Housing Finance Board,
the System’s regulator. Through these programs, the
FHLBS is expanding its traditional role as a wholesale
lender as a means of promoting housing finance and
community investment.
Significant developments in housing finance markets
over the past two decades, such as increasing
securitization, have reduced the role of portfolio lenders. Of about $4 trillion in residential mortgage debt
outstanding, only about 14 percent of loans are held
directly by thrifts and 18 percent are held by commercial banks. Together, Fannie Mae, Freddie Mac, and
Ginnie Mae hold or guarantee an additional 47 percent.
As a result of GSE and Federal agency sponsorship
of secondary markets and the increasing presence of
private securitizers, lenders have access to liquidity
sources other than FHLBS advances. In addition, the
Deposit Insurance Funds Act of 1996 called for merging
the Bank Insurance Fund and the Savings Association
Insurance Fund in 1999, contingent on legislation to
abolish the Federal thrift charter, which requires a significant degree of specialization in housing finance. Like
other GSEs, the role and risks of the FHLBS must
continue to be examined and monitored in the face
of rapidly changing financial markets and potential
changes in the structure and activities of the industry
served by the FHLBS.
Education Credit Programs and GSEs
Student Loans

8. UNDERWRITING FEDERAL CREDIT AND INSURANCE

The Department of Education helps to finance student loans through two major programs: the Federal
Family Education Loan (FFEL) program and the William D. Ford Federal Direct Student Loan (FDSL) program. Eligible institutions of higher education may
choose to participate in either program. Loans are
available to students and their parents regardless of
income. Borrowers with low family incomes are eligible
for higher interest subsidies.
In 1999, about 6 million borrowers will receive $40
billion in loans, of which $34 billion is for new loans
and the remainder to consolidate existing loans. Loan
levels have risen dramatically over the past 10 years
as a result of rising educational costs, higher loan limits, and more eligible borrowers. The upward trend is
expected to continue for the next five years.
The Federal Family Education Loan program provides loans through a complex administrative structure
involving over 4,800 lenders, 36 State and private guaranty agencies, 50 participants in the secondary markets, and nearly 7,000 participating schools. Under
FFEL, banks and other eligible lenders loan private
capital to students and parents, guaranty agencies insure the loans, and the Federal Government reinsures
the loans against borrower default. Lenders bear two
percent of the default risk, and the government is responsible for the remainder. The Department also
makes administrative payments to guaranty agencies
and pays interest subsidies to lenders on need-based
loans while a student is in school and during certain
grace and deferment periods.
The Federal Direct Student Loan program was authorized by the Student Loan Reform Act of 1993 to
enable students and parents to obtain and repay loans
more easily than under the FFEL program. Under
FDSL, the Federal Government provides loan capital
directly to schools, which then disburse loan funds to
students—greatly streamlining loan delivery for students, parents, and schools. The program offers a variety of flexible repayment plans including income-contingent repayment, under which annual repayment
amounts vary based on the income of the borrower and
payments can be made over 25 years.
Reform proposals. The Administration is proposing
legislation to restructure and improve the efficiency of
the guaranteed loan system and to reduce fees for students and parents. Proposed changes will save $1.8 billion over five years.
The General Accounting Office and Federal courts
have acknowledged that the Federal Government is the
actual guarantor of the loans. The State and non-profit
intermediaries in FFEL act as agents of the Federal
Government. Guaranty agencies are not independent
guarantors, but are in fact administrators of the Federal guarantee. The Administration proposes that direct
Federal payments be used to pay default claims, eliminating the need for guaranty agencies to hold Federal
funds in reserve from which to pay claims. This will
make possible the return to the Treasury of over $1
billion in reserve funds between 2000 and 2003.

175
To improve accountability for the Federal guarantee,
the Secretary’s agreements with guaranty agencies will
be revised and be subject to periodic recertification.
They will include specific, publicly released performance
information—confirmed by reliable audits—to ensure
the submission of timely, accurate, and consistent data
for management. Over the next five years, the Secretary expects to move to a system of performancebased contracts for the administration of the guarantee,
rather than designation of intermediary agencies.
The Department of Education continues to improve
program integrity and reduce default costs. The Department will use newly automated systems to review and
analyze institutional eligibility information, and will
target its regulatory and enforcement efforts on highrisk institutions. Over the past several years, improvements in oversight and termination of schools with high
default rates have led to the removal of approximately
1,000 schools, of which 203 were eliminated from the
student loan programs. This has helped reduce the national student loan cohort default rate from 10.7 percent for 1994 to 10.4 percent for 1995, the fifth straight
year of decline. This rate is the percentage of borrowers
who enter repayment in a given year and for whom
a default claim is paid before the end of the following
year.
Modernizing student aid benefit delivery is one of
the Department’s key priorities. To improve the management of both loan programs, attention will be given
to re-engineering information systems and expanding
electronic data exchange to improve customer service,
enhance data quality, and lower costs. The Department
will support adoption of private sector best practices
to improve servicing in both programs.
Sallie Mae
The Student Loan Marketing Association is a forprofit, shareholder-owned corporation chartered by Congress in 1972. Its purpose is to expand funds available
for student loans by providing liquidity to lenders participating in the FFEL program. Sallie Mae purchases
insured student loans from eligible lenders and makes
warehousing advances (secured loans to lenders). It currently holds about one-third of all outstanding guaranteed student loans. Sallie Mae also has authority to
finance academic facilities and equipment.
Pursuant to legislation enacted in 1996, Sallie Mae
shareholders voted in July 1997 to approve a plan to
reorganize the corporation as a fully private, state-chartered entity. Under the reorganization, which became
effective in August, shares of Sallie Mae common stock
were converted on a one-for-one basis into shares of
a new holding company, the SLM Holding Corporation.
Sallie Mae, which retains its status as a GSE, is now
a wholly owned subsidiary of the holding corporation.
According to the authorizing legislation, the GSE must
wind down and be liquidated by September 30, 2008.
Connie Lee
The College Construction Loan Insurance Association
was created by the Higher Education Amendments of

