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ANALYTICAL PERSPECTIVES BUDGET OF THE UNITED STATES GOVERNMENT Fiscal Year 2001 THE BUDGET DOCUMENTS Budget of the United States Government, Fiscal Year 2001 contains the Budget Message of the President and information on the President’s 2001 budget proposals. In addition, the Budget includes the Nation’s third comprehensive Government-wide Performance Plan. Analytical Perspectives, Budget of the United States Government, Fiscal Year 2001 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 2001 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 2005. 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 2001 Budget, so the data series are comparable over time. Budget of the United States Government, Fiscal Year 2001— 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 2001 provides general information about the budget and the budget process for the general public. Budget System and Concepts, Fiscal Year 2001 contains an explanation of the system and concepts used to formulate the President’s budget proposals. Budget Information for States, Fiscal Year 2001 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.gpo.gov/usbudget For more information on access to the budget documents, call (202) 512–1530 in the D.C. area or toll-free (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 2000 For sale by the U.S. Government Printing Office Superintendent of Documents, Mail Stop: SSOP, Washington, D.C. 20402–9328 1 TABLE OF CONTENTS Page Economic and Accounting Analyses 1. Economic Assumptions ............................................................................................. 3 2. Stewardship: Toward a Federal Balance Sheet ..................................................... 17 Federal Receipts and Collections 3. Federal Receipts ....................................................................................................... 47 4. User Fees and Other Collections ............................................................................. 93 5. Tax Expenditures ..................................................................................................... 107 Special Analyses and Presentations 6. Federal Investment Spending and Capital Budgeting .......................................... 143 7. Research and Development Funding ...................................................................... 183 8. Credit and Insurance ............................................................................................... 187 9. Aid to State and Local Governments ...................................................................... 241 10. Federal Employment and Compensation ................................................................ 257 11. Strengthening Federal Statistics ............................................................................. 263 Federal Borrowing and Debt 12. Federal Borrowing and Debt ................................................................................... 269 Budget Enforcement Act Preview Report 13. Preview Report ......................................................................................................... 285 Current Services Estimates 14. Current Services Estimates ..................................................................................... 297 Other Technical Presentations 15. Trust Funds and Federal Funds ............................................................................. 343 16. National Income and Product Accounts .................................................................. 361 17. Comparison of Actual to Estimated Totals for 1999 .............................................. 367 18. Relationship of Budget Authority to Outlays ......................................................... 373 19. Off-Budget Federal Entities and Non-Budgetary Activities ................................. 375 20. Outlays to Public, Net and Gross ............................................................................ 379 i ii TABLE OF CONTENTS—Continued Page 21. Report on the Government-Wide Rescissions in the Consolidated Appropriations Bill, P.L. 106–113 ............................................................................................ 381 Information Technology Investments 22. Program Performance Benefits from Major Information Technology Investments ............................................................................................................... 401 Federal Drug Control Funding 23. Federal Drug Control Funding ................................................................................ 441 Budget System and Concepts and Glossary 24. Budget System and Concepts and Glossary ........................................................... 445 Federal Programs by Agency and Account 25. Federal Programs by Agency and Account ............................................................. 467 List of Charts and Tables ...................................................................................................... 665 ECONOMIC AND ACCOUNTING ANALYSES 1 1. ECONOMIC ASSUMPTIONS Introduction The prudent macroeconomic policies pursued since 1993 have fostered the healthiest economy in over a generation. Budget surpluses have replaced soaring deficits. During this Administration, fiscal policy has been augmenting national saving, private investment, productivity, and economic growth, rather than restraining them. Monetary policy has helped reduce inflation while supporting economic growth, and minimizing the domestic effect of international financial dislocations. These sound policies have contributed to another year of outstanding economic achievement—and hold the promise of more successes to come. Real Gross Domestic Product (GDP) rose 4.2 percent during 1999, the fourth consecutive year that growth has been four percent or more. The last time growth was this strong for so long was in the mid-1960s. Strong and sustained growth has created abundant job opportunities and raised real wages. The Nation’s payrolls expanded by 2.7 million jobs last year, bringing the total number of jobs created during this Administration to 20.4 million. The unemployment rate during the last three months of the year fell to 4.1 percent of the labor force, the lowest level since January 1970, and 3.2 percentage points lower than the rate in January 1993. Despite robust growth and very low unemployment, inflation has remained low. The Consumer Price Index excluding the volatile food and energy components rose only 1.9 percent last year, the smallest increase since 1965. The combination of low inflation and low unemployment pulled the ‘‘Misery Index,’’ defined as the sum of the inflation and unemployment rates, to the lowest level since 1965. Households, businesses and investors have prospered in this environment. Wage growth has outpaced inflation during each of the last four years, reversing a two-decade decline in real earnings. In 1998, the poverty rate fell to the lowest level since 1980. Although the poverty rate for 1999 will not be known until later this year, another decline is likely in light of the economy’s strong job gains and declining unemployment. The healthy economy boosted consumer optimism last year to the highest level on record. Businesses’ confidence in the future is evident in a willingness to invest heavily in new, capacity-enhancing plant, equipment and software. During the past seven years, equipment and software spending has risen at a double-digit pace, spurred by purchases of high-tech capital. Rapid growth of investment has helped return labor productivity growth to rates not seen since before the first oil crisis in 1973. Rapid productivity growth has enabled firms to achieve healthy increases in profits, and to raise real wages while still holding the line on prices. Forward-looking financial markets have responded to these developments. The bull market in equities that began in 1994 continued in 1999. These past five years have recorded the largest percentage gains in stock prices in the postwar period. From December 31, 1994 to December 31, 1999, the Dow Jones Industrial Average rose 200 percent; the S&P 500 gained 220 percent; and the technology-laden NASDAQ soared 441 percent. During January, the Dow and the NASDAQ edged into record territory and the S&P 500 remained close to its record high. Short- and long-term interest rates rose during 1999 in response to the increased demand for credit that accompanied strong private-sector growth and the Federal Reserve’s tightening of monetary policy. Even so, long-term interest rates during 1998 and 1999 were still lower than in any year during the prior three decades. The real long-term interest rate (the nominal rate minus expected inflation), an important determinant of investment decisions, was also lower in these two years than in any other two-year period since 1980. As 2000 began, financial and nonfinancial market indicators were signaling that the economic outlook remains healthy. The economy has outperformed the consensus forecast during the past seven years, and the Administration believes that it can continue to do so if sound fiscal policies are maintained. However, for purposes of budget planning, the Administration continues to choose projections that are close to the consensus of private forecasters. The Administration assumes that the economy will grow between 2.5 and 3.0 percent yearly through 2010, while unemployment, inflation and interest rates are projected to remain relatively low. Even with the moderation in growth, the economy is expected to generate millions of new jobs. The unemployment rate, which by mainstream estimates is below the level consistent with stable inflation, is projected to edge up slightly until mid-2003. Thereafter, it is projected to average a relatively low 5.2 percent, the middle of the range that the Administration estimates is consistent with stable inflation in the long run. The Consumer Price Index (CPI), which rose 2.7 percent during 1999 because of rapidly rising energy prices, is projected to slow slightly in the next two years and then increase 2.6 percent per year on average through 2010. Short- and long-term interest rates are expected to remain in the neighborhood of the levels reached at the end of 1999. 3 4 ANALYTICAL PERSPECTIVES As of December, this business cycle expansion had lasted 105 months since the trough in March 1991. If the expansion continues through February, as seems highly likely, it will exceed the previous longevity record of 106 months set by the Vietnam War expansion of the 1960s. If macroeconomic policies continue to foster high investment without engendering inflationary pressures, there is every reason to believe that this expansion will continue for many more years. This chapter begins with a review of recent developments, and then discusses two statistical issues: the recent methodological improvements in the calculation of the Consumer Price Index, which slowed its rise; and the October comprehensive revisions to the National Income and Product Accounts, which incorporated computer software as a component of investment, among other changes. 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 budget surplus, and the cyclical and structural components of the surplus. The chapter concludes with estimates of the sensitivity of the budget to changes in economic assumptions. Recent Developments The outstanding performance of the economy is due to a combination of several factors. First, macroeconomic policies have promoted strong growth with low inflation. Second, thanks in part to robust investment and new, high-tech means of communicating and doing business, labor productivity growth in the last four years has approached 3 percent per year—double the rate that prevailed during the prior two decades, and comparable to the high rates achieved during the first three decades following World War II. Third, inflation has been restrained by recession in much of the world and by the rising exchange value of the dollar. These forces together—plus intensified competition, including competition from foreign producers—have kept down commodity prices and prevented U.S. producers from raising prices. Finally, the labor market appears to have changed in ways that now permit the unemployment rate to fall to lower levels without triggering faster inflation. Fiscal Policy: In 1992, the deficit reached a postwar record of $290 billion, representing 4.7 percent of GDP—and the prospects were for growing deficits for the foreseeable future. When this Administration took office in January 1993, it vowed to restore fiscal discipline. That goal has been amply achieved. By 1998, the budget moved into surplus for the first time since 1969; and in 1999 it recorded an even larger surplus of $124 billion. That is the largest surplus ever, and, at 1.4 percent of GDP, it is the largest as a share of the overall economy since 1951. This fiscal year, the surplus is projected to rise to $167 billion, or 1.7 percent of GDP. The dramatic shift from huge deficits to surpluses in the last seven years is unprecedented since the demobilization just after World War II. The historic improvement in the Nation’s fiscal position during this Administration is due in large measure to two landmark pieces of legislation, the Omnibus Budget Reconciliation Act of 1993 (OBRA) and the Balanced Budget Act of 1997 (BBA). OBRA enacted budget proposals that the Administration made soon after it came into office, and set budget deficits on a downward path. The deficit reductions following OBRA have far exceeded the predictions made at the time of its passage. OBRA was projected to reduce deficits by $505 billion over 1994–1998. The actual total deficit reduction during those years was more than twice that— $1.2 trillion. In other words, OBRA and subsequent developments enabled the Treasury to issue $1.2 trillion less debt than would have been required under previous estimates. While OBRA fundamentally altered the course of fiscal policy towards lower deficits, it was not projected to eliminate the deficit; without further action, deficits were expected to begin to climb once again. To prevent this and bring the budget into unified surplus, the Administration negotiated the Balanced Budget Act with the Congress in the summer of 1997. The BBA was not expected to produce surpluses until 2002, but like OBRA, the results of pursuing a policy of fiscal discipline far exceeded expectations. The budget moved into surplus in 1998, four years ahead of schedule, and achieved an even larger surplus in 1999. OBRA 1993 and BBA 1997, together with subsequent developments, are estimated to have improved the unified budget balance compared with the pre-OBRA baseline by a cumulative total of $6.7 trillion over 1993–2005. The better-than-expected budget results in recent years have contributed to the better-than-expected economic performance. Lower deficits and bigger surpluses helped promote a healthy, sustainable expansion by reducing the cost of capital, through both downward pressure on interest rates and higher prices for corporate equities. A lower cost of capital stimulated business capital spending, which expanded industrial capacity, boosted productivity growth, and restrained inflation. Rising equity prices also increased household wealth, optimism, and spending. The added impetus to consumer spending created new jobs and business opportunities. The faster-growing economy, in turn, boosted incomes and profits, which fed back into an even healthier budget. Though the benefits of fiscal discipline have been widely recognized, the surprise in recent years has been the magnitude of the positive impact on the economy. Growth of production, jobs, incomes, and capital gains have all exceeded expectations. The outstanding economic performance during this Administration is proof positive of the lasting benefits of prudent fiscal policies. Monetary Policy: During this expansion, the Federal Reserve tightened policy when inflation threatened to pick up, but eased when the expansion risked stalling out. In 1994 and early 1995, the monetary authority 1. ECONOMIC ASSUMPTIONS raised interest rates when rapid growth threatened to cause inflationary pressures. During 1995 and early 1996, however, the Federal Reserve reduced interest rates, because the expansion appeared to be slowing while higher inflation no longer threatened. From January 1996 until the fall of 1998, monetary policy remained essentially unchanged; the sole adjustment was a one-quarter percentage point increase in the federal funds rate target in March 1997 to 51⁄2 percent. During the second half of 1998, however, financial turmoil abroad threatened to spread to the United States. In addition, a large, highly leveraged U.S. hedge fund, which had borrowed heavily from major commercial and investment banks, nearly failed. In this environment, normal credit channels to even the most credit-worthy private businesses were disrupted. In response to these serious challenges to the financial system and the economy, the Federal Reserve quickly shifted policy by cutting the Federal funds rate by onequarter percentage point on three occasions in just seven weeks—the swiftest easing since 1991, when the economy was just emerging from recession. By early 1999, those actions had restored normal credit flows and risk spreads among credit market instruments and returned the stock market to its upward trajectory. With the return of financial market stability and amidst an environment of strong growth and falling unemployment, the Federal Reserve raised the Federal funds rate by one-quarter percentage point on three separate occasions during 1999, returning the rate to the 51⁄2 percent level that prevailed before the 1998 international financial dislocation. Real Growth: The economy expanded at a 3.7 percent annual rate over the first three quarters of 1999, and rose at an even faster 5.8 percent pace during the fourth quarter. Over the four quarters of the year, real GDP increased 4.2 percent, the fourth year in a row of robust growth exceeding 4.0 percent. The fastest growing sector last year was again business spending on new equipment and software, which rose 11.0 percent during 1999. The biggest gains continued to be for information processing and software, with added impetus from the need to upgrade systems to be Y2K compliant. Investment in new structures, in contrast, edged down during 1999. The exceptionally strong growth of spending for new equipment and software in recent years raised trend productivity growth. This helped to keep inflation in check by permitting firms to grant real wage increases without putting upward pressure on prices. The increase in productive capacity resulting from robust capital spending also eased the supply bottlenecks and strains that normally would accompany tight labor markets. In the fourth quarter of 1999, the manufacturing operating rate was below its long-term average, even though the unemployment rate was unusually low. Overall industrial capacity rose by more than 4 percent in each of the past six years—the fastest sustained increase in capacity in three decades. 