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ANALYTICAL PERSPECTIVES

1986 to insure and reinsure the financing of postsecondary education facilities. In 1988, the Department of
Education helped provide initial financing of the corporation by purchasing $19 million of newly issued common stock. Subsequently, the corporation sold additional stock to institutional investors. By 1996, Connie
Lee had insured over $2 billion of debt service on bonds
benefitting colleges, universities, and teaching hospitals. Legislation was enacted in 1996 that privatized
Connie Lee by repealing its legislation and requiring
the Government to sell, and Connie Lee to purchase,
the corporation’s federally owned stock. This sale was
completed in February 1997.
Business and Rural Development Credit
Programs and GSEs
Small Business Administration
SBA has successfully expanded small businesses’ access to capital, increasing its annual loan volume 46
percent over the past five years (from $7.4 billion in
1993 to $10.9 billion in 1997), while also reducing agency staff by about 20 percent.
In its principal program, Section 7(a) General Business loans, SBA has improved access to capital for the
Nation’s most under-served small businesses in several
ways. The Low Documentation (LowDoc) initiative reduced the application form for 7(a) loans under
$100,000 to a single sheet. The FA$TRACK pilot allows
lenders to use their own forms and processes in exchange for a reduced Government guarantee. These initiatives—and aggressive lending goals—have helped to
increase 7(a) loan volume to minority- and womenowned businesses from $1.8 billion (27 percent of 7(a)
loan volume) in 1993 to $3.8 billion (40 percent) in
1997.
Reliance on private sector partners. With its portfolio growing from $20.7 billion in 1993 to $35.0 billion
in 1997, SBA has relied increasingly on its private sector partners for loan servicing and liquidation, especially in the 7(a) program, which accounts for 75 percent of SBA business lending.
Prior to 1996, SBA’s most experienced lenders had
authority to approve, service, and liquidate SBA-guaranteed loans under the Preferred Lender Program
(PLP) in exchange for a lower SBA guaranty (70 percent compared to 80 or 90 percent for other lenders).
In 1996, Congress set the maximum guaranty for all
7(a) loans at 80 percent for loans under $100,000, and
75 percent for most others. Congress also authorized
PLP lenders to service and liquidate their loans. In
1997, SBA issued a new policy requiring all lenders
to service and liquidate loans approved on or after Oct.
1, 1997.
These changes in legislation, together with SBA’s
goal of increasing its use of PLP lenders, have led to
a large increase in lending. Loans approved through
PLP lenders grew from $3.0 billion in 1996 (39 percent
of all 7(a) loans approved) to $4.9 billion in 1997 (52

percent of approvals) and are currently estimated at
$5.5 billion in 1998.
SBA also delegates servicing and liquidation authority in its LowDoc program. LowDoc loans accounted
for 33 percent of all 7(a) loans in 1997 (down from
45 percent in 1996.)
Need for better oversight tools. Over the past four
years, SBA has significantly increased loan volume, reduced staffing, and delegated additional authorities to
its private sector partners. During this period, commercial small business lenders have become increasingly
more sophisticated in identifying credit risk, and some
of them now pursue aggressive small business lending
goals. This expands small businesses’ access to capital,
but may also concentrate higher risk loans in SBA loan
guarantee programs.
These trends reinforce SBA’s need to improve oversight tools. SBA continues to struggle with antiquated
financial systems. Its managers need improved access
to timely and accurate analysis of portfolio trends and
information on the performance of its private sector
partners. SBA will begin a new initiative in 1998 to
improve its lender monitoring and oversight tools.
Reform initiatives. In 1998, SBA will implement
a plan to complete its shift from a loan servicing to
a lender oversight financial institution. These initiatives include: (1) delegating remaining 7(a) servicing
and liquidation to its lending partners, including requiring them to service and liquidate all defaulted
loans, (2) selling all direct loans and defaulted guarantees, and (3) making strategic investments in better
portfolio oversight tools. This will allow SBA to focus
on its goals of increasing access to capital, while relying
on private lenders to perform functions where they have
historically been more efficient.
Portfolio oversight. To ensure that the agency
meets its portfolio management responsibilities, SBA
will invest $8 million in 1998 to improve portfolio oversight. An additional $12 million is requested for 1999.
This funding will allow SBA to recruit expertise in lender oversight, develop the necessary in-house systems
to support lender monitoring, and create a centralized
corporate database. Drawing on the experience of financial institutions such as Fannie Mae and Freddie Mac,
SBA will also establish loan servicing performance
goals for its field offices and private sector partners.
Loan asset sales. Completing its transition from
loan servicing to lender oversight, SBA will sell its portfolio of defaulted guaranteed loans and direct loans in
1998, 1999, and 2000. The Disaster loan portfolio will
be sold in 1999 and 2000. Drawing on the experience
of Federal agencies such as the Resolution Trust Corporation and the Department of Housing and Urban
Development, and SBA’s analysis of its portfolio value
stemming from its Liquidation Improvement Project,
the Administration estimates that SBA’s business loan
assets (face value of approximately $2 billion) can be