5 The consumer sector, which accounts for two-thirds of GDP, made a significant contribution to last year’s rapid growth, as it did in the previous two years. Consumer spending after adjustment for inflation rose 5.4 percent over the four quarters of 1999, the largest increase in a quarter century. Thanks to low unemployment, rising real incomes, extraordinary capital gains from the booming stock market and record levels of consumer confidence, households have the resources and willingness to spend heavily, especially on discretionary, big-ticket purchases. For example, sales of cars, minivans and other light-weight trucks reached nearly 17 million units last year, a new record. In 1999, growth of consumer spending again outpaced even the strong growth of disposable personal income, pulling down the saving rate to 2.4 percent, the lowest level in the postwar period. Because of the enormous increase in household wealth created by the soaring stock market, households felt confident enough to boost spending by reducing saving out of current income. Partly because of rising wealth, households took on considerably more debt. As a consequence, household debt service payments as a percent of disposable personal income rose from 11.7 percent at the end of 1992 to 13.4 percent in the third quarter of 1999. However, the ratio of debt service to income was still 3⁄4 percentage point below its prior peak, suggesting that the household sector on average was not overextended, especially considering the rapid rise in household equity wealth. The same factors spurring consumption pushed new and existing home sales during 1999 to their highest level since record-keeping began. The homeownership rate reached a record 66.8 percent last year. Buoyant sales and low inventories of unsold homes provided a strong incentive for new construction. Housing starts, which were already at a high level in 1998, increased further last year to the highest level since the mid1980s. Residential investment, after adjustment for inflation, increased during the first half of the year but edged down during the second half, reflecting the peak in housing starts early in the year. As a result of the healthier fiscal position of all levels of government, spending by the government sector rose more rapidly than it has in recent years. State and local consumption spending after adjustment for inflation rose 4.6 percent last year, while Federal Government spending increased 5.3 percent. The foreign sector was the primary restraint on GDP growth in 1999, as during the prior two years. Although the economic recovery of our trading partners boosted our exports, this positive contribution to GDP growth was more than offset by the very rapid rise of imports that accompanied the exceptionally strong growth of U.S. domestic demand. Over the year, exports of goods and services after adjustment for inflation rose 4.0 percent, while imports soared 13.1 percent. As a result, the net export balance widened considerably, and restrained real GDP growth by an average of 1.2 percentage points per quarter—a larger drag on growth than 6 during the two previous years when recessions abroad dramatically curtailed U.S. exports. The trade-weighted value for the dollar, which had risen strongly in recent years, was little changed, on average, during 1999. However, the dollar depreciated 7 percent against the Japanese yen, while it appreciated 15 percent against the newly launched Euro. Labor Markets: At the start of the year, most forecasters had expected growth to slow significantly and the unemployment rate to rise. Instead, the economy continued to expanded at a rapid pace, pulling the unemployment rate down from 4.3 percent at the end of 1998 to 4.1 percent during the last three months of 1999. When the Administration took office, the unemployment rate was 7.3 percent. In December, forty-five States had unemployment rates of 5.0 percent or less; rates in the other five were between 5.1 and 6.1 percent. Significantly, all demographic groups have participated in the improved labor market. The unemployment rates for Hispanics and Blacks during 1999 were the lowest on record. The Nation’s payrolls expanded by a sizeable 2.7 million jobs last year. As in 1998, employment did not increase in all industries; mining and manufacturing, which are especially vulnerable to adverse developments in international trade, lost jobs. However, a greater number of jobs were created in the private service sector, construction, and State and local government. The abundance of employment opportunities last year kept the labor force participation rate at the record-high level set in 1997 and 1998, and pulled up the employment/population ratio to the highest level ever. Inflation: Despite continued rapid economic growth and the low unemployment rate, inflation remained low last year, and the ‘‘core’’ rate even slowed. The core CPI, which excludes the volatile food and energy components, rose just 1.9 percent over the 12 months of 1999, down from 2.4 percent during 1998. Last year’s rise in the core rate was the smallest since 1965. However, because of a sharp rise in energy prices, driven to a considerable extent by international economic recovery, the total CPI rose 2.7 percent last year—up from 1.6 percent during 1998, when energy prices fell substantially. The broader GDP chain-weighted price index rose just 1.6 percent during 1999, not much higher than the 1.1 percent during the four quarters of 1998. This is the smallest two-year rise in overall prices since 1962–63. The favorable inflation performance was the result of intense competition, including from imports; very small increases in unit labor costs because of robust productivity growth; and perhaps structural changes in the link between unemployment and inflation. Last year, however, import and export prices exerted less of a restraint on inflation than in prior years. Because of the overall stability of the dollar last year, import prices other than petroleum were about un- ANALYTICAL PERSPECTIVES changed during 1999; by contrast, import prices had been falling for several years in response to the dollar’s rise. Moreover, the price of imported petroleum products doubled last year as a result of a recovery in world demand and a cutback in OPEC production. On the other side of the ledger, prices of exported goods (a component of the GDP price index) were about unchanged during 1999, after having fallen in 1998; the dollar’s stability enabled U.S. firms to avoid having to cut prices to remain competitive. Real wages grew again in 1999; but even with the low unemployment, hourly earnings and the broader measures of compensation rose slightly less during 1999 than in the prior year. Robust investment in new equipment contributed to unusually strong productivity growth for this stage of an expansion, helping to restrain inflation by offsetting the nominal rise in labor compensation. Unit labor costs rose at only a 1.8 percent annual rate during the first three quarters of 1998, down from 2.1 percent during 1999. The absence of any signs of a buildup of inflationary pressures despite low and falling unemployment and rapid growth 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 of lower unemployment without higher inflation, even after taking into account the influence of temporary factors. The economic projections for this Budget assume that NAIRU is in a range centered on 5.2 percent in the long run. That is the same rate as in the Mid-Session Review published last June, but 0.1 percentage point less than estimated in the 2000 Budget assumptions, and 0.5 percentage point less than in the 1997 Budget. Most private forecasters have also reduced their estimates of NAIRU in recent years. By the end of 1999, the unemployment rate was well below the current mainstream estimate of the long run NAIRU. The Administration’s forecast for real growth over the next three years implies that unemployment will return to 5.2 percent by the middle of 2003. Statistical Issues Statistical agencies must constantly improve their measurement tools to keep up with rapid structural changes in the U.S. economy. Last year, the Bureau of Labor Statistics (BLS) implemented the latest in a series of planned improvements to the Consumer Price Index; and the Bureau of Economic Analysis (BEA) made significant methodological and statistical changes to the National Income and Product Accounts. On balance, these changes revised real GDP growth and labor productivity growth significantly upward in recent years. Inflation: The CPI is not just another statistic. Perhaps more than any other statistic, it actually affects the incomes of governments, businesses and households via statutory and contractual cost-of-living adjustments. 1. ECONOMIC ASSUMPTIONS As such, recent improvements in measurement of the CPI—which, on balance, have slowed its increase—have significant impacts throughout the economy. Because the CPI is used to deflate some nominal spending components of GDP as well as household incomes, compensation, and wages, a slower rise in the CPI translates directly into a faster measured real growth of such key indicators as GDP, productivity, household incomes and wages. In recent years, considerable attention has been given to estimating the magnitude of the bias in the CPI and how best to reduce it. In December 1996, the Advisory Commission to Study the Consumer Price Index, appointed by the Senate Finance Committee, issued its recommendations on this subject. Beginning in 1995, the Bureau of Labor Statistics instituted a number of important methodological improvements to the CPI. Taken together, these changes are estimated to result in about a 0.6 percentage point slower annual increase in the index in 1999 and every year thereafter compared with the methodologies and market basket used in 1994. The most recent significant change, instituted beginning with the January 1999 CPI release, replaced the fixed-weighted Laspeyres formula, which had been used to aggregate lower level components of the CPI, with a geometric mean formula for most such aggregates. A CPI calculated using geometric means more closely approximates a cost-of-living index. Unlike the fixed-weighted aggregation, the geometric mean formula assumes consumer spending patterns shift in response to changes in relative prices within categories of goods and services. Also in 1999, BLS instituted new rotation procedures in its sampling of retail outlets where it selects items for price collection. The new procedures focus on expenditure categories rather than geographic areas, thereby enabling the CPI to incorporate price information on new, high-tech consumer products in a more timely fashion. The next scheduled improvement will be an updating of the consumption expenditure weights used in the CPI effective with the release of the CPI for January of 2002, when weights based on spending patterns in 1999–2000 will replace the current 1993–95 marketbasket weights. The BLS has announced that it will update expenditure weights every two years thereafter. It is expected that the shift to biennial updates of the weights will have little impact on measured inflation. For the Federal Government, slower increases in the CPI mean that outlays for programs with cost-of-living adjustments tied to this index or its components—such as Social Security, Supplemental Security Income (SSI), retirement payments for railroad and Federal employees, and Food Stamps—will rise at a slower pace, more in keeping with true inflation, than they would have without these improvements. In addition, slower growth of the CPI will raise the growth of tax receipts because personal income tax brackets, the size of the personal exemptions, and eligibility thresholds for the Earned 7 Income Tax Credit (EITC) are indexed to the CPI. Thus, the methodological improvements made in recent years act on both the outlays and receipts sides of the budget to increase the budget surpluses. For the National Income and Product Accounts, the Bureau of Economic Analysis follows the convention that changes in concepts and methods of estimation are incorporated into the historical series whenever possible. In contrast, the Bureau of Labor Statistics (BLS) follows the convention that the historical CPI series is never revised. The reasoning is that the public is probably better served by having an unchanged CPI series for convenient use in contract escalation clauses rather than one that is revised historically and might trigger claims for payment adjustments with every revision. The BLS, however, has recently published a research CPI series (the CPI-RS) that backcasts the current methods to 1978. (See ‘‘CPI Research Series Using Current Methods, 1978–98,’’ Monthly Labor Review, June 1999, for the series and an explanation of all the methodological improvements instituted since 1978.) This methodologically consistent series shows a slower rise in inflation, and therefore a faster rise in real measures, than the official CPI: during these 21 years, the CPI-RS increased 4.28 percent per year on average compared with 4.73 percent for the CPI, a difference of 0.45 percentage point per year. As discussed below, the National Income and Product Accounts had already incorporated many of the improvements in methods that have been made over the years in the CPI. The most recent significant improvement, the use of a geometric mean formula for combining lower level aggregates, was incorporated into the October benchmark national accounts for the period 1977–94; this change was already in the national accounts for the period since 1994. National Income and Product Accounts: In October, the BEA released a comprehensive revision of the National Income and Product Accounts (NIPA), also referred to as a ‘‘benchmark’’ revision. These periodic revisions differ from the usual annual revisions in that they are much wider in scope and include definitional, methodological and classification changes in addition to incorporation of new and revised source data. The latest comprehensive revision significantly changed the definition and estimates of nominal and real GDP, investment, and saving. (For details about the revision, see the August, October and December, 1999 issues of the Survey of Current Business.) Real and Nominal GDP: The most significant definitional change was the recognition of business and government expenditures on computer software (including the costs of in-house production of software) as investment, and therefore as a component of GDP and the Nation’s capital stock. Until this revision, BEA had treated software, except that embedded in other equipment, as if it were an intermediate good, and had not counted it in GDP until it appeared as part of a final 8 product. Intermediate goods do not add directly to GDP; capital goods do. (The Federal Government investment estimates presented in Chapter 6 of this volume also treat software as investment.) The rapid growth of spending on software in recent years has made a significant contribution to the new, upwardly revised estimates of real GDP growth. Although real GDP growth was raised by 0.4 percentage point per year on average during 1987–93 and by a similar amount since then, the sources of the revision differ greatly between the two periods. During 1987–93, new definitions, notably the inclusion of spending on computer software as a component of investment, boosted growth by only 0.1 percentage point. The downward revision to inflation estimates, notably the incorporation of the geometric mean formula to estimate consumer price inflation, contributed another 0.3 percentage point. New source data did not make any contribution to the upward revision of real growth. In contrast, during 1994–98, about 0.2 percentage point of the upward revision was due to the inclusion of computer software; and another 0.2 percentage point was due to revised source data. Revisions to inflation hardly affected the estimate of real GDP growth. The sources of the upward revision to nominal GDP provide another perspective on the importance of including software in the definition of GDP. For calendar year 1998, the benchmark revision in total raised nominal GDP by $249 billion, or 2.9 percent. Definitional sources, primarily the new classification of software, added $169 billion (2.0 percentage points). Statistical sources (including new and revised source data, the incorporation of the more recent input-output accounts, and preliminary data from the 1997 economic census) accounted for $80 billion (0.9 percentage point). Saving: By including computer software spending as investment, the comprehensive revisions boosted measured gross business saving (or undistributed profits and capital consumption) but increased gross national saving much more than net national saving. That is because including software as investment also increases capital consumption (depreciation) more than undistributed profits. In fact, most of the gross investment in software, as measured in NIPA, goes to replace the large amount of software that is annually ‘‘used up’’ or depreciated through technical obsolescence, as reflected in the short service lives. Therefore, net saving is only a slightly larger share of Net Domestic Product in recent years than it was in the previous data, and for some prior years, in which capital consumption increased more as a result of the revision than did gross saving, the revised net saving rate is smaller than it was previously. It is only net saving and its counterpart, net investment, that adds to the Nation’s net capital stock. In addition to defining software spending as part of GDP, the comprehensive revisions made other changes in the NIPA definitions. These did not have a noticeable effect on nominal or real GDP or overall national saving; they did, however, affect measured saving of gov- ANALYTICAL PERSPECTIVES ernment and households. These definitional changes included: • A shift in the classification of government employee pensions from the public sector to the private sector, which increased measured personal saving, and reduced the NIPA government surplus by an equal amount. (For an explanation of the differences between the NIPA definition of the Federal Government surplus and the unified surplus referred to in the Budget, see Chapter 16 of this volume.) • Estate and gift taxes were reclassified as ‘‘capital transfers.’’ This reduced government saving by reducing current receipts, and increased personal saving by reducing personal taxes. • Federal investment grants were also reclassified as ‘‘capital transfers,’’ which increased Federal saving by eliminating a category previously counted as a NIPA Federal government expenditure. As a counterpart, the reclassification reduced State and local government revenues and, therefore, the saving of that sector. These changes affected the composition of saving, shifting some saving from the government sector to the household sector. The new methodology treats government employee pensions the same as private employee pensions: the contributions to the pension programs are treated as saving of the household sector; the earnings on pension fund assets are treated as household income; and the benefits paid by the pension funds are defined as transfers within the household sector, not part of government transfer payments. The net effect of these changes is to raise the NIPA measures of personal saving while lowering the NIPA government surplus. The previously reported nonoperating surplus of State and local governments, which was composed in large part of the difference between pension fund receipts and payments, was nearly eliminated by this change. Productivity: The upward revisions to real GDP growth, and in particular, the even larger revisions to the growth of output in the Nation’s nonfarm business sector, have significantly raised measured labor productivity growth—especially beginning in 1994, because of the inclusion of software spending and the revised source data. The Administration had already raised its projections of real GDP and productivity growth in last summer’s Mid-Session Review. The further increase in trend growth of GDP and productivity in the 2001 assumptions presented below reflects the new information in the benchmark revision that revealed that underlying source data in recent years have been revised upward. Productivity growth, which had averaged 1.4 percent per year from 1994 through 1998, was revised up to 1.9 percent per year. During the four years through the third quarter of 1999, the most recent quarter available, productivity growth averaged an even faster 2.7 percent per year. In other words, the recent growth of productivity is double the pace experienced from 1973 to 1995, and on a par with the rapid rates that pre- 1. 9 ECONOMIC ASSUMPTIONS vailed from the end of World War II until the first oil crisis in 1973. The growth of productivity would be even faster in recent years if nonfarm business output were measured from the income side of the national accounts (using Gross Domestic Income) rather than from the slowergrowing GDP product side. Since the third quarter of 1995, gross domestic income in real terms has grown 0.4 percentage point per year faster than the growth of GDP. That is because the statistical discrepancy— the difference between the product and income sides of the accounts—has shifted from $3 billion to –$141 billion over these four years. In principle, the product and income sides of the accounts should be equal. In practice, this does not occur because the two measures are estimated from different source data. What is unique about recent years, however, is the extent of the difference and the magnitude of the swing. Although there is no perfect measure of productivity and real growth, the income side perspective provides some reason to believe that productivity and real growth recently may have been even stronger than the official series suggest. Economic Projections The economy’s outstanding performance last year— indeed, over the last seven years—and the maintenance of sound policies raise the possibility that future economic developments may continue even better than assumed. Nonetheless, it is prudent to base budget estimates on a conservative set of economic assumptions, close to the consensus of private-sector forecasts. The economic assumptions summarized in Table 1–1 are predicated on the adoption of the policies proposed in this Budget. The maintenance of unified budget surpluses in the coming years is expected to contribute to continued favorable economic performance. Growing Federal Government surpluses reduce real interest rates, stimulate private-sector investment in new plant Table 1–1. ECONOMIC ASSUMPTIONS 1 (Calendar years; dollar amounts in billions) Actual 1998 Projections 1999 2000 8,760 8,516 102.9 9,232 8,850 104.3 9,685 10,156 10,621 11,105 11,644 12,236 12,847 13,477 14,118 14,777 15,471 9,142 9,393 9,629 9,870 10,146 10,451 10,758 11,064 11,360 11,655 11,958 105.9 108.1 110.3 112.5 114.8 117.1 119.4 121.8 124.3 126.8 129.4 5.9 4.6 1.1 5.2 3.8 1.4 4.8 2.9 1.9 4.6 2.6 2.0 4.6 2.5 2.0 4.5 2.5 2.0 5.0 3.0 2.0 5.1 3.0 2.0 4.9 2.9 2.0 4.9 2.8 2.0 4.7 2.6 2.0 4.7 2.6 2.0 4.7 2.6 2.0 5.5 4.3 1.2 5.4 3.9 1.4 4.9 3.3 1.6 4.9 2.7 2.0 4.6 2.5 2.0 4.6 2.5 2.0 4.9 2.8 2.0 5.1 3.0 2.0 5.0 2.9 2.0 4.9 2.8 2.0 4.8 2.7 2.0 4.7 2.6 2.0 4.7 2.6 2.0 Incomes, billions of current dollars: Corporate profits before tax ........................................... Wages and salaries ........................................................ Other taxable income 2 ................................................... 