8. UNDERWRITING FEDERAL CREDIT AND INSURANCE

sold at a gain to the government. It is estimated that
disaster loans can be sold at their current value. These
sales are also expected to yield future operational cost
savings.
Criminal background checks. In 1999, $1 million
is requested for SBA to conduct criminal background
checks of loan applicants prior to the disbursement of
the loans. According to recent research conducted by
SBA’s Office of Inspector General (OIG), loans made
to borrowers with an undisclosed criminal record are
approximately 2.5 times more likely to become delinquent or to default. This proposal will likely result in
future subsidy rate reductions for SBA’s credit programs.
Doing more with less. These initiatives will allow
SBA to continue to ‘‘do more with less’’. Through improved portfolio oversight and lender servicing of defaulted loans, the Government’s subsidy cost of SBA’s
7(a) loan program is estimated to decline from 2.14
percent in 1998 to 1.39 percent in 1999, reducing the
Government’s contribution to the cost of this program
by nearly $83 million. Additional savings may be
achieved in the future if increasing reliance on lenders
allows SBA to further reduce agency staffing.
USDA Rural Infrastructure and Business Development Programs
USDA provides grants, loans, and loan guarantees
to communities for constructing facilities such as
health-care clinics, day-care centers, and water and
wastewater systems. Direct loans are available at lower
interest rates for lower-income communities. These programs are targeted to rural communities with fewer
than 10,000 residents. Each program has low default
rates.
USDA also provides grants, direct loans, and loan
guarantees to assist rural businesses, including cooperatives, to increase employment and diversify the
rural economy. In 1999, USDA proposes to provide $1
billion in loan guarantees to rural businesses, and $50
million in direct loans. USDA’s assistance to rural businesses has grown from $100 million in 1993 to almost
$800 million in 1998. The default rate for these programs is low.
The 1996 Farm Bill enacted the ‘‘Rural Community
Assistance Program’’ (RCAP). Funding for 12 USDA
rural development activities was consolidated into a
‘‘performance partnership’’ to provide more flexibility
in targeting Federal assistance to the highest-priority
needs of States. In FY 1997, Congress provided increased flexibility through three funding ‘‘streams,’’ but
blocked transfers among streams. In FY 1998, Congress
consolidated the three streams into one RCAP account,
but still did not allow transfers between funding
streams. The budget proposes $715 million for a fully
flexible RCAP.
Electric and Telecommunications Loans

177
USDA’s rural electric and telephone program makes
new loans to maintain existing infrastructure and to
modernize electric and telephone service. Historically,
the Federal risk associated with the over $40 billion
loan portfolio in electric and telephone loans has been
small, although several large defaults occurred in the
electric program, primarily as a result of nuclear power
construction loans, and $400 million was written off
in 1997. However, both the telephone and electric industries are moving into a more competitive environment.
In the electric industry, deregulation may erode loan
security and the ability of borrowers to repay. Maintaining the goal of ‘‘affordable, universal service’’ is also
of concern to USDA. Many rural cooperatives are by
nature high cost providers of electricity, since there
are fewer subscribers per line-mile than in urban areas.
USDA will propose legislation to restructure its outstanding $30 billion portfolio of rural electric loans.
This Budget includes a legislative proposal for a new
direct Electric Loan Program with a loan level of $400
million. Borrowers would pay an interest rate tied to
the Treasury rate. The demand for loans to rural electric co-ops will continue to rise as borrowers replace
many of the 40-year-old electric plants.
The Rural Telephone Bank (RTB) provides financing
for rural telecommunications systems. The FY 1998
Budget proposed, but did not achieve, privatization of
the RTB. The 1999 Budget proposes legislation to charter the RTB as a Performance-Based Organization
(PBO). As a PBO, the RTB would remain under the
Secretary of Agriculture through majority Federal membership on the RTB Board of Directors. The RTB’s managers would be required to set strategic and financial
goals. A key goal would be to achieve privatization
within 10 years; the RTB would be on-budget until
fully privatized.
As a PBO, the RTB would have authority to hire
its own personnel, and appoint its own CEO and CFO.
It could seek waivers from government-wide regulations, policies, and procedures. Funding for both administrative expenses and subsidy budget authority would
be provided from the RTB liquidating account balances
beginning in 1999. It could establish its interest rates,
charge administrative fees, and retain proceeds from
any negative subsidies for RTB operations. It would
also have authority to prepay its outstanding Treasury
borrowing without penalty. This approach would allow
the RTB to establish a private governance structure
and demonstrate its ability to be financially self-sufficient, which should help prepare it for privatization.
A privatization feasibility study would be required within 3 years.
Loans to Farm Operators
Farm Service Agency (FSA) direct and guaranteed
operating loans provide credit to farmers and ranchers
for annual production expenses and purchases of livestock, machinery, and equipment. Direct and guaranteed farm ownership loans assist producers in acquiring

178
their farming or ranching operations. These loans are
proposed to increase as part of USDA’s Civil Rights
Initiative. As a condition of eligibility for direct loans,
borrowers must have been denied private credit at reasonable rates and terms, or they must be beginning
or socially disadvantaged farmers. Loans are provided
at Treasury rates or 5 percent. High defaults and delinquencies are inherent in the direct loan program.
FSA guaranteed farm loans are made to more creditworthy borrowers who have access to private credit
markets. Because the private loan originators must retain 10 percent of the risk, they exercise care in examining borrower repayment ability. As a result, guaranteed farm loans have not experienced losses as high
as those on direct loans.
The 1996 Farm Bill changed many of the servicing
requirements for delinquent borrowers. The FSA no
longer can make a new loan to a borrower who is delinquent on an existing loan. Borrowers who have previously received a FSA loan write-down or write-off are
no longer eligible for additional loans. The 1999 Budget
proposes to allow farmers to become eligible for assistance after 7 years, which is consistent with commercial
terms. Property acquired through foreclosure on direct
loans must now be sold at auction within 105 days
of acquisition, and leasing of inventory property is no
longer permitted except to beginning farmers. Prior to
these changes, acquired property remained in inventory
on average for five years before the FSA could dispose
of it.
The Farm Credit System and Farmer Mac
The Farm Credit System (FCS) and the Federal Agricultural Mortgage Corporation (Farmer Mac) are GSEs
that enhance credit availability for the agricultural sector. The FCS is a direct lender, financing its loans
largely through bond sales in the national credit markets, while Farmer Mac facilitates a secondary market
for agricultural loans. Both GSEs face the risk of concentration in certain agricultural commodities. The
Farm Credit Banks are also geographically limited,
often to areas dependent on one or a few commodities.
The downturn in the agricultural economy in the 1980s
led the FCS to the brink of insolvency. Legislation in
1987 bailed out the FCS and created Farmer Mac.
The Nation’s agricultural sector and its lenders are
now on much firmer ground. Strong farm income has
enabled borrowers to repay debt, and lenders to augment their capital. Farmland prices have regained most
of their previous levels and continue to increase. Interest rates and inflationary expectations are significantly
lower. Credit usage by farmers and credit standards
of lenders are more conservative.
Another sign of the increasing health of agricultural
finance is the greater share of credit provided by commercial banks. From 1986 to 1996, commercial banks’
share of all farm debt increased from 24 percent to
39 percent, while the share for FCS declined from 29
percent to 25 percent and for USDA from 12 percent
to 6 percent. In 1995, however, FCS’s share of farm

ANALYTICAL PERSPECTIVES

operating loans began to creep up—a trend that continued in 1996 and 1997.
The Farm Credit System
The Farm Credit System earned income every year
in the past decade, including over $1 billion in each
of the last four years. Nonperforming loans have been
reduced to 1.5 percent of the portfolio. Loan volume
has been gradually increasing since 1992, although the
$63.0 billion in September 1997 is far below the high
of over $80 billion in the early 1980s. Increases in
loan volume, declines in the cost of funds, and increases
in capital have widened the FCS’s net interest margin
from less than one percent in 1987 to 2.99 for 1996.
Improved asset condition and income enabled FCS
to post record capital levels; by September 30, 1997,
capital stood at $11.4 billion—half again larger than
five years ago, primarily as a result of retained earnings. Included in this capital are investments set aside
to repay about $600 million of the $1.3 billion of Federal assistance provided through the Financial Assistance Corporation (FAC) due beginning in 2003. The
System has adopted an annual repayment mechanism
to cover the remainder. The FCS has retired all of
its high-coupon long-term debt, moved to marginal cost
loan pricing, and adopted asset liability management
practices designed to reduce its interest rate risk.
Operating risk is also being reduced. Substantial consolidation has occurred in the structure of the FCS.
In January 1988, there were 12 districts with 36 banks
plus 376 associations; by October 1997, there were only
6 districts, 8 banks and 206 associations. System staff
declined by 14 percent over 1990–1995. Operating expenses as a percent of loans outstanding have begun
to decline.
The 1987 Act established the FCS Insurance Corporation (FCSIC) to insure timely payment of interest and
principal on FCS obligations. Insurance fund balances,
largely comprised of premiums from FCS institutions,
supplements the System’s capital, the joint and several
liability of all System banks for FCS obligations, and
the Farm Credit Administration’s enforcement authorities. On September 30, 1997, the Insurance Fund’s assets were $1.3 billion, and are estimated to attain the
statutorially required level of two percent of outstanding debt in 1998.
Improvement in the FCS’s financial condition is also
reflected in the evaluations of the Farm Credit Administration (FCA), its Federal regulator. The FCA rates
each of the System’s institutions for capital, asset quality, management, earnings, and liquidity (CAMEL). At
the end of 1990, 94 institutions carried the best
‘‘CAMEL’’ ratings of ‘‘1’’ or ‘‘2,’’ and 40 were rated in
the problem range of ‘‘4’’ or ‘‘5.’’ By September 1997,
in contrast, 203 institutions were given the top ratings,
only 9 received the mid-range rating of ‘‘3,’’ and one
institution was rated ‘‘4.’’ Enforcement actions to correct
illegal or unsafe operations were applied to 77 institutions, with 80 percent of the FCS’s assets, in 1991,