782 4,186 1,990 845 4,470 2,088 842 4,711 2,161 828 4,942 2,231 827 5,161 2,293 824 5,388 2,356 852 5,629 2,431 892 5,892 2,518 933 6,176 2,609 971 6,458 2,703 1,001 6,747 2,802 1,034 7,039 2,904 1,062 7,342 3,015 Consumer Price Index (all urban): 3 Level (1982–84 = 100), annual average ........................ Percent change, fourth quarter over fourth quarter ...... Percent change, year over year .................................... 163.1 1.5 1.6 166.7 2.7 2.2 171.0 2.3 2.6 175.1 2.5 2.4 179.6 2.6 2.6 184.3 2.6 2.6 189.1 2.6 2.6 194.0 2.6 2.6 199.0 2.6 2.6 204.2 2.6 2.6 209.5 2.6 2.6 215.0 2.6 2.6 220.6 2.6 2.6 4.4 4.5 4.1 4.2 4.3 4.2 4.7 4.5 5.1 5.0 5.2 5.2 5.2 5.2 5.2 5.2 5.2 5.2 5.2 5.2 5.2 5.2 5.2 5.2 5.2 5.2 2.8 2.8 3.6 3.6 4.8 4.8 3.7 3.7 3.7 3.7 3.2 3.2 3.2 3.2 3.2 3.2 NA NA NA NA NA NA NA NA NA NA 4.8 5.3 4.7 5.6 5.2 6.1 5.2 6.1 5.2 6.1 5.2 6.1 5.2 6.1 5.2 6.1 5.2 6.1 5.2 6.1 5.2 6.1 5.2 6.1 5.2 6.1 Gross Domestic Product (GDP): Levels, dollar amounts in billions: Current dollars ................................................................ Real, chained (1996) dollars .......................................... Chained price index (1996 = 100), annual average ...... Percent change, fourth quarter over fourth quarter: Current dollars ................................................................ Real, chained (1996) dollars .......................................... Chained price index (1996 = 100) .................................. Percent change, year over year: Current dollars ................................................................ Real, chained (1996) dollars .......................................... Chained price index (1996 = 100) .................................. Unemployment rate, civilian, percent: Fourth quarter level ........................................................ Annual average ............................................................... Federal pay raises, January, percent: Military 4 ........................................................................... Civilian 5 .......................................................................... Interest rates, percent: 91-day Treasury bills 6 .................................................... 10-year Treasury notes .................................................. 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 NA = Not Available. 1 Based on information available as of late November 1999. 2 Rent, interest, dividend and proprietor’s components of personal income. 3 Seasonally adjusted CPI for all urban consumers. 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. 10 and equipment, boost productivity growth, and thereby raise real incomes and help keep inflation under control. The Federal Reserve is assumed to continue to pursue the goal of keeping inflation low while promoting growth. The economy is likely to continue to grow during the next few years, although at a more moderate pace than during 1999. While job opportunities are expected to remain plentiful, the unemployment rate is projected to rise gradually to the range that mainstream privatesector forecasters estimate is consistent with stable inflation. New job creation will boost incomes and consumer spending, and keep confidence at a high level. Continued low inflation will support economic growth. Growth, in turn, will further help the budget balance. Real GDP, Potential GDP and Unemployment: During 2000, real GDP is expected to rise 2.9 percent, then average 2.5 percent during the following three years. This shift to more moderate growth recognizes that by mainstream assumptions, growth must proceed at a pace below the Nation’s potential GDP growth rate for a while; the unemployment rate would then rise somewhat, thereby avoiding a build-up of inflationary pressures. Beginning in 2004, real GDP growth is assumed to match the growth of potential GDP. Inflation-adjusted potential and actual growth are projected to moderate from 3.0 percent yearly during 2004–2005 to 2.6 percent during 2008–2010. As has been the case throughout this expansion, business fixed investment is again expected to be the fastest-growing component of GDP, although capital spending is likely to slow from the double-digit pace of recent years. Consumer spending is also expected to moderate, as the stimulus from the soaring stock market of the last few years approaches its full effect. Although residential investment is also expected to benefit from relatively low mortgage rates and strong demand for second homes for vacation or retirement, the high level of housing starts in recent years and underlying demographic trends may tend to reduce future growth from the pace of the last few years. The growth of the Federal and State/local government components of GDP is also projected to moderate from the pace of recent years. The net export balance is expected to be less of a restraint on growth this year than during 1998–99, because more moderate growth of domestic demand is expected to slow the growth of imports. After 2000, the foreign sector is projected to make a modest, positive contribution to GDP growth in each year, reflecting the fundamental competitiveness of U.S. business, and the increased demand for U.S. exports that is likely to accompany a sustained recovery of activity abroad. The real GDP growth projection is consistent with a gradual rise in the unemployment rate to 5.2 percent by mid-2003. The unemployment rate is then projected to remain at that level on average thereafter, as real GDP growth returns to the Administration’s estimate of the economy’s potential growth rate. ANALYTICAL PERSPECTIVES Potential GDP growth depends largely on the trend growth of labor productivity in the nonfarm business sector and the growth of the labor force. Productivity growth is assumed to moderate gradually from the high rates of recent years. During 2000–2001, productivity is projected to rise 2.1 percent annually on average, then phase down to 1.8 percent (which is the average rate experienced during the 1990s after allowance is made for the procyclical behavior of productivity) from 2007 onwards. The productivity path in the projection is a conservative estimate that allows the near-term projection to rely more heavily on recent experience and the longer-term projection to rely on the productivity experience over a longer period. The labor force component of potential GDP growth is assumed to rise 1.2 percent per year through 2007 and then slow to 1.0 percent yearly as the first of the baby-boomers begin to retire. Inflation: With the unemployment rate well below mainstream estimates of the NAIRU, inflation is projected to creep up. The CPI is projected to increase 2.3 percent during this year, rising to 2.6 percent in 2002 and thereafter. The GDP chain-weighted price index is projected to increase 1.9 percent during 2000, and 2.0 percent thereafter. The 0.6 percentage point difference between the CPI and the GDP chain-weighted price index matches the average difference between these two inflation measures during the past five years. The CPI tends to increase relatively faster than the GDP chain-weighted price index in part because sharply falling computer prices exert less of an impact on the CPI than on the GDP price measure. In the 2000 budget, this ‘‘wedge’’ between the two measures was projected to be 0.2 percentage point. The larger wedge assumed in this projection tends to reduce the Federal budget surplus because Social Security payments and other indexed programs increase with the faster-rising CPI, while Federal revenues are expected to increase in step with the slower-rising GDP chainweighted price index. In addition, a relatively fasterrising CPI reduces the rate of growth of Federal receipts because the CPI is used to index personal income tax brackets, the size of the personal exemptions, and the eligibility thresholds for the Earned Income Tax Credit. Interest Rates: The assumptions, which were based on information as of late November, project stable short- and long-term interest rates. The 91-day Treasury bill rate is expected to average 5.2 percent over the forecast horizon; the yield on the 10-year Treasury bond is projected to average 6.1 percent. Since the completion of the assumptions, market rates have edged up somewhat. Incomes: On balance, the share of total taxable income in nominal GDP is projected to decline gradually. This is primarily because the corporate profits share of GDP is expected to fall. That is a consequence of 1. 11 ECONOMIC ASSUMPTIONS the expected rapid growth of depreciation, a component of business expenses. Robust growth of capital spending, especially on rapidly depreciating high-tech equipment and software, suggests that depreciation will account for an increasing share of GDP at the expense of the corporate profits share. The personal interest income share is also projected to decline, as interest rates remain relatively low and as households hold less Federal Government debt because of the projected unified budget surpluses. The share of labor compensation in GDP is expected to be little changed. Comparison with CBO The Congressional Budget Office (CBO) prepares the economic projections used by Congress in formulating budget policy. In the executive branch, this function is performed jointly by the Treasury, the Council of Economic Advisers (CEA), and the Office of Management and Budget (OMB). It is natural that the two sets of economic projections be compared with one another, but there are several important differences, along with the similarities, that should be kept 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 to hold; thus, it makes a ‘‘pre-policy’’ projection. In recent years, and currently, CBO has made economic projections based on a fiscal policy similar to the budget’s. An additional source of difference is that CBO and Administration forecasts are finalized at somewhat different times. Table 1–2 presents a summary comparison of the Administration and CBO projections. Briefly, they are very similar for all the major variables affecting the budget outlook. Real growth and unemployment: Over the 10-year projection horizon, the average rates of real GDP growth projected by CBO and the Administration are quite close. However, CBO projects somewhat faster growth through 2003 than does the Administration, while the Administration assumes somewhat faster growth than CBO during the following four years. During the last three years of the projection period, CBO projects a slight pickup in the growth rate to a faster pace than that projected by the Administration. These differences in real growth contribute to the differences in the unemployment rate paths. While both projections assume that the rate will gradually rise to, and level off at, 5.2 percent, the Administration’s projection reaches this sustainable level in 2003 while CBO’s projection reaches it in 2008. Inflation: The Administration and CBO forecast the same moderate rates of increase for the CPI for 2000 and 2001, and differ by only 0.1 percentage point thereafter, with the Administration higher. Over the same period, both project low and steady rates of increase Table 1–2. COMPARISON OF ECONOMIC ASSUMPTIONS (Calendar years; percent) Projections 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Real GDP CBO January ........................................ 2001 Budget .......................................... 2.9 2.9 3.0 2.6 2.7 2.5 2.6 2.5 2.6 3.0 2.7 3.0 2.7 2.9 2.7 2.8 2.8 2.6 2.9 2.6 2.9 2.6 Chain-weighted GDP Price Index: 1 CBO January ........................................ 2001 Budget .......................................... 1.7 1.9 1.6 2.0 1.7 2.0 1.7 2.0 1.7 2.0 1.7 2.0 1.7 2.0 1.7 2.0 1.7 2.0 1.7 2.0 1.7 2.0 Consumer Price Index (all-urban): 1 CBO January ........................................ 2001 Budget .......................................... 2.3 2.3 2.5 2.5 2.5 2.6 2.5 2.6 2.5 2.6 2.5 2.6 2.5 2.6 2.5 2.6 2.5 2.6 2.5 2.6 2.5 2.6 Unemployment rate: 2 CBO January ........................................ 2001 Budget .......................................... 4.1 4.2 4.2 4.5 4.4 5.0 4.7 5.2 4.8 5.2 5.0 5.2 5.0 5.2 5.1 5.2 5.2 5.2 5.2 5.2 5.2 5.2 Interest rates: 2 91-day Treasury bills: CBO January .................................... 2001 Budget ..................................... 5.4 5.2 5.6 5.2 5.3 5.2 4.9 5.2 4.8 5.2 4.8 5.2 4.8 5.2 4.8 5.2 4.8 5.2 4.8 5.2 4.8 5.2 10-year Treasury notes: CBO January .................................... 2001 Budget ..................................... 6.3 6.1 6.4 6.1 6.1 6.1 5.8 6.1 5.7 6.1 5.7 6.1 5.7 6.1 5.7 6.1 5.7 6.1 5.7 6.1 5.7 6.1 Taxable income (share of GDP): 3 CBO January ........................................ 2001 Budget .......................................... 79.9 79.6 79.3 78.8 78.6 78.0 78.0 77.2 77.5 76.5 77.1 76.0 76.8 75.6 76.4 75.2 76.1 74.7 75.8 74.3 75.4 73.8 (chain-weighted): 1 1 Percent change, fourth quarter over fourth quarter. averages, percent. 3 Taxable personal income plus corporate profits before tax. 2 Annual 12 ANALYTICAL PERSPECTIVES for the GDP price index, with CBO’s projection 0.3 percentage point lower in each year, 2000–2010. Interest rates: The Administration and CBO have very similar paths for long- and short-term interest rates. In 2000 and 2001, CBO’s rates are slightly higher; from 2003 onward, CBO’s are slightly lower. Income shares: Although both projections envision a decline in the total taxable income share of GDP, primarily because of a decline in the profits share, the CBO total taxable share is higher in every year, and declines more slowly, than the Administration’s share. 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 fundamental shift in fiscal posture from large unified budget deficits to moderate unified budget surpluses would result in a significant boost in investment, which would serve to extend the economic expansion at a moderate pace while helping to maintain low, steady rates of inflation and unemployment. The shift to unified budget surpluses and the ensuing stronger investment were also expected to continue to have favorable effects on receipts and the budget balance, because of stronger profits, capital gains, and high taxable incomes. 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 economic performance in 1999 that has, once again, proven more favorable than was anticipated at the beginning of last year. Economic growth was stronger than expected in 1999, while inflation and unemployment were lower. Because of this favorable performance, the projected annual averages for the unemployment rate and GDP price index have again been reduced slightly this year—but conservatively. At the same time, interest rates are assumed in this budget to remain near their current low levels. The net effects on the budget of these modifications in the economic assumptions are shown in Table 1–4. By far the largest effects come from higher receipts during 2000–2005 resulting from higher nominal incomes. In all years through 2005, there are higher outlays for interest due to the higher interest rates in the 2001 Budget assumptions than in the 2000 Budget assumptions, and, in most years, higher outlays for cost-of-living adjustments to Federal programs due to higher CPI inflation assumptions. On net, the changes in economic assumptions since last year increase unified budget surpluses by $61 billion to $85 billion a year. 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 Table 1–3. COMPARISON OF ECONOMIC ASSUMPTIONS IN THE 2000 AND 2001 BUDGETS (Calendar years; dollar amounts in billions) 1999 2000 2001 2002 2003 2004 2005 9,108 9,232 9,495 9,685 9,899 10,156 10,345 10,621 10,823 11,105 11,325 11,644 11,850 12,236 2.1 3.8 2.1 2.9 2.1 2.6 2.5 2.5 2.5 2.5 2.5 3.0 2.5 3.0 1.9 1.4 2.1 1.9 2.1 2.0 2.1 2.0 2.1 2.0 2.1 2.0 2.1 2.0 2.3 2.7 2.3 2.3 2.3 2.5 2.3 2.6 2.3 2.6 2.3 2.6 2.3 2.6 4.8 4.2 5.0 4.2 5.2 4.5 5.3 5.0 5.3 5.2 5.3 5.2 5.3 5.2 4.2 4.7 4.3 5.2 4.3 5.2 4.4 5.2 4.4 5.2 4.4 5.2 4.4 5.2 4.9 5.6 5.0 6.1 5.2 6.1 5.3 6.1 5.4 6.1 5.4 6.1 5.4 6.1 Nominal GDP: 2000 Budget assumptions 1 .................. 2001 Budget assumptions .................... Real GDP (percent change): 2 2000 Budget assumptions .................... 2001 Budget assumptions .................... GDP price index (percent change): 2 2000 Budget assumptions .................... 2001 Budget assumptions .................... Consumer Price Index (percent change): 2 2000 Budget assumptions .................... 2001 Budget assumptions .................... Civilian unemployment rate (percent): 3 2000 Budget assumptions .................... 2001 Budget assumptions .................... 91-day Treasury bill rate (percent): 3 2000 Budget assumptions .................... 2001 Budget assumptions .................... 10-year Treasury note rate (percent): 3 2000 Budget assumptions .................... 2001 Budget assumptions .................... 1 Adjusted for October 1999 NIPA revisions. quarter-to-fourth quarter. 3 Calendar year average. 2 Fourth 1. 13 ECONOMIC ASSUMPTIONS Table 1–4. EFFECTS ON THE BUDGET OF CHANGES IN ECONOMIC ASSUMPTIONS SINCE LAST YEAR (In billions of dollars) 2000 2001 2002 2003 2004 2005 1,899.3 1,793.6 1,947.5 1,835.7 2,004.1 1,893.1 2,076.2 1,960.3 2,166.4 2,041.3 2,259.3 2,128.8 Unified budget surplus ....................................................... Changes due to economic assumptions: Receipts .......................................................................................... Outlays: Inflation ....................................................................................... Unemployment ........................................................................... Interest rates .............................................................................. Interest on changes in borrowing ............................................. 105.7 111.8 111.0 116.0 125.1 130.5 57.0 71.5 77.1 71.3 69.7 81.6 –1.8 –7.8 6.9 –1.4 –0.9 –7.7 12.2 –4.4 0.3 –3.5 13.2 –7.8 2.0 –0.7 12.5 –11.2 3.7 –0.9 11.5 –14.4 5.8 –1.1 9.9 –17.9 Total, outlay changes (net) ................................................ –4.1 –0.7 2.2 2.6 –0.2 –3.4 Increase in surplus ............................................................. Budget totals under 2001 Budget economic assumptions and policies: Receipts .......................................................................................... Outlays ........................................................................................... 61.0 72.2 74.9 68.7 69.9 85.0 1,956.3 1,789.6 2,019.0 1,835.0 2,081.2 1,895.3 2,147.5 1,962.9 2,236.1 2,041.1 2,340.9 2,125.5 Unified budget surplus ....................................................... 166.7 184.0 185.9 184.6 195.0 215.4 Budget totals under 2000 Budget economic assumptions and 2001 Budget policies: Receipts .......................................................................................... Outlays ........................................................................................... Note: The surplus allocation for debt reduction is part of the President’s overall budgetary framework to extend the solvency of Social Security and Medicare, and is shown in Tale S–1 in Part 6 of the 2001 Budget. is larger than it would be if unemployment were at the long-run NAIRU. The portion of the surplus or deficit that can be traced to this factor is called the cyclical surplus or deficit. The remainder, the portion that would remain with unemployment at the long-run NAIRU (consistent with a 5.2 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 do changes in 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 achieves permanently sustainable operating levels. In the early 1990s, large swings in net outlays for deposit insurance (savings and loan and bank 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. For the period 1999 through 2002, the unemployment rate is slightly below the long-run NAIRU of 5.2 percent, resulting in cyclical surpluses. Thereafter, unemployment is projected to equal the NAIRU, so the cyclical component of the surplus vanishes. Deposit insurance net outlays are now relatively small and do not change greatly from year to year. Two significant points are illustrated by this table. First, of the $415 billion swing in the actual budget balance between 1992 and 1999 (from a $290 billion deficit to a $124 billion surplus), 44 percent ($181 billion) resulted from cyclical improvement in the economy. The rest of the reduction stemmed in major part from policy actions—mainly those in the Omnibus Budget Reconciliation Act of 1993, which reversed a projected continued steep rise in the unified budget deficit and set the stage for the remarkable cyclical improvement that has occurred. Second, the structural surplus is expected to rise sub- Table 1–5. ADJUSTED STRUCTURAL BALANCE (In billions of dollars) 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Unadjusted deficit (–) or surplus ...................... Cyclical component ....................................... –290.4 –106.1 –255.0 –106.1 –203.1 –73.0 –163.9 –30.9 –107.4 –13.1 –21.9 16.7 69.2 48.3 124.4 74.8 166.7 74.1 184.0 57.9 185.9 35.4 184.6 15.2 195.0 1.7 215.4 .......... Structural deficit (–) or surplus ......................... Deposit insurance outlays ............................ –184.3 –2.3 –148.9 –28.0 –130.1 –7.6 –133.0 –17.9 –94.3 –8.4 –38.6 –14.4 21.0 –4.4 49.6 –5.3 92.6 –1.4 126.1 –1.6 150.5 –1.3 169.5 –1.0 193.3 –0.7 215.4 0.2 Adjusted structural deficit (–) or surplus .......... –186.6 –176.9 –137.7 –150.9 –102.7 –53.0 16.6 44.3 91.2 124.5 149.2 168.5 192.5 215.7 14 ANALYTICAL PERSPECTIVES stantially over the projection horizon—in part due to the effects of the Balanced Budget Act of 1997—even though the cyclical component of the surplus is projected to vanish by 2005. 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. 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 high rate of real GDP growth is generally associated with a declining rate of unemployment, while moderate 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 2000 only, and the unemployment rate rises by one-half percentage point, the fiscal 2000 surplus would decrease by $10.5 billion; receipts in 2000 would be lower by about $8.5 billion, and outlays, primarily for unemployment-sensitive programs, would be higher by about $2.0 billion. In fiscal year 2001, the receipts shortfall would grow further to about $18.3 billion, and outlays would increase by about $6.8 billion relative to the base, even though the growth rate in calendar 2001 equals the rate originally assumed. This effect grows because the level of real (and nominal) GDP and taxable incomes would be permanently lower, and unemployment higher. 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 (2000–2005) 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 $179.3 billion relative to the base case by 2005. 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 $145.5 billion worsening of the budget balance by 2005. Joint changes in interest rates and inflation have a smaller effect on the budget balance 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 2000 only. In subsequent years, the price level and nominal GDP would be one percent higher than in the base case, but interest rates are assumed to return to their base levels. Outlays for 2000 rise by $5.8 billion and receipts by $9.9 billion, for an increase of $4.1 billion in the 2000 surplus. In 2001, outlays would be above the base by $11.9 billion, due in part to lagged cost-of-living adjustments; receipts would rise $19.8 billion above the base, however, resulting in a $7.8 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 $50.4 billion to outlays and $117.3 billion to receipts in 2005, for a net increase in the surplus of $66.9 billion. The table shows the interest rate and the inflation effects separately. These separate effects for interest rates and inflation rates do not sum to the effects for simultaneous changes in both. This occurs because, when the unified budget is in surplus and some debt is being retired, the combined effects of two changes in assumptions affecting debt financing patterns and interest costs may differ from the sum of the separate effects, depending on assumptions about Treasury’s selection of debt maturities to retire and the interest rates they bear. In any case, the sensitivity of the budget to interest rate changes has been greatly reduced since the budget shifted into unified surplus. The last entry in the table shows rules of thumb for the added interest cost associated with changes in the unified budget surplus. 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. 1. 15 ECONOMIC ASSUMPTIONS 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. 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 2000 only: 1 Receipts ................................................................................................... Outlays ..................................................................................................... 2000 2001 2002 2003 2004 2005 –8.5 2.0 –18.3 6.8 –21.5 7.6 –22.4 9.4 –23.3 11.4 –24.3 13.5 Decrease in surplus (–) ...................................................................... Sustained during 2000–2005: 1 Receipts ................................................................................................... Outlays ..................................................................................................... –10.5 –25.2 –29.1 –31.7 –34.6 –37.8 –8.5 2.0 –27.1 8.9 –49.5 16.7 –73.2 26.4 –98.7 38.5 –126.4 52.9 Decrease in surplus (–) ...................................................................... Sustained during 2000–2005, with no change in unemployment: Receipts ................................................................................................... Outlays ..................................................................................................... –10.5 –36.0 –66.1 –99.7 –137.2 –179.3 –8.5 0.2 –27.1 1.2 –49.5 3.4 –73.2 7.1 –98.7 12.3 –126.4 19.1 Decrease in surplus (–) ...................................................................... Inflation and Interest Rates Budgetary effects of 1 percentage point higher rate of: Inflation and interest rates during calendar year 2000 only: Receipts ................................................................................................... Outlays ..................................................................................................... –8.7 –28.3 –52.9 –80.3 –110.9 –145.5 9.9 5.8 19.8 11.9 19.2 9.5 17.6 8.3 18.3 7.9 19.3 7.7 Increase in surplus (+) ....................................................................... Inflation and interest rates, sustained during 2000–2005: Receipts ................................................................................................... Outlays ..................................................................................................... 4.1 7.8 9.8 9.3 10.4 11.6 9.9 5.8 30.2 17.5 50.9 26.8 70.8 35.3 92.7 43.0 117.3 50.4 4.1 12.7 24.0 35.5 49.6 66.9 1.4 4.7 3.5 12.0 4.4 15.1 4.8 16.5 5.1 16.9 5.5 16.6 Decrease in surplus (–) ...................................................................... Inflation only, sustained during 2000–2005: Receipts ................................................................................................... Outlays ..................................................................................................... –3.4 –8.5 –10.7 –11.7 –11.8 –11.1 8.5 1.1 26.7 5.7 46.5 12.3 66.0 19.8 87.6 27.8 111.8 36.2 Increase in surplus (+) ....................................................................... Interest Cost of Higher Federal Borrowing Outlay effect of $100 billion reduction in the 2000 unified surplus ............... 7.4 21.0 34.2 46.2 59.8 75.6 2.8 5.7 6.0 6.4 6.7 7.1 Increase in surplus (+) ....................................................................... Interest rates only, sustained during 2000–2005: 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 full evaluation of the Government’s financial condition must consider a broad range of data—more than would usually be shown on a business balance sheet. A balanced assessment of the Government’s financial condition requires several alternative perspectives. This chapter presents a framework for such analysis. No single table in this chapter is ‘‘the balance sheet’’ of the Federal Government. Rather, the chapter taken as a whole provides an overview of the Government’s financial resources, the current and expected future claims on them, and what the taxpayer gets in exchange for these resources. This is the kind of assessment for which a financial analyst would turn to a business balance sheet, but expanded to take into account the Government’s unique roles 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 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 analysis, but they are only a partial reflection of the full range of Government resources and responsibilities. Only those items actually owned by the Government are included in the table; but Government’s resources extend beyond the assets defined in this narrow way. Government can rely on taxes and other measures to meet future obligations. Similarly, while the table’s liabilities include all of the binding commitments resulting from prior Government action, Government’s full responsibilities are much broader than this. • The second part presents possible paths for extending the Federal budget, beginning with an extension of the 2001 Budget. Table 2–2 summarizes this information. 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 deserve 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 1998. • The third part of the presentation features information on economic and social conditions which the Government affects by its actions. Table 2–4 presents summary data for national wealth while highlighting the Federal investments that have contributed to that wealth. Table 2–5 presents a small sample of economic and social 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 presentation here explores an experimental approach for meeting this objective at the Governmentwide level. 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; but the standard budget presentation, with its focus on annual outlays, receipts, and the surplus/deficit, does not provide all the information needed for a full analysis of the Government’s financial and investment decisions. 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. 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. 17 18 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 in such a fashion. Why does the Government not manage its finances more 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 own balance sheet, but to benefit the Nation—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. For example, 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 Table 2–1 seems to imply that the Government is insolvent. Is it? No. Just as the Federal Government’s responsibilities are of a different nature than those of a private business, so are its resources. Government 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. These powers give the Government the ability to meet present obligations and those that are anticipated from 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 or likely to become so. Where governments totter on the brink of insolvency, lenders are either unwilling to lend them money, or do so only in return for a substantial interest premium. 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 as the budget has moved from deficit to surplus, the excess of Government liabilities over assets has leveled off and begun to shrink both in real terms and relative to the size of the economy. 3. The Government does not comply with the accounting requirements imposed on private businesses. Why does the Government not keep a proper set of books? Because the Government is not a business, and its primary goal is not to earn profits or to enhance its own wealth, accounting standards designed to illuminate how much a business earns and how much equity it has would not provide useful information if applied to the Government, and might even be misleading. In recent years, the Federal Accounting Standards Advisory Board has developed, and the Federal Government has adopted, a conceptual accounting framework that reflects the Government’s functions and answers the questions for which Government should be accountable. This framework addresses 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; an audited Government-wide consolidated financial report has been issued. 2. STEWARDSHIP: TOWARD A FEDERAL BALANCE SHEET QUESTIONS AND ANSWERS ABOUT THE GOVERNMENT’S ‘‘BALANCE SHEET’’—Continued This chapter addresses the ‘‘stewardship objective’’—assessing the interrelated condition of the Federal Government and of the Nation. The data in this chapter are intended to illuminate 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 is Social Security not shown as a liability in Table 2–1? Providing promised Social Security benefits is a political and moral responsibility of the Federal Government, but these benefits are not a liability in the usual sense. In the past, the Government has unilaterally decreased as well as increased Social Security benefits, and the Social Security Advisory Council has suggested further reforms that would alter future benefits if enacted by Congress. When the amount in question can be changed unilaterally, it is not ordinarily considered a liability. Furthermore, there are other Federal programs that are very similar to Social Security in the promises they make—Medicare, Medicaid, Veterans pensions, and Food Stamps, to name a few. Should the future benefits expected from these programs also be treated as liabilities? It would be difficult to justify a different accounting treatment for them if Social Security were classified as a liability of the Government. There is no bright dividing line separating Social Security from other income-maintenance programs. Finally, if future Social Security benefits were to be treated as liabilities, logic would suggest that future Social Security payroll tax receipts that are earmarked to finance those benefits ought to be considered assets. However, other tax receipts are not counted as assets; and drawing a line between Social Security taxes and other taxes would be questionable. 5. It is all very well to run a budget surplus now, but can it be sustained? When the babyboom generation retires, will the deficit not 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, the current budget surplus means the country will be better prepared to address these problems. If the surplus is maintained, there will be a significant decline in Federal debt which will substantially reduce Federal net interest payments. This is a key step towards keeping the budget 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. 19 20 ANALYTICAL PERSPECTIVES QUESTIONS AND ANSWERS ABOUT THE GOVERNMENT’S ‘‘BALANCE SHEET’’—Continued 6. Would it be sensible for the Government to borrow to finance needed capital—permitting a deficit in the budget—so long as it was no larger than the amount spent on Federal investments? Probably not, 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 really only applies to net investment, after depreciation is subtracted, because only net investment augments the Government’s assets and offsets the increase in liabilities that result from borrowing. If the Government financed all new capital by borrowing, it should pay off the debt as the capital acquired in this way loses value. As discussed in Chapter 6 of Analytical Perspectives, net investment in physical capital owned by the Federal Government is estimated to have been negative recently, so no deficit spending would actually be justified by this borrowingfor-investment criterion. 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 and training and 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 slightly positive. It is not clear whether this type of capital investment would fall under the borrowing-for-investment criterion. Certainly, these investments do not create Federally owned assets, even though they are part of national wealth. 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 surplus/deficit. Finally, the Federal Government must pursue policies that support the overall financial and economic well-being of the Nation. In this broader context, the Government may need to manage its fiscal policy to run a surplus, so as to augment private saving and investment even if this means paying for its own investments from current revenues, instead of borrowing in the credit market and crowding out private investment. Other considerations than the size of Federal investment need to be weighed in choosing the appropriate level of the surplus or deficit. 7. Is it misleading to include the Social Security surplus when measuring the Government’s budget surplus? Experts say that the Federal budget has three purposes: to plan the Government’s fiscal program; to impose financial discipline on the Government’s activities; and to measure the Government’s effects on the economy. It should not be surprising that, with more than one purpose, the budget is routinely presented in more than one way. For years, there have been several alternative measures of the budget, each with its appropriate use. None of these measures is always right, or always wrong; it depends upon the purpose to which the budget is put. 2. STEWARDSHIP: TOWARD A FEDERAL BALANCE SHEET QUESTIONS AND ANSWERS ABOUT THE GOVERNMENT’S ‘‘BALANCE SHEET’’—Continued For the purpose of measuring the Government’s effects on the economy, it would be misleading to omit any part of the budget; doing so would simply miss part of what we were trying to measure. For example, we would need to know all of the Government’s receipts and outlays to know whether it will have the wherewithal to meet its future obligations—such as Social Security. And for purposes of fiscal discipline, leaving out particular Government activities could be dangerous. In fact, the principle of a ‘‘unified,’’ all-inclusive budget was established by President Johnson’s Commission on Budget Concepts largely to forestall a trend toward moving favored programs off-budget—which had been done explicitly to shield those programs from scrutiny and funding discipline. To plan the government’s fiscal program, however, alternative perspectives can sometimes be useful. In particular, by law, Social Security has been moved off-budget. The purpose was to stress the need to provide independent, sustainable funding for Social Security in the long term; and to show the extent to which the rest of the budget had relied on annual Social Security surpluses to make up for its own shortfall. Policy under this Administration has been consistent with these goals. The non-Social Security deficit has been eliminated, and the President has made long-term Social Security soundness a key priority. In sum, the budget is like a toolbox that contains different tools to perform different functions. There is a right tool for each task, but no one tool is right for every task. If we choose the right tool for the job at hand, we can achieve our objectives. 8. What good does it do for the Federal Government to run a budget surplus, if the surplus is only used to retire Government debt? Is this just another way of pouring the money down the drain? When the Government retires its debt, it is not pouring money down the drain. The Government contributes to the accumulation of national wealth by using a budget surplus to repay Government debt. Because of the large budget deficits of the 1980s and early 1990s, Federal debt, measured relative to the size of the economy, has reached levels not seen since the early 1960s, although it is now on a downward trend. Further reducing the accumulated debt will have several desirable economic effects. It will help to hold down real interest rates, which is good for business investment and home ownership. Lowering the debt will give the Government more flexibility should it face an unexpected need to borrow in the future. When the Government uses a budget surplus to reduce its debt, it adds to national saving. Even though the Government is simply repaying its debt, the resources represented by the surplus are available for private investment in new plant and equipment, new homes, and other durable assets. 21 22 The data needed to judge Government’s performance go beyond a simple measure of net assets. Consider, for example, Federal investments in education or infrastructure whose returns flow mainly to the private sector and which are often owned by households, private businesses or other levels of Government. 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 does not accrue to the Federal Government. A good starting point for the evaluation of Government finances is to measure its assets and liabilities. An illustrative tabulation of net liabilities 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 deficits in the 1980s and early 1990s 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 appear on a conventional balance sheet. These include 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 longrun projection of the Federal budget (as is done in the second part of this chapter). The budget provides a comprehensive measure of the Government’s annual cash flows. Projecting it forward shows how the Government is expected to use its powers 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 pension obligations to Government employees. These obligations have counterparts in the business world, and would 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 in Table 2–1 with other Government liabilities. ANALYTICAL PERSPECTIVES These formal obligations, however, 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 Nation’s elected representatives in Congress. Such changes are a regular part of the legislative cycle. Allowing for the possibility of 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 in part two 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 economy and society. Some such data are currently available, but 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 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 Chart 2–1 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 affects society or the economy. 