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8. UNDERWRITING FEDERAL CREDIT AND INSURANCE

but only 5 institutions, with 3.9 percent of the FCS’s
assets, in 1997.
Loans to farmers and other eligible producers comprise 73 percent of the System’s portfolio. Lending secured by farm land has been stagnant since 1990, but
farm operating loans have increased by 41 percent since
1992, with most of the gain since 1994. Loans to finance
processing, marketing, credit cooperatives, and rural
utilities cooperatives increased the cooperatives’ share
of FCS’s portfolio to almost 27 percent at year-end
1996.
During 1997, the FCA published regulations that expand the loan-making authority of Farm Credit System
banks. Previously, System banks could only lend to
businesses that provided custom services performed on
the customer’s farm. Under the revised rules, farmrelated businesses are eligible for full-firm financing
if more than 50 percent of their income is derived from
farm-related services. Furthermore, if less than 50 percent of the firm’s income is farm-service related, then
at least the farm-related service portion of the firm’s
business is eligible for financing. The rule also permits
Farm Credit banks to finance non-farm, single-family,
moderately priced homes for residents of rural areas
(population does not exceed 2,500 in a village or town).
The Farm Credit System is stronger now than it has
been in years. But primarily due to its concentration
in agriculture, it is exposed to risks arising from natural disasters, changes in Government policies toward
agriculture, and to structural changes in the agricultural and commercial banking sectors. During 1995 and
1996, FCS’s loan growth rate accelerated, in part due
to more aggressive lending as its capital strengthened.
This coincided with a surge in agricultural exports and
a rise in crop prices, which have propelled land values
upward in regions with export concentration. The volatility of these forces will be a risk factor for future
repayment and collateral capacity.

and must estimate them accurately to set fees and decide the appropriate level of capital reserves.
The 1996 Act gave Farmer Mac three additional
years to reach its capital requirements, and 2 years
to raise capital to $25 million. In December 1996, Farmer Mac sold 1.4 million shares of Class C common stock,
generating $32 million of new equity. In November
1997, Farmer Mac completed its second public offering,
selling 400,000 shares of Class C common stock and
raising $23 million of new equity. Farmer Mac’s yearend 1997 capital is estimated to be about $75 million—
three times greater than the 1996 statutory capital requirement well ahead of the deadline.
Farmer Mac has also taken steps to minimize losses
on securitized loans under the new authorities. These
steps include: (1) a higher annual guarantee fee of 50
basis points on securitized loans, (2) a loan loss reserve
adequate to cover anticipated losses, and (3) loan underwriting standards that include a maximum loan-tovalue ratio of 70 percent for loans up to $2.3 million
and 60 percent for loans between $2.3 million and $3.3
million.

Farmer Mac

Leveling the playing field. The Federal Government provides credit to U.S. exporters to offset the subsidies that foreign governments, largely in Europe and
Japan, provide their exporters usually through export
credit agencies (ECAs). Although the Arrangement on
Official Export Credits of the Organization for Economic
Cooperation and Development (OECD) has significantly
constrained direct interest rate subsidies and tied-aid
grants, foreign ECAs continue to provide implicit subsidies (by charging interest rates or fees that do not
fully compensate for risk).
The Export-Import Bank (Eximbank) attempts to
‘‘level the playing field’’ and to fill gaps in the availability of private export credit. Compared to the other
major ECAs, Eximbank provides the most unrestricted
financing, and provides this financing in almost twice
as many markets as its nearest competitor.
USDA’s GSM-102 and 103 programs guarantee credit
extended by private U.S. exporters and U.S. or foreign
financial institutions to expand agricultural exports.
The GSM programs are targeted to countries where
government guarantees are needed to counter competi-

Farmer Mac was established in 1987 to create and
oversee a secondary market for, and to guarantee securities based on, farm real estate and rural housing
loans. Since the 1987 Act, Farmer Mac has been authorized to issue its own debt securities, and to purchase and securitize the guaranteed portions of farm
program, rural business, and community development
loans guaranteed by the USDA (‘‘Farmer Mac II’’). The
Farm Credit System Reform Act of 1996 transformed
Farmer Mac from just a guarantor of securities formed
from loan pools into a direct purchaser of mortgages
in order to form pools to securitize.
The 1996 Act was passed in response to a steady
erosion of Farmer Mac’s capital base. Revenues had
not met expectations and showed no prospect of improvement. The new powers increase commercial banks’
incentives to participate in Farmer Mac. However,
these powers also subject the Corporation to more credit
risk. As a direct purchaser of loans with no required
subordination, Farmer Mac will be exposed to losses,

International Credit Programs
Seven Federal agencies, the Departments of Agriculture, Defense, State, and Treasury and the Agency
for International Development, the Export-Import
Bank, and the Overseas Private Investment Corporation, provide direct loans, loan guarantees, and insurance to a variety of foreign private and sovereign borrowers. At the end of 1997, the amount outstanding
was about $130 billion.
Through the Trade Promotion Coordinating Committee (TPCC), agencies providing export credit have developed a unified National Export Strategy, and they are
working together to make the delivery of trade promotion support more effective and convenient for U.S.
exporters.