23 2. STEWARDSHIP: TOWARD A FEDERAL BALANCE SHEET Chart 2-1. A Balance Sheet Presentation For The Federal Government Assets/Resources Federal Assets Financial Assets Monetary Assets Mortgages and Other Loans Other Financial Assets Less Expected Loan Losses Physical Assets Fixed Reproducible Capital Defense Nondefense Inventories Non-reproducible Capital Land Mineral Rights Resources/Receipts Projected Receipts Liabilities/Responsibilities Federal Liabilities Federal Governmental Assets and Liabilities (Table 2-1) Financial Liabilities Debt Held by the Public Miscellaneous Guarantees and Insurance Deposit Insurance Pension Benefit Guarantees Loan Guarantees Other Insurance Federal Pension Liabilities Net Balance Long-Run Federal Budget Projections (Table 2-2) Change in Trust Fund Balances (Table 2-3) Responsibilities/Outlays Discretionary Outlays Mandatory Outlays Social Security Health Programs Other Programs Net Interest Deficit National Assets/Resources Federally Owned Physcial 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) National Needs/Conditions Indicators of economic, social, educational, and environmental conditions to be used as a guide to Government investment and management. 24 ANALYTICAL PERSPECTIVES PART I—THE FEDERAL GOVERNMENT’S ASSETS AND LIABILITIES Table 2–1 summarizes what the Government owes as a result of its past operations netted against the value of what it owns, for selected years beginning in 1960. Assets and liabilities are measured in terms of constant FY 1999 dollars. Ever since 1960, 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 prices have declined. 2 Currently, the total real value of Federal assets is estimated to be only about 18 percent greater than it was in 1960. Meanwhile, Federal liabilities have increased by 185 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 certain asset values. Currently, the net excess of liabilities over assets is about $3.2 trillion, or $11,600 per capita. Table 2–1. GOVERNMENT ASSETS AND LIABILITIES * (As of the end of the fiscal year, in billions of 1999 dollars) 1960 1965 1970 1975 1980 1985 1990 1995 1997 1998 1999 ASSETS Financial Assets: Foreign Exchange, SDRs, and Gold ..................... Cash and Checking Deposits ................................ Other Monetary Assets .......................................... Mortgages ............................................................... Other Loans ............................................................ less Expected Loan Losses ............................... Other Treasury Financial Assets ........................... 9 40 1 26 96 –1 49 7 58 1 25 133 –3 66 15 36 1 37 166 –4 48 12 29 1 39 165 –9 45 17 45 2 72 211 –16 63 31 30 2 74 276 –16 89 41 40 2 94 194 –19 150 58 41 1 65 150 –23 172 40 51 3 47 156 –42 158 47 48 4 45 168 –46 153 46 63 5 45 179 –50 164 Total .................................................................... Fixed Reproducible Capital: ....................................... Defense ................................................................... Nondefense ............................................................. Inventories ................................................................... Nonreproducible Capital .............................................. Land ........................................................................ Mineral Rights ......................................................... 222 1,042 908 134 254 412 89 323 287 1,101 895 206 220 422 124 299 300 1,123 873 250 204 400 154 246 283 1,015 736 280 182 581 239 342 393 945 643 302 224 925 303 621 485 1,111 778 333 259 1,027 327 701 503 1,159 808 351 229 802 328 474 463 1,145 779 367 162 605 251 354 412 1,075 709 366 139 688 265 423 419 1,037 677 360 136 633 279 354 452 1,030 663 367 135 658 294 364 Subtotal ............................................................... 1,708 1,743 1,727 1,778 2,093 2,397 2,190 1,913 1,902 1,806 1,823 1,930 2,030 2,027 2,061 2,487 2,882 2,692 2,376 2,315 2,225 2,275 12 1,085 14 6 13 1,118 20 3 21 1,011 20 1 21 1,024 30 4 25 1,263 53 0 25 2,105 79 0 29 2,875 114 9 30 3,821 88 7 29 3,867 86 4 28 3,771 84 7 26 3,633 82 7 Total .................................................................... Insurance Liabilities: Deposit Insurance ................................................... Pension Benefit Guarantee 1 .................................. Loan Guarantees .................................................... Other Insurance ...................................................... 1,117 1,154 1,053 1,079 1,342 2,209 3,027 3,946 3,986 3,890 3,748 0 0 0 30 0 0 0 27 0 0 2 21 0 41 6 20 2 30 12 26 9 42 10 16 69 42 15 19 5 20 29 17 1 30 31 16 1 48 29 16 1 41 29 16 Subtotal ............................................................... Federal Pension Liabilities ........................................... Total Liabilities ........................................................... Balance ........................................................................ 30 766 1,913 17 27 971 2,152 –122 24 1,155 2,232 –205 67 1,312 2,457 –396 70 1,734 3,147 –660 78 1,736 4,023 –1,141 146 1,693 4,866 –2,173 70 1,642 5,658 –3,282 79 1,612 5,676 –3,362 94 1,624 5,609 –3,384 86 1,627 5,461 –3,186 Addenda:. Balance Per Capita (in 1999 dollars) ....................... Ratio to GDP (in percent) ......................................... 95 0.7 –626 –3.9 –997 –5.5 –1,836 –9.4 –2,889 –13.0 –4,771 –19.0 –8,669 –31.2 –12,444 –41.4 –12,509 –39.0 –12,474 –37.6 –11,634 –34.1 Total Assets ................................................... LIABILITIES Financial Liabilities: Currency and SDRs ............................................... Debt held by the Public ......................................... Trade Payables ....................................................... Miscellaneous ......................................................... * This table shows assets and liabilites for the Government as a whole excluding the Federal Reserve System. 1 The model and data used to calculate this liability were revised for 1996–1999. 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. 25 2. STEWARDSHIP: TOWARD A FEDERAL BALANCE SHEET Chart 2-2. Net Federal Liabilities Percent of GDP 50 40 30 20 10 0 -10 1960 1965 1970 1975 Assets Table 2–1 shows a comprehensive list of assets—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 almost $0.5 trillion at the end of FY 1999. 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 as 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 subsidies on these loans is about $50 billion as of 1999. These estimated losses are subtracted from the face value of outstanding loans to obtain a better estimate of their economic worth. Reproducible Capital: The Federal Government is a major investor in physical capital and computer software. Government-owned stocks of such capital amounted to about $1.0 trillion in 1999 (OMB esti- 1980 1985 1990 1995 2000 mate). 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 (and of course, in a realistic sense, much of this land could or would never be sold). 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 declined sharply in 1997–1998 but rebounded sharply in 1999, causing the value of Federal mineral deposits to fluctuate. (The estimates omit other types of valuable assets owned by the Government, such as works of art or historical artefacts, simply because the valuation of such assets would have little realistic basis in fact, and because, as part of the Nation’s historical heritage, most of these objects would never be sold.) Total Assets: The total real value of Government assets is lower now than at the end of the 1980s, because of declines in defense capital and the real value of nonreproducible assets. Even so, the Government’s holdings are vast. At the end of 1999, the value of 26 ANALYTICAL PERSPECTIVES Government assets is estimated to have been about $2.3 trillion. Liabilities Table 2–1 includes those liabilities that would appear on a business balance sheet, and only those liabilities. These include various forms of Federal debt, Federal pension obligations to civilian and military employees, and the estimated liability arising from Federal insurance and loan guarantee programs. Financial Liabilities: Financial liabilities amounted to about $3.7 trillion at the end of 1999. The single largest component was Federal debt held by the public, amounting to around $3.6 trillion. In addition to debt held by the public, the Government’s financial liabilities include approximately $0.1 trillion 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, cash disbursements may initially be small or, if a fee is charged, the Government may even collect money; but the risk of future cash payments associated with such commitments can be very large. The figures reported in Table 2–1 are prospective estimates showing the current discounted value of expected future losses. The present value of all such losses taken together is less than $0.1 trillion. The resolution of the many failures in the Savings and Loan and banking industries has helped to reduce the liabilities in this category by more than 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. The discounted present value of the benefits is estimated to have been around $1.6 trillion at the end of FY 1999. 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 only about 13 percent of GDP; by 1995, it was 41 percent of GDP. Since then, the net balance as a percentage of GDP has fallen for four straight years. The real value—adjusted for inflation— of net liabilities has also fallen by about $180 billion since 1997, reflecting the back-to-back budget surpluses in these years. If a budget surplus is maintained, the net balance will continue to improve. PART II—THE BALANCE OF RESOURCES AND RESPONSIBILITIES As noted in the preceding section, a business-type accounting of Government assets and liabilities does not reflect the Government’s unique sovereign powers, such as taxation. The best way to examine the balance between future Government obligations and resources is by projecting the budget over a long enough period to reveal any long-run stresses. The budget provides a comprehensive measure of the Government’s annual financial burdens and resources. By projecting annual receipts and outlays, it is possible to consider 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 that extend beyond the normal 5- to 10-year 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 into the future the projections are pushed. Even so, longrun budget projections are needed to assess the full implications of current policies and to sound warnings about future problems that could be avoided by timely action. Federal responsibilities extend well beyond the 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 1999 liability is extrapolated from recent trends. next decade. There is no time limit on the Government’s constitutional responsibilities, and programs like Social Security are intended to continue indefinitely. It is evident even now that there will be mounting challenges to the budget early in this 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 Social Security and for the Government’s health programs—Medicare and Medicaid—which serve the elderly. Long-range projections can help indicate how serious these strains might become and what would be needed to withstand them. The retirement of the baby-boomers will dictate the timing of the future budgetary problem, but the underlying cause is deeper. U.S. population growth 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 given current retirement patterns. That change has been held temporarily in abeyance as the baby-boom cohort has moved into its prime earning years, while the retirement of the much smaller cohorts born during the Great Depression and World War II has been holding down the rate of growth in the retired population. The suppressed budgetary pressures are likely to burst forth when the baby- 27 2. STEWARDSHIP: TOWARD A FEDERAL BALANCE SHEET boomers begin to retire. However, even after the babyboomers have passed from the scene, later in the century, a higher ratio of retirees to workers will persist, given the underlying pattern of low fertility and improving longevity, with concomitant problems for Federal retirement programs. These same problems are gripping other developed nations, even those that never experienced a baby-boom; in fact, some of the nations that did not have baby-booms are facing demographic pressures already. The Improvement in the Long-Range Outlook.— Since this Administration first took office, there has been a major change in the long-run budget outlook. In January 1993, the deficit was on an unstable trajectory. Had the policies then in place continued unchanged, the deficit was projected to mount steadily not only in dollar terms, but relative to the size of the economy. 4 The unified deficit was projected to rise to over 10 percent of GDP by 2010—an unprecedented level in peacetime—and to continue sharply upward thereafter. This pattern of rising deficits also would have driven Federal debt held by the public to unprecedented levels. 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 1999 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 surplus/ deficit and other budget categories to the expected size of the economy as measured by GDP. The Omnibus Budget Reconciliation Act of 1993 (OBRA) changed that. Not only did it reduce the nearterm deficit, but, aided by the strong economy that it helped bring about, it also reduced the long-term deficit. Prior to enactment of the Balanced Budget Act in 1997, however, the deficit was still expected to persist into the long run, although at a more moderate level. Under the policies in place at the beginning of 1997, the deficit was projected to remain at around 1.5 percent of GDP through 2010, and only afterwards to begin a steady rise that would push it above 20 percent of GDP shortly after 2050. The 1997 Balanced Budget Agreement (BBA) took the next major step by eliminating the deficit in the unified budget. When the BBA was passed, that was expected to happen in 2002; but the unexpected strength of the economy and the boom in the financial markets over the last four years have enabled the unified budget to reach balance much sooner than was expected. The unified budget is now projected to remain in surplus throughout the coming decade under policies in this budget. Extending those policies beyond the usual budget window, a unified budget surplus could be sustained for many years, although in the very long run a deficit is projected to reemerge absent further policy changes. How long the surplus will actually be preserved depends on certain key factors, some of the most important of which are illustrated in Chart 2–3. Chart 2-3. Long Run Budget Projections Surplus(+)/deficit(-) as a percent of GDP 5 Discretionary Grows with Inflation 0 -5 Continued Rapid Medicare Growth -10 Discretionary Grows with Inflation Plus Population Pre-OBRA Baseline -15 -20 1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 28 ANALYTICAL PERSPECTIVES Budget discipline is crucial for long-run budget stability. Another key factor is the expected growth of Federal health care costs. Chart 2–3 illustrates how the surplus varies depending on assumptions about future growth in discretionary spending and health care costs. The conventions adopted in past budgets were to assume future growth in discretionary spending sufficient to preserve a constant real level of spending, and to base long-range projections for Medicare on the latest projections of the Medicare actuaries as reflected in the annual Medicare Trustees’ Report. Those projections include an expected slowdown in the rate of growth in real per capita Medicare spending. More rapid growth of Medicare, closer to the historical trend for the program, would result in a faster return to deficits, as shown in Chart 2–3. Under most reasonable alternative assumptions, the long-run budget outlook contrasts favorably with the generally prevailing opinion among budget experts just a few years back. Then, it was held that the longrun outlook for the deficit was necessarily bleak. For some time, there has been a general consensus among demographers and economists that population trends in the 21st century would put strains on the budget, and it was thought until recently that those strains must inevitably lead to large deficits. For example, the 1994 report of the Bipartisan Commission on Entitlement and Tax Reform found 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 (CBO) observed as recently as 1997: ‘‘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 Social Security and Medicare have projected for some time long-run actuarial deficiencies that would deplete those programs’ Trust funds over the next several decades. The consensus has shifted somewhat as a result of recent policy actions and because of the unexpected strength of the economy in the second half of the 1990s, which put the budget on a much sounder footing and thereby provided a better jumping-off point for longrange budget projections. The General Accounting Office (GAO) in its 1997 report on the long-run budget outlook observed 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.’’ 6 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 has been postponed significantly as a result of recent actions. Another sign of the shifting consensus is provided in CBO’s latest long-run budget projections released in December 1999. Under current policies, CBO foresees a unified budget surplus through 2010, reaching 3 percent of GDP in that year. 7 As CBO correctly points out, how long the surplus can be extended depends on uncertain future policy and economic developments, but: ‘‘Saving all of the surpluses projected in CBO’s 10-year baseline could delay the onset of serious fiscal problems until the second half of the next century.’’ The summary measure that CBO uses to indicate the magnitude of the long-run fiscal imbalance—the permanent change in taxes needed to stabilize the ratio of publicly held Federal debt to GDP—has declined to 0.5 percent of GDP in its most optimistic projections, compared with a baseline projection of 5.4 percent of GDP in its May 1996 projections. Under other assumptions, CBO shows a larger imbalance, but even under its most pessimistic alternative, the imbalance is only about half as large as projected in 1996. The main reason for this improvement in the outlook can be traced to the increase in the near-term budget surplus. If the surpluses are allowed to continue reducing Federal debt, as was done in 1998 and 1999, they will bring about dramatic reduction in Federal debt held by the public and in the Government’s net interest payments over the next several years. In FY 1999, net interest amounted to 21⁄2 percent of GDP. Under current estimates that could be cut to around 1⁄2 percent of GDP by 2010, and soon thereafter, if the surpluses were allowed to continue, the Government would begin to acquire financial assets that would generate interest income that would add to the unified budget surplus. This means that when demographic pressures on Social Security and the Federal health programs begin to mount around that time, there would be more budgetary resources available to meet the problem, postponing the date on which a deficit in the unified budget reappears. While the long-range outlook for Social Security has improved only modestly, it now appears that there could be more resources available in the rest of the budget when the Social Security shortfall begins to emerge. Economic and Demographic Projections.—Longrun budget projections require a long-run demographic and economic forecast—even though any such forecast is highly uncertain. The forecast used here extends the Administration’s medium-term economic projections described in the first chapter of this volume, augmented by the long-run 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 budget projections, 2010—2.6 percent per year for CPI inflation, 5.2 percent for the unemployment rate, and 6.1 percent for the yield on 10-year Treasury notes. • Productivity growth as measured by real GDP per hour is assumed to continue at the same constant rate as it averages in the Administration’s me- 5 Long-Term 6 Analysis Budgetary Pressures and Policy Options, March 1997. of Long-Term Fiscal Outlook, October 1997. 7 The Long-Term Budget Outlook: An Update, December 1999. 2. STEWARDSHIP: TOWARD A FEDERAL BALANCE SHEET dium-term projections—1.7 percent per year. (In 1999, there were substantial upward revisions to recorded productivity growth, which have resulted in an increase in the budget projections for this series; see the discussion of statistical issues in Chapter 1 of this volume.) • In line with the current projections of the Social Security Trustees, U.S. population growth is expected to slow over the next several decades. This is consistent with recent trends in the birth rate, and it allows for further reductions in mortality and continuing immigration at around current levels. The slowdown is expected to lower the rate of population growth from over 1 percent per year in the 1990s to about half that rate by 2025. • Labor force participation is also expected to decline as the population ages and the proportion of retirees in the population increases. The Administration projects a somewhat higher rate of labor force participation over the next ten years than is assumed in the latest annual report of the Social Security Trustees. That difference in the level of labor force participation is preserved in the long-run projections. • The projected rate of real economic growth in the long run is determined by labor force growth plus productivity growth. Because labor force growth is expected to slow and productivity growth is assumed to be constant, real GDP growth is expected to decline gradually after 2006 from around 3 percent per year to an average rate of just under 2 percent per year by 2020. This is a logical implication of the other assumptions which are based on reasonable forecasting conventions; however, it implies a marked departure from the historical rate of growth in the U.S. economy, which has averaged over 3 percent per year. 