180
tion from countries that offer credit through ECAs or
commodity marketing boards.
The increase in world trade and the globalization
of capital markets have made ECAs somewhat less important in recent years. During 1993–95, ECA credit
from G-7 countries averaged $70 billion annually. In
comparison, private credit to developing countries was
$230 billion in 1996.
Stabilizing international financial markets. In
today’s global economy, the health and prosperity of
the American economy depend importantly on the stability of the global financial system and the economic
health of our major trading partners. The United States
has several ways in which it can help to stabilize world
financial markets. It can provide resources on a multilateral basis through the IMF (discussed in other sections of the President’s Budget), or through a bilateral
loan provided by the Exchange Stabilization Fund
(ESF).
The ESF provides ‘‘bridge loans’’ to other countries
in times of short-term liquidity problems and financial
crises. In the past, ‘‘bridge loans’’ from ESF have usually provided dollars to a country over the short period
before the first disbursement under an IMF loan. A
$12.5 billion ‘‘bridge loan’’ of ESF was provided to Mexico during its crisis in 1995. This loan was essential
in helping to stabilize Mexico, as well as the global
financial markets. Mexico paid back its loan ahead of
schedule in 1997, and the loan didn’t cost the taxpayers
any money.
Use of the ESF is also being considered in response
to the crises in some Asian economies. In particular,
an ESF agreement with South Korea is near completion, as part of a broader undertaking by 13 countries
to provide ‘‘second line’’ support to that country. This
ESF facility will carry interest rates that will result
in zero subsidy cost for the United States as defined
under credit reform.
Helping economies in transition. The dramatic
transformation that has been underway in Eastern and
Central Europe in recent years presents U.S. businesses
with unprecedented opportunities matched by unprecedented risks. Since 1991, Eximbank has provided financing for exports to Russia and other New Independent States, as well as countries in Central Europe, to
increase U.S. exports and assist the region’s economic
transformation. Eximbank provided $3.2 billion in financing from FY 1995 through 1997, and expects to
provide $1.5 billion in additional credits each year for
exports to the region in FYs 1998 and 1999.
For example:
• In July 1993, Eximbank signed the Oil and Gas
Framework Agreement (OGFA) under which it
may provide $2 billion or more in financial assistance for purchases of U.S. equipment and services
to revitalize Russia’s energy sector. Nine transactions for $971 million have been authorized
under this agreement.

ANALYTICAL PERSPECTIVES

• In January 1996, Eximbank signed a Memorandum of Understanding with the Russian state timber industry governmental entity, helping to open
the way for the export of U.S. goods and services
to modernize Russia’s timber and forest products
industry.
• In November 1996, Eximbank initiated a Russian
commercial bank program to expand Eximbank financing for the private sector. Eximbank currently
accepts commercial bank guarantees from Russia,
Kazakhstan, Lithuania, Latvia, and Estonia, and
expects to accept commercial bank guarantees
from other NIS countries and most Central European countries as their banking sectors develop.
Through its Urban and Environmental Credit Program, USAID has provided loan guarantees to Poland,
the Czech Republic, and Hungary. These guarantees,
accompanied by technical assistance, will assist in developing financial markets for mortgages, municipal finance, and infrastructure finance.
Using credit to promote sustainable development. Credit has become an increasingly important tool
in U.S. bilateral assistance to promote sustainable development. USAID received funding through transfer
authority in the FY 1998 budget for a new credit program, the Development Credit Authority (DCA). The
DCA will provide loan guarantees in cases where credit
is the most effective mechanism to achieve sustainable
development, such as more effective financial markets
or reductions in global climate change-causing emissions. Funding for this program has been doubled in
the FY 1999 Budget. OPIC investment guarantees also
support development by promoting U.S. direct investment in developing countries. This can transfer skills
and technology, and create more efficient financial markets.
International credit management initiative. The
Administration proposes as part of the Director’s management agenda to improve credit management at
USAID, Eximbank, OPIC, DSAA, DOD/DELG, and
USDA. This will include improvements to loan servicing, portfolio tracking, and credit budgeting policies and
procedures. More accurate financial records, using consistent accounting standards, will improve repayment
practices and collections.
International lending cost estimates. Since 1992,
the President’s budget requests have used the same
assumptions about default risk in international lending.
These assumptions were obsolete given the changes in
financial markets over the last six years. In addition,
due to the scarcity of emerging market debt information
in 1992, these assumptions were based on domestic corporate bond risk spreads, rather than international
bond market data.
The FY 1999 Budget makes new assumptions about
default risk, as defined by the risk premia set for each
country-risk category in the International Country Risk
Assessment System (ICRAS). The new premia reflect

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8. UNDERWRITING FEDERAL CREDIT AND INSURANCE

the risk spreads observed on international debt market
instruments from 1992 to 1997 for a variety of risk
categories. These new cost estimates will continue to
be updated and refined over time, given agencies’ default experience and additional observation of emerging
market debt data.
The ‘‘subsidy cost’’ of international credit programs
is the government’s contribution to an agency’s longterm expense from extending a foreign credit, excluding
III.

administrative costs. Agency subsidy rates depend not
only on the international lending risks measured by
the ICRAS risk premia, but also on what fees or subsidies (such as below-market interest rates) the agencies offer with their credits. Most international credit
agencies charge borrowers fees that substantially offset
the cost due to credit risk. The FY 1999 Budget Credit
Supplement shows lending terms and subsidy rates for
each international credit agency.