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 conclusions reached by the current approach. Both CBO and GAO in their investigations of the long-run outlook have explored such feedback effects and found that they accelerate the destabilizing effects of sustained budget deficits. Similarly, but in the opposite direction, budget surpluses would be expected to lead to higher national saving, lower real interest rates, and more economic growth, which would increase Federal receipts and reduce outlays, further augmenting projected surpluses. Alternative Budget Baselines.—Chart 2–3 above shows four alternative budget projections: one based on the policies in place prior to enactment of OBRA 1993 and three others showing current policy projections under alternative assumptions about discretionary 29 spending and future Federal health care costs. 8 The chart illustrates the dramatic improvement in the deficit that has already been achieved. Furthermore, it shows that if the unified budget remains in surplus throughout the coming decade, as is now expected, the task of maintaining fiscal stability will be eased when the demographic bulge begins to hit after 2008. Table 2–2 shows long-range projections for the major categories of spending under the three current policy alternatives shown in Chart 2–3. Under each of these alternatives, the major entitlement programs are expected to absorb an increasing share of budget resources. • Social Security benefits, driven by the retirement of the baby-boom generation, rise from 4.2 percent of GDP in 2000 to 6.7 percent in 2030. They continue to rise after that but more gradually, eventually reaching 7.4 percent of GDP by 2075. • Federal Medicaid spending goes up from 1.2 percent of GDP in 2000 to 3.2 percent in 2030 and to 8.6 percent of GDP in 2075. • Based on the Medicare actuaries’ long-range projections of future health-care cost trends, Medicare spending would rise from 2.1 percent of GDP in 2000 to 4.1 percent in 2030 and 4.8 percent by 2075. If the real per capita growth rate in Medicare does not slow as much as the actuaries have assumed, the program could expand even more rapidly. In the alternative with faster spending growth, Medicare outlays reach 4.7 percent of GDP in 2030, and 8.9 percent by 2075. • Assuming that discretionary spending grows only with inflation it would decline as a share of GDP, from 6.5 percent in 2000 to 3.9 percent in 2030 and 2.3 percent of GDP in 2075. The programs funded by this spending grow with inflation under this assumption, but they do not keep pace with population growth or any growth in real per capita income. Allowing discretionary spending to expand with both inflation and population would moderate the decline in spending as a share of GDP. Under this assumption, discretionary spending is 4.4 percent of GDP in 2030, and 2.9 percent of GDP in 2075. The long-run budget outlook has been much improved by the actions taken by this Administration in cooperation with the Congress. Eliminating the unified deficit has set the budget on a solid footing for many years to come. Under a conservative extension of the Administration’s latest economic assumptions and using various reasonable technical assumptions regarding future spending and taxes, the budget could continue in surplus for several decades. As currently projected, receipts are higher and net interest outlays are lower than they were before meas8 The President’s budget program includes investing no more than 15 percent of the Social Security trust fund in corporate equities. To be conservative, these projections assume that the equities in the trust fund have the same yield as Government securities (so the equity investment does not add to the Government’s projected investment income), and net the value of the equities against the amount of outstanding Federal debt. This yields the same numerical outcome as if Social Security did not invest in equities. If, as expected, Social Security equity investment yields a higher rate of return, the financial position of the Federal Government will be better than is presented in these projections. 30 ANALYTICAL PERSPECTIVES Table 2–2. LONG–RUN BUDGET PROJECTIONS OF 2001 BUDGET POLICY (Percent of GDP) 1995 2000 2005 2010 2015 2020 2030 2040 2050 2060 2075 Discretionary Grows with Inflation Receipts ........................................................................ Outlays ......................................................................... Discretionary ............................................................ Mandatory ................................................................ Social Security ..................................................... Medicare .............................................................. Medicaid .............................................................. Other .................................................................... Net Interest .............................................................. Surplus(+)/Deficit(–) ...................................................... Federal Debt Held by Public ....................................... Primary Surplus(+)/Deficit(–) ........................................ 18.5 20.7 7.4 10.1 4.6 2.1 1.2 2.2 3.2 –2.2 49.2 0.9 20.4 18.7 6.5 9.9 4.2 2.1 1.2 2.4 2.3 1.7 36.3 4.0 19.4 17.6 5.8 10.4 4.3 2.3 1.5 2.3 1.4 1.8 21.3 3.1 19.1 16.7 5.1 11.1 4.5 2.5 1.8 2.3 0.5 2.4 7.1 2.9 19.2 16.5 4.7 12.0 5.0 2.9 2.1 2.1 –0.3 2.7 –6.3 2.5 19.3 16.9 4.4 13.3 5.7 3.3 2.4 2.0 –0.9 2.5 –16.9 1.6 19.5 18.2 3.9 15.6 6.7 4.1 3.2 1.7 –1.4 1.4 –26.9 0.0 19.7 18.7 3.4 16.7 6.8 4.4 4.0 1.5 –1.4 1.0 –26.9 –0.5 19.9 19.3 3.1 17.6 6.9 4.4 5.0 1.4 –1.3 0.5 –24.5 –0.8 19.9 21.1 2.7 19.1 7.2 4.5 6.2 1.3 –0.8 –1.1 –13.8 –2.0 20.0 26.3 2.3 22.1 7.4 4.8 8.6 1.2 1.9 –6.3 37.3 –4.5 Discretionary Grows with Population and Inflation Receipts ........................................................................ Outlays ......................................................................... Discretionary ............................................................ Mandatory ................................................................ Social Security ..................................................... Medicare .............................................................. Medicaid .............................................................. Other .................................................................... Net Interest .............................................................. Surplus(+)/Deficit(–) ...................................................... Federal Debt Held by Public ....................................... Primary Surplus(+)/Deficit(–) ........................................ 18.5 20.7 7.4 10.1 4.6 2.1 1.2 2.2 3.2 –2.2 49.2 0.9 20.4 18.7 6.5 9.9 4.2 2.1 1.2 2.4 2.3 1.7 36.3 4.0 19.4 17.6 5.8 10.4 4.3 2.3 1.5 2.3 1.4 1.8 21.3 3.1 19.1 16.7 5.1 11.1 4.5 2.5 1.8 2.3 0.5 2.4 7.1 2.9 19.2 16.6 4.9 12.0 5.0 2.9 2.1 2.1 –0.2 2.6 –5.8 2.3 19.3 17.3 4.7 13.3 5.7 3.3 2.4 2.0 –0.8 2.1 –15.1 1.3 19.5 18.9 4.4 15.6 6.7 4.1 3.2 1.7 –1.1 0.6 –20.3 –0.5 19.7 20.0 4.0 16.7 6.8 4.4 4.0 1.5 –0.7 –0.3 –13.3 –1.0 19.9 21.1 3.6 17.6 6.9 4.4 5.0 1.4 –0.2 –1.2 –2.3 –1.4 19.9 23.3 3.3 19.1 7.2 4.5 6.2 1.3 0.9 –3.4 18.8 –2.5 20.0 29.6 2.9 22.1 7.4 4.8 8.6 1.2 4.6 –9.6 89.0 –5.0 Continued Rapid Medicare Growth. Receipts ........................................................................ Outlays ......................................................................... Discretionary ............................................................ Mandatory ................................................................ Social Security ..................................................... Medicare .............................................................. Medicaid .............................................................. Other .................................................................... Net Interest .............................................................. Surplus(+)/Deficit(–) ...................................................... Federal Debt Held by Public ....................................... Primary Surplus(+)/Deficit(–) ........................................ 18.5 20.7 7.4 10.1 4.6 2.1 1.2 2.2 3.2 –2.2 49.2 0.9 20.4 18.7 6.5 9.9 4.2 2.1 1.2 2.4 2.3 1.7 36.3 4.0 19.4 17.6 5.8 10.4 4.3 2.3 1.5 2.3 1.4 1.8 21.3 3.1 19.1 16.7 5.1 11.1 4.5 2.5 1.8 2.3 0.5 2.4 7.1 2.9 19.2 16.5 4.7 12.0 5.0 2.9 2.1 2.1 –0.3 2.7 –6.3 2.5 19.3 17.1 4.4 13.5 5.7 3.4 2.4 2.0 –0.8 2.3 –16.4 1.4 19.5 19.1 3.9 16.3 6.7 4.7 3.2 1.7 –1.2 0.5 –21.6 –0.7 19.7 20.9 3.4 18.0 6.8 5.7 4.0 1.5 –0.6 –1.2 –9.6 –1.8 19.9 23.2 3.1 19.5 6.9 6.3 5.0 1.4 0.6 –3.3 –13.5 –2.7 19.9 27.3 2.7 21.7 7.2 7.1 6.2 1.3 2.9 –7.4 56.5 –4.6 20.0 38.1 2.3 26.2 7.4 8.9 8.6 1.2 9.6 –18.2 186.0 –8.6 ures were taken to bring down the deficit, but the longrun demographic challenge has not been changed, and rising per capita health care costs are also likely to continue to put pressure on the budget. Extending the 2001 budget under the assumption that discretionary spending grows with inflation, a primary, or non-interest, deficit reappears in 2030. Although the underlying imbalance remains small, and the unified budget is projected to continue in surplus for many more years, a sustained primary deficit is sufficient to begin a slow but irreversible spiral. The recurrence of a unified deficit is inevitable once this spiral is set in motion unless there are future changes in policy that eliminate the primary deficit. 9 Under the alternative baselines shown in Chart 2–3 and Table 2–2, the primary deficit would reappear even sooner. When discretionary spending grows with both population and inflation, the primary deficit reappears in 2027, and when Medicare grows 9 The primary or non-interest surplus is the difference between all outlays, excluding interest, and total receipts. It is positive even when the total budget is in deficit provided that interest outlays exceed the overall 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. more rapidly, it also recurs in 2027. In all cases, a unified deficit reappears before the end of the 75-year forecast period. The Effects of Alternative Economic and Technical Assumptions.—The results discussed above are sensitive to changes in underlying economic and technical assumptions. The three alternatives in Table 2–2 illustrate the impact of some of the key assumptions, but other scenarios are also possible. While the budget could remain under control for several decades before underlying problems reemerge, other assumptions can produce more pessimistic—or more optimistic—outcomes. Some of the most important of these alternative economic and technical assumptions and their effects on the budget outlook are described below. Each highlights one of the key uncertainties in the outlook. Generally, negative possibilities receive more attention than positive ones in these scenarios, because the dangers would seem to be greater in this direction. 1. Discretionary Spending: By convention, the current services estimates of discretionary spending are as- 31 2. STEWARDSHIP: TOWARD A FEDERAL BALANCE SHEET sumed to rise only 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. The current services assumption implies that the real value of Federal services is unchanging over time, which has the implication that the size of Federal discretionary spending would shrink relative to the size of the economy. It also implies that the Nation’s future defense needs do not vary systematically from currently projected levels. One alternative to this assumption has already been presented in Chart 2–3 and Table 2–2. The second alternative for current policy considered there allows discretionary spending to increase with both population and inflation. Discretionary spending is frozen in real per capita terms, but not in absolute terms. This might be the appropriate assumption for such domestic activities as those of the FBI or the Social Security Administration (for program administration, not benefit costs), which are sensitive to population trends. Some budget analysts have assumed alternatively that discretionary spending is proportional to GDP in the long run; this requires it to increase in real terms whenever there is positive real economic growth. That is a more generous assumption for Government spending than the current services assumption or even the assumption of constant real per capita spending. It might be argued that with rising real per capita incomes, the public demand for Government services— more national parks, better roads, and additional Federal support for scientific research—will increase as well. Some of these demands might be met within fixed real spending limits through increased productivity in the Federal sector, such as has accompanied recent reductions of the Federal workforce. The assumption also flies in the face of recent experience; since its peak in 1968, the discretionary spending share of GDP has been cut in half—from 13.6 percent to 6.5 percent in 2000. Thus, there are arguments on both sides. Chart 2–4 compares the baseline alternatives with a scenario in which discretionary spending rises in step with nominal GDP. 2. Health Spending: After 2010, which is the last year of the standard budget estimates, real per capita growth rates for Medicare benefits are based on the actuarial projections in the latest report of the Medicare Trustees. These projections slow down markedly in the long run. At some point, spending for Medicare must grow at approximately the same rate as GDP. Eventually, the rising trend in health care costs for both Government and the private sector will have to end, but it is hard to know when and how that will happen. Improved health and increased longevity are highly valued, and society may be willing to spend an even larger share of income on them than it has heretofore. As an alternative, one of the current policy baselines allows real per capita Medicare benefits to rise at an annual rate of 21⁄4 percent per year. This is about twice as fast as the actuarial assumption, and implies a rapidly rising level of Medicare spending for many years Chart 2-4. Alternative Discretionary Spending Assumptions Surplus(+)/deficit(-) as a percent of GDP 5 Growth with Inflation 0 -5 Growth with Inflation Plus Population -10 Growth with Nominal GDP -15 -20 1995 2005 2015 2025 2035 2045 2055 2065 2075 32 ANALYTICAL PERSPECTIVES to come. Eventually, Medicare would approach 9 percent of GDP on this assumption (see Table 2–2). 3. Taxes: In the absence of policy changes, the ratio of taxes to GDP is not assumed to vary much in these long-range projections. Individual income taxes tend to rise relative to income, because the assumed rate of real income growth implies some ‘‘real bracket creep.’’ The tax code is indexed for inflation, but not for increases in real income. Eventually, a larger percentage of taxpayers will be in higher tax brackets and this will raise the ratio of taxes to income. However, other Federal taxes tend to decline in real terms in the absence of policy changes. Many excise taxes are set in nominal terms, so collections tend to decline as a share of GDP. In the very long run, Federal receipts are projected to rise by about 1 percentage point of GDP compared with their level in 2010. The starting point for these projections is the current ratio of Federal receipts to GDP. That ratio reached 20.0 percent in 1999, and it is expected to be 20.4 percent in 2000—the highest levels since World War II. This was not the result of new Federal taxes. Tax rates have been essentially unchanged since 1994, when the changes enacted in OBRA took effect. Since then, however, tax collections as a share of GDP have risen about two percentage points. The reasons for this increase are not yet fully understood. The rapid rise in the stock market, which has generated large capital gains for investors and made possible lucrative stock options and bonuses for executives, is generally believed to be a major factor. This Budget assumes that there will be some moderation in the ratio of receipts to GDP over the next few years. The share of revenues in the medium term is below the peak levels recently experienced. Even so, receipts are projected to remain above their historical average relative to the economy. Should the share of tax receipts instead return to near its historical average that would have an adverse effect on the long-range budget projections. In Chart 2–5, the current services baseline is compared with two alternatives for receipts. In one, the share of receipts is assumed to return to the level posted in 1996, 18.9 percent of GDP; in the other, to its level in 1994, before the recent runup in the revenue share—18.1 percent of GDP. The return to these earlier levels is completed by 2001. Afterwards, the current services rules apply, under which the share of receipts rises over time, but at a very gradual rate. The difference in the starting point for taxes can alter the outlook for the surplus/deficit quite dramatically. This is another example of how small differences in the primary surplus can eventually produce large effects on the total surplus/deficit. 4. Alternative Uses of the Budget Surpluses: Current projections show the unified budget in surplus for several decades under a wide range of assumptions. These surpluses dramatically reduce debt held by the public and net interest outlays, which in turn augments the surpluses. In a sense, a budget surplus that is used to reduce debt feeds on itself by reducing future interest outlays. Thus, if these surpluses were limited by increased spending or reduced taxes, it would change the Chart 2-5. Alternative Receipts Assumptions Surplus(+)/deficit(-) as a percent of GDP 5 2001 Budget Policy 0 -5 1996 Receipts Share 18.9 Percent of GDP -10 -15 1994 Receipts Share 18.1 Percent of GDP -20 -25 1995 2005 2015 2025 2035 2045 2055 2065 2075 33 2. STEWARDSHIP: TOWARD A FEDERAL BALANCE SHEET outlook. Chart 2–6 shows the budget’s path if it were held exactly in balance rather than being allowed to run surpluses. This would require policy changes to increase spending or reduce taxes. These changes could take two general forms. The spending or tax changes made possible by the surpluses could be purely temporary. This would be the case for tax rebates or onetime grants. If such changes were made, program spending and receipts could eventually return to their original baseline paths after the temporary spending and taxes came to an end, although interest spending would be permanently higher. Alternatively, the spending increases or tax reductions could be permanently built into the budget. This would be the case if the changes took form of tax rate cuts or increases in entitlements. Such changes would alter the baselines for outlays or receipts permanently, and have a larger longrun effect on the projected surplus. In both cases, the deficit returns sooner than it would if the surplus were used to reduce debt. 5. What Happens When the Federal Debt Is Repaid? A surplus means the Government takes in more receipts from the public than it pays out in the form of Government outlays. The extra receipts are used to retire debt. This is not unlike a family paying off its mortgage, and like a family with a mortgage, the Government may eventually be free from debt. This has happened only once before in the history of the United States, and then only briefly a century and a half ago; but with the current level of projected surpluses, such an eventuality has become a real possibility. When the budget window closes in 2010, the Administration projects that debt held by the public will be 7 percent of GDP, a lower level than at any time since before the United States entered World War I. With unified budget surpluses projected to be running between 2 and 3 percent of GDP, it is obvious where the debt is headed. All of the debt held by the public could be repaid. At that point, any further surpluses would no longer be used to retire Federal debt; instead, they would have to be accumulated in the form of Federal assets. Assuming the Government used them to acquire financial reserves, these reserves would earn interest which would add to the surplus further adding to the assets. In the long-run budget projections, Federal financial assets continue to build up until shifts in the underlying budgetary position cause the surplus gradually to unwind. Eventually, a deficit reappears and the assets are drawn down; ultimately, Federal debt is issued again. It is a measure of the severity of the impending demographic pressures that the national asset does not grow into the indefinite future— which it could, just as easily as did the national debt in the adverse projections of just a few years ago. Such a scenario is somewhat artificial and would have been thought most unlikely just a few years ago, but to assume any other approach would require a policy judgment. The purpose of these long-range projec- Chart 2.6. Alternative Uses Of The Surplus Surplus(+)/deficit(-) as a percent of GDP 5 2001 Budget Policy 0 -5 Surplus Used for Temporary Tax Rebates or Spending Increases -10 Surplus Used for Continuing Tax Cuts or Spending Increases -15 -20 1995 2005 2015 2025 2035 2045 2055 2065 2075 34 ANALYTICAL PERSPECTIVES tions, is to show what would happen to the budget if current policies were extended. That assumption implies that, with sufficient discipline, the Federal debt would be repaid under an extension of current budget policies and a Federal asset accumulated. Given the ground rules, the base scenario presents that result. Chart 2–7 compares the current services baseline with a scenario in which spending is permanently increased or taxes permanently cut when Federal debt held by the public reaches zero. Without the national asset, the deficit reappears much sooner. The interest earned by the asset is no longer available to fill the budgetary hole when the drain of future entitlement claims begins to mount. 6. Productivity: Productivity growth in the U.S. economy slowed after 1973. This slowdown was responsible for the slower rise in U.S.real incomes after that time. Recently, productivity growth has increased. Since the end of 1995, productivity has grown about as fast as it did during the 25-year period prior to 1973. The revival of productivity growth is one of the most welcome developments of the last several years. Productivity is affected by changes in the budget surplus/deficit which alter the level of national saving and investment, but many other factors also influence productivity as well. The surplus/deficit in turn is affected by changes in productivity growth which determine the size of the economy, and hence future receipts. Two alternative scenarios illustrate what would happen to the budget deficit if productivity growth were either higher or lower than assumed. A higher rate of growth would make the task of preserving a balanced budget much easier; indeed, it would permit expanded spending or reduced taxes without worsening the budget picture. A lower productivity growth rate would have the opposite effect. Chart 2–8 shows how the surplus/deficit varies with changes of one-half percentage point of average productivity growth in either direction. 7. Population: In the long run, shifting demographic patterns are the main source of change in these projections. The changing rate of population growth feeds into real economic growth through its effect on labor supply and employment. Changing demographic patterns also affect entitlement spending, contributing to the surge of spending expected for Social Security, Medicare, and Medicaid. The key assumptions underlying these demographic projections concern future fertility, mortality and immigration. • The main reason for the projected slowdown in population growth in the 21st century 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, slightly below the replacement rate needed to maintain a constant population. The fertility rate was even lower than this 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 1940s and 1950s and the baby bust in the 1960s and 1970s surprised demographers. A return to higher fertility rates is possible, but Chart 2-7. Alternative Assumptions About a Federal "Asset" Surplus(+)/deficit(-) as a percent of GDP 5 2001 Budget Policy 0 -5 No Asset Accumulates -10 -15 -20 1995 2005 2015 2025 2035 2045 2055 2065 2075 35 2. STEWARDSHIP: TOWARD A FEDERAL BALANCE SHEET Chart 2-8. Alternative Productivity Assumptions Surplus(+)/deficit(-) as a percent of GDP 40 Half Percent Higher Productivity Growth 20 0 2001 Budget Policy -20 Half Percent Lower Productivity Growth -40 -60 -80 1995 2005 2015 2025 so is another drop in fertility. The U.S. fertility rate has never fallen below 1.7, but such low rates have been observed recently in some European countries. Chart 2–9 shows the effects of alternative fertility assumptions on the surplus/deficit; higher fertility contributes to a larger labor force, increased aggregate incomes, and revenues; and hence increases the projected surplus. Lower fertility has the opposite effect. • The increasing proportion of the elderly projected for the U.S. population is due to both low fertility, which reduces the number of children per adult, and longer lifespans. Since 1970, the average lifespan for U.S. women has increased from 74.9 years to 79.5 years, and it is projected to rise to 82.8 years by 2050. Men do not live as long as women on average, but their lifespan has also increased from 67.2 years in 1970 to 73.6 years in 1999, and it is expected to reach 78.1 years by 2050. If the U.S. population were to experience much slower improvements in mortality, than in the recent past, the relatively shorter lifespans would help to improve the surplus/deficit by reducing Social Security benefits. Conversely, if the population were to live significantly longer than is now expected, the outlook for the surplus/deficit would worsen. This is illustrated in Chart 2–10. Last year, the technical panel to the Social Security Advisory Board recommended raising expected lifespans in the annual Trustees’ Report. The recommendation essentially is to adopt what had been the high-cost assumption as the inter- 2035 2045 2055 2065 2075 mediate or base case. This would raise expected lifespans in 2050 to 85.6 years for women and to 80.8 years for men. • A final factor influencing long-run projections is the rate of immigration. The United States is an open society. In the 19th century, a huge wave of immigration helped build the country; the last two decades of the 20th century have witnessed another burst of immigration. The net flow of legal immigrants has been averaging around 850,000 per year since 1992, while illegal immigration adds to these figures. 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 2–11 presents alternatives in which future immigration is held to zero and allowed to rise 50 percent above and below the intermediate actuarial assumptions in the Social Security Trustees’ Report. Conclusion.—Under President Clinton, the long-run budget outlook has improved significantly. When this Administration took office, the deficit was projected to continue spiraling out of control until, early in the 21st century, it was projected to reach levels seen before only during major wars. The outlook now is drastically different. Under current policy assumptions, the unified budget surpluses in 1998–1999 mark the beginning of a period of sustained budget surpluses. Eventually, without further reforms to the entitlement programs, a return to budget deficits is still projected, but how soon this will occur is difficult to estimate. A quick 36 ANALYTICAL PERSPECTIVES Chart 2-9. Alternative Fertility Assumptions Surplus(+)/deficit(-) as a percent of GDP 5 Higher Fertility 0 2001 Budget Policy -5 Lower Fertility -10 -15 1995 2005 2015 2025 2035 2045 2055 2065 2075 Chart 2-10. Alternative Mortality Assumptions Surplus(+)/deficit(-) as a percent of GDP Shorter Life Expectancy 5 0 2001 Budget Policy -5 Longer Life Expectancy -10 -15 1995 2005 2015 2025 2035 2045 2055 2065 2075 37 2. STEWARDSHIP: TOWARD A FEDERAL BALANCE SHEET return to deficits can be avoided with continued budget discipline. Both Social Security and Medicare confront long-run deficits in their respective Trust Funds, which must be addressed regardless of the prospects for the unified surplus. But the favorable outlook for the unified budget should make it easier to solve these otherwise difficult problems. 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 2010. 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 Funds from 1998 to 1999. There was a small improvement in the consolidated OASDI Trust fund and a larger gain in the HI Trust Fund. The changes were due to revisions in the actuarial assumptions. In the case of the OASDI funds, a small improvement in the economic assumptions was made; while for the HI program the actuaries revised their view of likely health care cost trends, which helped to prolong the projected surplus in the Trust Fund. The Trustees now project that the HI Trust Fund will not be depleted until 2015, which they describe as ‘‘a substantial improvement over prior estimates.’’ Chart 2-11. Alternative Immigration Assumptions Surplus(+)/deficit(-) as a percent of GDP 10 Higher Net Immigration 5 0 -5 2001 Budget Policy -10 Lower Net Immigration -15 -20 Zero Net Immigration -25 1995 2005 2015 2025 2035 2045 2055 2065 2075 38 ANALYTICAL PERSPECTIVES Table 2–3. CHANGE IN 75–YEAR ACTUARIAL BALANCE FOR OASDI AND HI TRUST FUNDS (INTERMEDIATE ASSUMPTIONS) (As a percent of taxable payroll) OASI Actuarial balance in 1998 Trustees’ Report ............................................................. Changes in balance due to changes in: Legislation ................................................................................................................ Valuation period ....................................................................................................... Economic and demographic assumptions .............................................................. Technical and other assumptions ........................................................................... Total Changes .......................................................................................................... Actuarial balance in 1999 Trustees’ Report ............................................................. DI OASDI HI –1.81 –0.38 –2.19 –2.10 0.00 –0.07 0.16 0.02 0.00 –0.01 0.02 0.00 0.00 –0.08 0.18 0.02 0.00 –0.05 0.01 0.68 0.10 0.02 0.12 0.64 –1.70 –0.36 –2.07 –1.46 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 Federal 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, such hypothetical capital stocks are obviously not owned by the Federal Government, nor would they appear on a conventional 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 into three categories: physical assets, education capital, and R&D capital. The Federal Government has made contributions to each of these categories of capital, and these contributions are shown separately in the table. Data in this table are especially uncertain, because of the strong assumptions needed to prepare the estimates. The conclusion of the table is that 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—$4.8 trillion. The Federal contribution is down from around 9 percent in the mid-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 12 percent of GDP to 7 percent since the end of the Cold War. 39 2. STEWARDSHIP: TOWARD A FEDERAL BALANCE SHEET Table 2–4. NATIONAL WEALTH (As of the end of the fiscal year, in trillions of 1999 dollars) 1960 1965 1970 1975 1980 1985 1990 1995 1997 1998 1999 ASSETS Publically 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 ......................................................................................... 2.0 1.2 1.0 0.1 0.8 0.7 2.4 1.3 1.1 0.2 1.0 0.6 2.9 1.4 1.1 0.3 1.4 0.6 3.4 1.5 1.0 0.5 1.9 0.8 3.6 1.6 0.9 0.6 2.1 1.1 3.9 1.8 1.1 0.7 2.1 1.3 4.2 2.0 1.2 0.8 2.3 1.0 4.7 2.0 1.1 0.9 2.6 0.8 4.9 2.0 1.1 1.0 2.8 0.8 4.8 2.0 1.0 1.0 2.8 0.8 4.8 2.0 1.0 1.0 2.7 0.8 Subtotal ...................................................................................................... 2.7 3.0 3.5 4.2 4.8 5.2 5.3 5.4 5.7 5.6 5.6 Privately Owned Physical Assets: Reproducible Assets .......................................................................................... Residential Structures .................................................................................... Nonresidential Plant & Equipment ................................................................ Inventories ...................................................................................................... Consumer Durables ....................................................................................... Land .................................................................................................................... 6.5 2.5 2.6 0.6 0.8 2.0 7.5 2.9 3.0 0.7 0.9 2.4 9.2 3.5 3.7 0.8 1.1 2.7 11.7 4.5 4.9 1.0 1.3 3.6 15.2 6.1 6.3 1.2 1.6 5.4 16.2 6.3 6.9 1.2 1.7 6.1 18.4 7.3 7.7 1.3 2.2 6.0 20.2 8.2 8.3 1.3 2.4 4.8 21.4 8.7 8.8 1.3 2.5 5.1 22.2 9.1 9.2 1.3 2.6 5.3 23.2 9.4 9.7 1.4 2.7 5.6 Subtotal .......................................................................................................... 8.5 9.8 11.9 15.4 20.6 22.3 24.4 25.0 26.5 27.6 28.8 Education Capital: Federally Financed ............................................................................................. Financed from Other Sources ........................................................................... 0.1 5.8 0.1 7.4 0.2 10.0 0.3 12.3 0.4 15.9 0.6 19.3 0.7 24.9 0.8 27.5 0.9 29.7 1.0 31.5 1.0 33.3 Subtotal .......................................................................................................... 5.8 7.5 10.2 12.6 16.4 19.8 25.6 28.3 30.6 32.5 34.3 Research and Development Capital: Federally Financed R&D .................................................................................... R&D Financed from Other Sources .................................................................. 0.2 0.1 0.3 0.2 0.5 0.3 0.5 0.4 0.6 0.4 0.6 0.6 0.8 0.8 0.9 1.0 0.9 1.2 0.9 1.2 0.9 1.3 Subtotal .......................................................................................................... 0.3 0.5 0.7 0.9 1.0 1.3 1.6 1.9 2.1 2.2 2.2 17.3 20.8 26.2 33.0 42.8 48.6 56.9 60.6 64.8 67.8 70.9 Total Assets ............................................................................................... Net Claims of Foreigners on U.S. (+) ..................................................................... -0.1 -0.2 -0.1 -0.1 -0.3 0.0 0.8 1.5 2.2 2.5 3.5 Balance ....................................................................................................... 17.4 21.0 26.4 33.1 43.1 48.5 56.1 59.1 62.6 65.2 67.4 96.1 7.0 0.4 11.9 107.8 6.7 0.5 11.3 128.7 7.1 0.8 10.3 153.2 7.8 1.2 9.3 188.7 8.5 2.1 8.6 203.0 8.1 3.1 8.9 223.7 8.0 3.8 8.0 224.3 7.5 4.2 7.6 232.9 7.3 4.5 7.4 240.5 7.3 4.6 7.1 246.1 7.2 4.8 7.1 ADDENDA: Per Capita Balance (thousands of dollars) ........................................................... Ratio of Balance to GDP (in percent) ................................................................... Total Federally Funded Capital (trillions of 1999 dollars) .................................... Percent of National Wealth .................................................................................... Physical Assets: The physical assets in the table include stocks of plant and equipment, office buildings, residential structures, land, and the Government’s physical assets such as military hardware and highways. Automobiles and consumer appliances are also included in this category. The total amount of such capital is vast, around $34 trillion in 1999; by comparison, GDP was about $9 trillion. The Federal Government’s contribution to this stock of capital includes its own physical assets plus $1 trillion in accumulated grants to State and local Governments for capital projects. The Federal Government has financed about one-fourth 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. Invest- ment 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 formal education and training. The estimate is based on the cost of replacing the years of schooling embodied in the U.S. population aged 16 and over; in other words, the idea is to measure how much it would cost to reeducate the U.S. workforce at today’s prices (rather than at its original cost). This is more meaningful economically than the historical cost, 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 for the current value of the investment in education. According to this measure, the stock of education capital amounted to $34 trillion in 1999, of which about 3 percent was financed by the Federal Government. It is equal in total value to the Nation’s stock of physical capital. The main investors in education capital have been State and local 40 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 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 the costs of acquiring only 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. 10 That stock is estimated to have been about $2 trillion in 1999. Although this is a large amount of research, it is a relatively small portion of total National wealth. Of this stock, about 40 percent was funded by the Federal Government. 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, which is intended to show National totals only, 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 deficit in the U.S. current account which has been rising; but even so, the size of this debt remains small compared with the total stock of U.S. assets. It amounted to 5 percent of the total assets in Table 2–4 in 1999. 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 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 about 5 percent of net U.S. wealth as shown in Table 2–4. 10 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. ANALYTICAL PERSPECTIVES Trends in National Wealth The net stock of wealth in the United States at the end of 1999 was about $67 trillion. Since 1980, the stocks of it has increased in real terms at an average annual rate of 2.4 percent per year—only half the 4.7 percent real growth rate it averaged from 1960 to 1980. Public physical capital formation has slowed even more drastically. Since 1980, the stock of public physical capital has increased at an annual rate of only 0.8 percent, compared with 2.9 percent over the previous 20 years. The net stock of private nonresidential plant and equipment grew 2.3 percent per year from 1980 to 1999, compared with 4.5 percent in the 1960s and 1970s; and the stock of business inventories increased even less, just 0.6 percent per year on average since 1980. However, private nonresidential fixed capital has increased more rapidly since 1992—3.2 percent per year— reflecting the recent investment boom. The accumulation of education capital, as measured here, has also slowed down since 1980, but not as much. It grew at an average rate of 5.2 percent per year in the 1960s and 1970s, about 0.9 percentage point faster than 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 increasing in economic value. R&D stocks have grown at about 4.4 percent per year since 1980, the fastest growth rate for any major category of investment over this period, but slower than the growth of R&D in the 1960s and 1970s. Other Federal Influences on Economic Growth Federal policies contributed to the slowdown in capital formation that occurred after 1980. Federal investment decisions, as reflected in Table 2–4, obviously were important, but the Federal Government also contributes to wealth in ways that cannot be easily captured in a formal presentation. The Federal Reserve’s monetary policy affects the rate and direction of capital formation in the short run, and Federal regulatory and tax policies also affect how capital is invested, as do the Federal Government’s policies on credit assistance and insurance. One important channel of influence is the Federal budget surplus/deficit, which determines the size of Federal saving when it is positive or the Federal borrowing requirement when it is negative. Had deficits been smaller in the 1980s, the gap between Federal liabilities and assets shown in Table 2–1 would be smaller today. 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 3 to 5 percent larger in 1999 had fiscal policy avoided the buildup in the debt. 41 2. STEWARDSHIP: TOWARD A FEDERAL BALANCE SHEET Social Indicators There are certain broad responsibilities that are unique to the Federal Government. Especially important are 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 a limited subset drawn from the vast 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 to varying degrees by many Government policies and programs, as well as by external factors beyond the Government’s control. They do not measure the outcomes of Government policies, because they generally do not show 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 Table 2–5. ECONOMIC AND SOCIAL INDICATORS General categories Economic: Living Standards ......... Economic Security ...... Employment Prospects Wealth Creation .......... Innovation .................... Social: Families ....................... Safe Communities ....... Health and Illness ....... Learning ....................... Participation ................. Environment: Air Quality ................... Water Quality .............. 1 The Specific measures 1960 1965 1970 1975 1980 1985 1990 1995 1997 1998 1999 Real GDP per person (1996 dollars) ................................. average annual percent change (5-year trend) ............ Median Income (1998 dollars):. All Households ............................................................... Married Couple Families ................................................ Female Householder, No Spouse Present .................... Income Share of Lower 60 percent of All Families .......... 