INSURANCE PROGRAMS

Deposit Insurance
Federal deposit insurance was begun in the 1930s
to provide coverage against depositor losses from failures of insured institutions. Deposit insurance also protects the Nation against widespread disruption in financial markets by reducing the probability that the failure
of one financial institution will lead to a cascade of
other failures. The Federal Deposit Insurance Corporation (FDIC) insures the deposits of banks and thrifts
through separate insurance funds, the Bank Insurance
Fund (BIF) and the Savings Association Insurance
Fund (SAIF). Deposits of credit unions are insured
through the National Credit Union Administration
(NCUA).
Deposits are currently insured up to $100,000 per
account. The FDIC insures about $2.7 trillion at over
9,200 commercial banks and about 1,800 savings institutions. The NCUA insures about 11,300 credit unions
with $290 billion in insured deposits.
Current Industry and Insurance Fund Conditions. The 1980s and early 1990s were a turbulent
period for the bank and thrift industries, with over
1,400 bank failures and 1,100 thrift failures. The Federal Government responded with the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA)
of 1989 and the Federal Deposit Insurance Corporation
Improvement Act (FDICIA) of 1991. These reforms,
combined with more favorable economic conditions,
helped to restore the health of depository institutions
and the deposit insurance system. The FDIC currently
classifies only 98 institutions with $7 billion in assets
as ‘‘problem’’ institutions, compared to over 1,000 institutions with almost $600 billion in assets just five years
ago.
No commercial banks or thifts failed during 1997—
a record year for BIF and SAIF. Eight credit unions
with $19 million in assets failed during 1997. Although
depository institutions and their Federal insurance
funds are currently in good financial condition, an economic downturn could put pressure on the deposit insurance funds.
Banks have achieved very strong levels of earnings
in the last few years, which enabled the industry to
recapitalize BIF. BIF reached its statutorily designated
reserve ratio of 1.25 percent in mid-1995. As a result,
the FDIC continues to maintain deposit insurance premiums for banks in a range from zero for the healthiest

banks to 27 cents per $100 of deposits for the riskiest
banks. Currently, 95 percent of commercial banks pay
no deposit insurance premiums.
The earnings of the thrift industry also have significantly improved in the last few years. The industry
remains in strong financial condition despite enactment
of the Deposit Insurance Funds Act of 1996 (DIFA)
which imposed a $4.5 billion special assessment to
bring SAIF’s reserves up to 1.25 percent of insured
deposits. As a result, most thrifts paid no deposit insurance premiums in 1997.
In addition, the DIFA merges the BIF and SAIF on
January 1, 1999, provided that no savings associations
exist at that time. This makes the merger conditional
on legislation this year to combine the bank and thrift
charters.
The National Credit Union Share Insurance Fund
(NCUSIF) also remains strong with assets of $3.7 billion. Each insured credit union is required to deposit
and maintain in the fund 1 percent of its member share
accounts. In 1997, the income generated from the 1
percent deposit eliminated the need to assess an additional insurance premium, and after the end of the
fiscal year, the NCUA Board approved a dividend to
reduce the Fund’s equity ratio to the statutory ceiling
of 1.30 percent. This was the third consecutive year
that the Fund paid a dividend to federally insured credit unions. The Board also waived premiums for 1998.
Other Legislative and Regulatory Developments.
Recent legislation and regulatory changes highlight the
importance of financial modernization in a rapidly
changing financial market. Depository institutions have
faced increasing competition from non-bank providers
of financial services in recent years. Legislative and
regulatory changes that alter depository institution
charters and/or expand the range of permissible activities for bank subsidiaries, holding companies, or affiliates will contribute toward the increasing integration
and efficiency of the financial services industry.
In May 1997, the Administration presented its recommendations for modernizing the financial services industry and developing a common depository institution
charter to Congress. The Administration’s proposal removes Depression-era barriers to competition, preserves
the safety and soundness of our nation’s depository institutions and protects consumer rights. The proposal
promotes competition and efficiency within the indus-

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ANALYTICAL PERSPECTIVES

try, which will foster the creation of new products and
services and benefit consumers.
In October 1997 the Supreme Court heard arguments
on two related cases: the National Credit Union Administration v. First National Bank and the AT&T Family
Federal Credit Union v. First National Bank. At issue
is the question of how broadly a credit union may interpret its field of membership. The Supreme Court decision in these cases, which is expected during the current term, could have a significant impact on the
growth rate and total size of credit unions.
Pension Guarantees
The Pension Benefit Guaranty Corporation (PBGC)
insures most defined-benefit pension plans sponsored
by private employers. PBGC pays the benefits guaranteed by law when a company with an underfunded pension plan becomes insolvent. PBGC’s exposure to claims
relates to the underfunding of pension plans, that is,
to any amount by which expected future benefits exceed
plan assets. In the near term, its loss exposure results
from financially distressed firms with underfunded
plans. In the longer term, additional loss exposure results from firms which are currently healthy but become distressed, and from changes in the funding of
plans and their investment results. Two-thirds of all
plans are sufficiently funded, and much of the underfunding is in plans sponsored by financially healthy
firms. Underfunding is spread across all industries,
with a heavier concentration in the steel, automobile,
and transportation equipment industries.
The number of plans insured by PBGC has been declining as small companies with defined benefit plans
terminate them and shift to defined contribution plans.
At the same time, the number of workers whose pensions are insured by PBGC has increased. In particular,
the number of defined benefit pension plans with 1,000
or more participants has increased to 4,400 compared
to 3,600 in 1980.
During the past five years, PBGC has been working
to prevent and mitigate losses. Under the Early Warning Program, it has negotiated more than 50 major
settlements providing more than $15 billion in new pension contributions from companies and improving pension security for 1.6 million people. In 1995, the Early
Warning Program was one of the first six Federal programs to receive an award from the Ford Foundation
and Harvard’s Kennedy School of Government. The program also received the National Performance Review’s
Hammer Award. In 1996, PBGC expanded the Early
Warning Program to include more companies. In 1997,
PBGC posted the second year with a positive financial
position in its 23-year history.
The Retirement Protection Act of 1994 (RPA) improved PBGC’s early intervention capability, was an
important factor in achieving a number of the settlements, and is beginning to strengthen PBGC’s financial
condition. The RPA requires companies to increase their
contributions to underfunded plans over 10 to 15 years,
and relates companies’ premiums more fairly to PBGC’s

exposure by increasing the insurance premiums for
those pension plans that are the most underfunded.
RPA requires privately held companies with seriously
underfunded plans to give PBGC advance notice of any
transactions that potentially are harmful to their plans.
When this ‘‘Early Warning Program’’ shows benefits
to pensioners to be seriously at risk, PBGC begins negotiating funding and other arrangements in order to
forestall its taking over the plan.
PBGC fared well in 1997. There were no major plan
terminations, and investment performance was strong.
Premium revenues dropped somewhat, largely reflecting lower underfunding-related premiums as pension
funding improved. Premiums were also reduced by an
RPA provision that became effective July 1, 1997 which
increased the interest rate used to calculate underfunding-related premiums.
The multi-employer program guarantees pension benefits of certain unionized plans offered by several employers in an industry. The program continues to be
financially strong. In May 1996, the Administration
proposed to increase the maximum guarantee level on
pension benefits paid to retirees for the first time since
1980. It would be increased from $5,580 to $12,870
per year for retirees with 30 years of service. Although
it passed the Senate, this provision was not enacted
and is being proposed again.
This Budget proposes a new and simplified definedbenefit pension plan for small businesses, featuring accounts for individual participants. Unlike defined-contribution plans, the new plan guarantees a known level
of annual income throughout workers’ retirement years.
The new plan is designed to be fully funded virtually
constantly, but would also be protected by PBGC.
Disaster Insurance
Flood Insurance
The Federal Government provides flood insurance
through the National Flood Insurance Program (NFIP)
administered by the Federal Emergency Management
Agency (FEMA). This insurance is available to property
owners living in communities that have adopted and
enforced appropriate floodplain management measures.
Coverage is limited to buildings and their contents.
Policies for structures built before a community joined
the flood insurance program are subsidized by law,
while policies for structures built after a community
joined the NFIP are actuarially rated.
When the Federal flood insurance program was created in the early 1970s, private insurance companies,
with little information on flood risks by geographic
area, had deemed the risk of floods uninsurable. In
response, the NFIP provided insurance coverage, required building standards and other mitigation efforts
to reduce losses, and undertook flood hazard mapping
to quantify the geographic risk of flooding. The program
has substantially met these goals.
Flood insurance premium revenue grew by approximately 45 percent from 1994 to 1997, exceeding the

8. UNDERWRITING FEDERAL CREDIT AND INSURANCE

goal of 20 percent set three years ago. The NFIP’s
‘‘Cover America’’ initiative, which is a major marketing
and advertising campaign, should continue to increase
awareness of flood insurance and educate people about
the risks of floods. FEMA is using three strategies to
increase the number of flood insurance policies in force:
lender compliance, program simplification, and expanded marketing.
The NFIP’s Community Rating System (CRS) now
allows policyholders in over 900 communities to receive
discounts of at least 5 percent on their premiums by
undertaking activities which will reduce flood losses,
facilitate accurate insurance rating, and promote public
awareness of flood insurance and flood risk.
In 1997, the NFIP expanded mitigation insurance as
authorized by the National Flood Insurance Reform Act
of 1994. Mandatory Increased Cost of Construction
(ICC) coverage, which took effect May 1, 1997, allows
repetitively flooded or substantially damaged structures
to be rebuilt in accordance with existing floodplain
management requirements. This will reduce the
amount and cost of future flood damage and allow those
structures to be actuarially rated.
In 1998 and 1999, FEMA will continue efforts to reduce future flood damage by educating Federal regulators about mandatory flood insurance requirements
for federally backed home and business loans on property located in flood hazard areas; simplifying policy
language; using mitigation insurance to allow flood victims to rebuild to code, thereby reducing future flood
damage costs; and using flood insurance premium adjustments to encourage community and State mitigation
activities beyond those required by the NFIP.
Crop Insurance
Subsidized Federal crop insurance administered by
USDA assists farmers in managing catastrophic yield
shortfalls due to bad weather or other natural disasters.
Private companies are unwilling to offer multi-peril
crop insurance because losses tend to be correlated
across geographic areas, and the companies are therefore exposed to large losses. For example, a drought
will affect many farms at the same time. Damage from
hail, on the other hand, tends to be more localized,
and a private market for hail insurance has existed
for over 100 years.
The USDA crop insurance program is a cooperative
effort between the Federal Government and the private
insurance industry. Private insurance companies sell
and adjust crop insurance policies. The Federal Government reimburses private companies for the administrative expenses associated with extending crop insurance
and reinsures the private companies for excess insurance losses on all policies. The Federal Government
also subsidizes premiums for farmers.

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A major program reform was enacted in 1994 to address a growing problem caused by the repeated provision of Federal ad hoc agricultural disaster payments.
Participation in the crop insurance program had been
kept low by the availability of post-event disaster aid
to farmers from the Federal Government. Because disaster payments were no-cost grants, farmers had little
incentive to purchase Federal crop insurance. The 1994
reform repealed agricultural disaster payment authorities and substituted a ‘‘catastrophic’’ insurance policy
that indemnifies farmers at a rate roughly equal to
the previous disaster payments. The catastrophic policy
is free to farmers except for an administrative fee. Private companies sell and adjust the catastrophic portion
of the crop insurance program, and also provide higher
levels of cover