13,038 NA 15,454 3.5 17,306 2.3 18,751 1.6 21,398 2.7 23,857 2.2 26,734 2.3 28,647 1.4 30,467 2.5 31,472 2.9 32,407 2.9 NA 29,730 15,024 34.8 NA 34,626 16,834 35.2 34,471 41,504 20,101 35.2 34,224 43,120 19,850 35.2 35,076 45,832 20,614 34.5 35,778 47,112 20,693 32.7 37,343 49,754 21,116 32.0 36,446 50,335 21,061 30.3 37,581 52,395 21,350 29.8 38,885 54,180 22,163 29.8 NA NA NA NA Poverty Rate (percent) 1 ..................................................... Civilian Unemployment (percent) ....................................... CPI-U (Percent Change) .................................................... Increase in Total Payroll Employment (millions) ............... Managerial or Professional Jobs (percent of total) ........... Net National Saving Rate (percent of GDP) ..................... Patents Issued to U.S. Residents (thousands) ................. Multifactor Productivity (average annual percent change) 22.2 5.5 1.7 –0.5 NA 10.2 42.1 1.0 17.3 4.5 1.6 2.9 NA 12.1 54.1 3.1 12.6 4.9 5.8 –0.5 NA 8.2 50.1 1.0 12.3 8.5 9.1 0.4 NA 6.5 40.5 1.2 13.0 7.1 13.5 0.2 NA 7.5 40.8 0.7 14.0 7.2 3.5 2.5 24.1 6.0 43.5 0.6 13.5 5.5 5.4 0.3 25.8 4.6 53.0 0.3 13.8 5.6 2.8 2.2 28.3 4.7 64.5 0.2 13.3 5.0 2.3 3.4 29.1 6.2 70.0 0.6 12.7 4.5 1.6 2.9 29.6 6.6 90.7 NA NA 4.2 2.2 NA NA 6.5 NA NA Children Living with Mother Only (percent of all children) Violent Crime Rate (per 100,000 population) 2 ................. Murder Rate (per 100,000 population) 2 ............................ Murders/Nonnegligent Manslaughter per 100,000 Persons Age 14 to 17). Infant Mortality (per 1000 Live Births) 3 ............................. Low Birthweight [<2,500 gms] Babies (percent) ............... Life Expectancy at birth (years) ......................................... Cigarette Smokers (percent population 18 and older) ...... Bed Disability Days (average days per person) ............... High School Graduates (percent of population 25 and older). College Graduates (percent of population 25 and older) National Assessment of Educational Progress 3. Mathematics High School Seniors ................................. Science High School Seniors ........................................ Voting for President (percent eligible population) ............. Voting for Congress (percent eligible population) ............. Individual Charitable Giving per Capita (1999 dollars) ..... 9.2 160 5 NA 10.2 199 5 NA 11.6 364 8 NA 16.4 482 10 11 18.6 597 10 13 20.2 557 8 10 21.6 732 9 24 24.0 685 8 24 23.2 611 7 17 23.6 566 6 NA NA 521 5 NA 26.0 7.7 69.7 NA 6.0 44.6 24.7 8.3 70.2 42.3 6.2 49.0 20.0 7.9 70.8 39.5 6.1 55.2 16.1 7.4 72.6 36.5 6.6 62.5 12.6 6.8 73.7 33.2 7.0 68.6 10.6 6.8 74.7 30.0 6.1 73.9 9.2 7.0 75.4 25.4 6.2 77.6 7.6 7.3 75.8 24.7 6.1 81.7 7.2 7.5 76.5 24.7 NA 82.1 7.2 7.6 76.7 NA NA 82.8 NA NA NA NA NA NA 8.4 9.4 11.0 13.9 17.0 19.4 21.3 23.0 23.9 24.4 NA NA NA 62.8 58.5 218 NA NA NA NA 261 NA 305 NA 43.5 313 302 293 NA NA 332 300 286 52.8 47.6 362 301 288 NA NA 373 305 290 NA 33.1 413 307 295 NA NA 398 NA NA NA NA 423 NA NA NA 33.4 NA NA NA NA NA NA 14,140 22,245 NA NA 17,424 26,380 NA NA 21,369 31,161 221 NA 23,151 28,011 160 NA 24,875 25,905 74 NA 23,488 23,230 23 134 23,436 23,678 5 155 23,768 19,189 4 166 23,576 NA 4 NA NA NA NA NA NA NA NA NA Nitrogen Oxide Emissions (thousand short tons) .............. Sulfur Dioxide Emissions (thousand short tons) ............... Lead Emissions (thousand short tons) .............................. Population Served by Secondary Treatment or Better (millions). poverty rate does not reflect noncash government transfers such as Medicaid or food stamps. all crimes are reported, and the fraction that go unreported may have varied over time, 1999 data are preliminary. 3 Some data from the national educational assessments have been interpolated. 2 Not 42 ANALYTICAL PERSPECTIVES 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 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. It is worth noting that, in recent years, many of the indicators in this table have turned around. The improvement in economic conditions has been widely noted, but there have also been some significant social improvements. Perhaps most notable has been the turnaround in the crime rate. Since reaching a peak in the early 1990s, the violent crime rate has fallen by over 25 percent, and preliminary data suggest that the improvement continued in 1999. The turnaround is especially dramatic in the murder rate, which is lower now than at any time since the 1960s. Government policies are only one set of factors in this remarkable reversal, but more effective policing along with broader changes that have helped improve economic prospects for all Americans appear to be having a good effect. 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 promotion of national saving through fiscal policy, and other Administration policies to enhance economic growth are expected 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. The gold stock was 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 and software purchases. 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 was necessary to deflate the nominal investment series. This was done using price deflators for Federal investment from the National Income and Product Accounts. 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 for oil deposits from the Producer Price Index for Crude Energy Materials. Liabilities: Financial Liabilities: The principal source of data is the Federal Reserve’s Flow-of-Funds Accounts. Insurance Liabilities: Sources of data are the OMB Deposit Insurance Model and the OMB Pension Guarantee Model. Historical data on liabilities for deposit insurance were also drawn from the CBO’s study, The Economic Effects of the Savings and Loan Crisis, issued January 1992. Pension Liabilities: For 1979–1998, 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 extrapolations. The estimate for 1999 is a projection. Long-Run Budget Projections The long-run budget projections are based on longrun demographic and economic projections. A simplified model of the Federal budget developed at OMB computes the budgetary implications of this forecast. Demographic and Economic Projections: For the years 2000–2010, the assumptions are identical to those used in the budget. These budget assumptions reflect the President’s policy proposals. The long-run projections extend these budget assumptions by holding inflation, interest rates, and unemployment constant at the levels assumed in the final year of the budget. Population growth and labor force growth are extended using the intermediate assumptions from the 1999 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 constant at the aver- 2. STEWARDSHIP: TOWARD A FEDERAL BALANCE SHEET age rate of growth implied by the budget’s economic assumptions. Budget Projections: For the budget period through 2010, 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 is projected according to current services assumptions in which it grows at the composite rate of inflation in Federal pay and non-pay spending; it is also projected on alternative assumptions which permit it to grow with both inflation and population, and also to grow with nominal GDP. Social Security is projected by the Social Security actuaries using these long-range assumptions. Medicare and Federal pensions are derived from the most recent actuarial forecasts available at the time the budget was prepared, repriced using Administration inflation assumptions. OMB’s Health Division projects Medicaid outlays based on the economic and demographic projections in the model. 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. National Balance Sheet Data Publicly Owned Physical Assets: Basic sources of data for the federally owned or financed stocks of capital are the Federal investment flows described in Chapter 6. Federal grants for State and local Government capital are added, 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 revised capital stock data prepared by the Bureau of Economic Analysis extrapolated for 1998–1999. 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 extrapolated for 1998–1999 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. Estimates of students’ forgone earnings are based on the year-round, full-time earnings of 18–24 year olds with selected educational attainment levels. These yearround earnings are reduced by 25 percent because students are usually out of school three months of the year. For high school students, these adjusted earnings are further reduced by the unemployment rate for 16–17 year olds; for college students, by the unemployment rate for 20–24 year olds. Yearly earnings by age 43 and educational attainment are from Money Income in the United States, series P60, published by the Bureau of the Census. 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 because these outlays are classified elsewhere as investment in physical 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, Lexington Books, 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 estimated stock of 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 estimated based on data from the National Science Foundation, Surveys of Science Resources. The industry-financed R&D stock component is estimated from that source and from the U.S. Department of Labor, The Impact of Research and Development on Productivity Growth, Bulletin 2331, September 1989. 44 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 2–4 assume that basic research does not depreciate. BEA also assumes a slightly higher rate of depre- ANALYTICAL PERSPECTIVES ciation 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 such general sources as the annual Economic Report of the President and the Statistical Abstract of the United States, and from the agencies’ Web sites. FEDERAL RECEIPTS AND COLLECTIONS 45 3. FEDERAL RECEIPTS Receipts (budget and off-budget) are taxes and other collections from the public that result from the exercise of the Federal Government’s sovereign or governmental powers. The difference between receipts and outlays determines the surplus or deficit. The Federal Government also collects income from the public from market-oriented activities. Collections from these activities, which are subtracted from gross outlays, rather than added to taxes and other governmental receipts, are discussed in the following chapter. Growth in receipts.—Total receipts in 2001 are estimated to be $2,019.0 billion, an increase of $62.8 billion or 3.2 percent relative to 2000. 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 3.8 percent between 2001 and 2005, rising to $2,340.9 billion. As a share of GDP, receipts are projected to decline from 20.4 percent in 2000 to 19.4 percent in 2005. Table 3–1. RECEIPTS BY SOURCE—SUMMARY (In billions of dollars) Estimate Source 1999 actual 2000 2001 2002 2003 2004 2005 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 .................................................................... 879.5 184.7 611.8 (167.4) (444.5) 70.4 27.8 18.3 34.9 951.6 192.4 650.0 (173.3) (476.8) 68.4 30.5 20.9 42.5 972.4 194.8 682.1 (182.2) (499.9) 76.7 32.3 20.9 39.9 995.2 195.4 712.2 (189.9) (522.2) 79.8 34.9 22.6 41.2 1,025.6 195.7 741.7 (197.4) (544.2) 80.8 36.3 24.3 43.2 1,066.1 200.0 771.3 (204.7) (566.7) 81.8 38.7 25.7 52.6 1,116.8 205.9 815.3 (216.7) (598.6) 83.4 37.0 27.9 54.5 Total receipts ......................................................................... (On-budget) ......................................................................... (Off-budget) ......................................................................... 1,827.5 (1,383.0) (444.5) 1,956.3 (1,479.5) (476.8) 2,019.0 (1,519.1) (499.9) 2,081.2 (1,559.0) (522.2) 2,147.5 (1,603.2) (544.2) 2,236.1 (1,669.4) (566.7) 2,340.9 (1,742.3) (598.6) Table 3–2. EFFECT ON RECEIPTS OF CHANGES IN THE SOCIAL SECURITY TAXABLE EARNINGS BASE (In billions of dollars) Estimate Social security (OASDI) taxable earnings base increases:. $76,200 to $80,100 on Jan. 1, 2001 ......................................................................................................................... $80,100 to $83,700 on Jan. 1, 2002 ......................................................................................................................... $83,700 to $87,300 on Jan. 1, 2003 ......................................................................................................................... $87,300 to $90,600 on Jan. 1, 2004 ......................................................................................................................... $90,600 to $93,900 on Jan. 1, 2005 ......................................................................................................................... 2001 2002 2003 2004 1.8 ................ ................ ................ ................ 4.8 1.6 ................ ................ ................ 5.2 4.3 1.6 ................ ................ 5.7 4.7 4.3 1.5 ................ 2005 6.3 5.2 4.7 4.0 1.5 47 48 ANALYTICAL PERSPECTIVES ENACTED LEGISLATION Several laws were enacted in 1999 that have an effect on governmental receipts. The major legislative changes affecting receipts are described below. To Extend the Tax Benefits Available With Respect to Services Performed in a Combat Zone to Services Performed in the Federal Republic of Yugoslavia (Serbia/Montenegro) and Certain Other Areas, and for Other Purposes.—This Act, which was signed by President Clinton on April 19, 1999, provides the same tax relief to military personnel participating in Operation Allied Force as that provided as a consequence of the Executive Order that designates the Kosovo area of operations as a combat zone. In addition, this Act extends the tax filing and payment deadlines provided as a consequence of the Executive Order to military personnel outside the United States who are deployed outside their duty station as part of Operation Allied Force. Under the Executive Order, which was issued by President Clinton on April 13, 1999, the Kosovo area of operations, including the above airspace, encompasses The Federal Republic of Yugoslavia (Serbia/Montenegro), Albania, the Adriatic Sea, and the Ionian Sea above the 39th parallel. The tax benefits provided military personnel serving in those areas include extension of deadlines for filing and paying taxes; exemption of military pay earned while serving in the combat zone (subject to a dollar limit for commissioned officers) from withholding and income tax; and, exemption of toll telephone calls originating in the combat zone from the telephone excise tax. Miscellaneous Trade and Technical Corrections Act of 1999—This Act makes miscellaneous technical and clerical corrections to U.S. trade laws, corrects obsolete references, and authorizes the temporary suspension or refund of tariffs on over 120 categories of imported items. These items include 13 inch televisions, chemicals (some of which are used to develop cancer and AIDS-fighting drugs), textile printing machines, weaving machines, manufacturing equipment, certain rocket engines, and a number of pigments and dyes. The Act also extends tariff credits for wages paid in the production of watches in the Virgin Islands to the production of fine jewelry. The receipt losses associated with the tariff refunds and suspensions are offset by a provision that clarifies the tax treatment of certain corporate restructuring transactions, which is described below. Restrict basis creation through section 357(c).—A transferor generally is required to recognize gain on a transfer of property in certain tax-free exchanges to the extent that the sum of the liabilities assumed, plus those to which the transferred property is subject, exceeds the transferor’s basis in the property. This gain recognition to the transferor generally increases the basis of the transferred property in the hands of the transferee. However, if a recourse liability is secured by multiple assets, prior law was unclear as to 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 this provision, the distinction between the assumption of a liability and the acquisition of an asset subject to a liability generally is eliminated. Except as provided in regulations, a recourse liability is treated as assumed to the extent that the transferee has agreed and is expected to satisfy the liability (whether or not the transferor has been relieved of the liability). Except as provided in regulations, a nonrecourse liability is treated as assumed by the transferee of any asset subject to the liability. However, the amount of nonrecourse liability treated as assumed is reduced by the amount of the liability that an owner of other assets not transferred to the transferee and also subject to the liability has agreed with the transferee to satisfy, and is expected to satisfy, up to the fair market value of such other assets. The transferor’s recognition of gain as a result of assumption of liability shall not increase the transferee’s basis in the transferred asset to an amount in excess of its fair market value. Moreover, if no person is subject to U.S. tax on gain recognized as the result of the assumption of a nonrecourse liability, then the transferee’s basis in the transferred assets is increased only to the extent such basis would be increased if the transferee had assumed only a ratable portion of the liability, based on the relative fair market value of all assets subject to such nonrecourse liability. The Treasury Department has authority to prescribe regulations necessary to carry out the purposes of the provision, and to apply the treatment set forth in this provision where appropriate elsewhere in the Internal Revenue Code. This provision applies to transfers made after October 18, 1998. Consolidated Appropriations Act for FY 2000.— This Act, which was signed by President Clinton on November 30, 1999, makes progress on several important fronts: it puts education first, makes America a safer place, strengthens our effort to preserve natural areas and protect our environment, and strengthens America’s leadership role in the world. Although most of the provisions in this Act affect Federal spending programs, a transfer from the surplus funds of the Federal Reserve System to the Treasury of $3.752 billion in FY 2000 affects governmental receipts. Ticket to Work and Work Incentives Improvement Act of 1999.—This Act, which was signed by President Clinton on December 17, 1999, ensures that individuals with disabilities have a greater opportunity to participate in the workforce and in the American Dream and extends important tax provisions. Despite these accomplishments, the President is disappointed that this Act includes a provision for a special allowance adjustment for student loans, that it delays the implementation of a proposed Department of Health 3. FEDERAL RECEIPTS and Human Services final rule on the distribution of human organs for transplantation, and that the revenue losses are not fully offset. The major provisions of this Act affecting governmental receipts are described below. Expired and Expiring Provisions Extend minimum tax relief for individuals.—Certain nonrefundable personal tax credits (dependent care credit, credit for the elderly and disabled, adoption credit, child tax credit, credit for interest on certain home mortgages, HOPE Scholarship and Lifetime Learning credit, and the D.C. homebuyer’s credit) are provided under current law. Generally, these credits are allowed only to the extent that the individual’s regular income tax liability exceeds the individual’s tentative minimum tax. An additional child tax credit is provided under current law to families with three or more qualifying children. This credit, which may be offset against social security payroll tax liability (provided that liability exceeds the amount of the earned income credit), is reduced by the amount of the individual’s minimum tax liability (that is, the amount by which the individual’s tentative minimum tax exceeds the individual’s regular tax liability). For taxable year 1998, prior law allowed nonrefundable personal tax credits to offset regular income tax liability in full (as opposed to only the amount by which the regular tax liability exceeded the tentative minimum tax). In addition, for taxable year 1998, the additional child credit provided to families with three or more qualifying children was not reduced by the amount of the individual’s minimum tax liability. This Act extends the provision that allows the nonrefundable personal tax credits to offset regular income tax liability in full to taxable years beginning in 1999. For taxable years beginning in 2000 and 2001 the nonrefundable personal credits may offset both the regular tax and the minimum tax. In addition, for taxable years beginning in 1999, 2000, and 2001, the additional child credit provided to families with three or more qualifying children will not be reduced by the amount of the individual’s minimum tax liability. Extend and modify research and experimentation tax credit.—The 20-percent tax credit for certain research and experimentation expenditures is extended to apply to qualifying expenditures paid or incurred during the period July 1, 1999 through June 30, 2004. In addition, effective for taxable years beginning after June 30, 1999, the credit rate applicable under the alternative incremental research credit is increased by one percentage point per step, and the definition of qualified research is expanded to include research undertaken in Puerto Rico and possessions of the United States. Under this Act, credits attributable to the period beginning on July 1, 1999 and ending on September 30, 2000 may not be taken into account in determining any amount required to be paid for any purpose under the Internal Revenue Code prior to October 1, 2000. On or after October 1, 2000, such credits may be taken into account through the filing of an amended return, 49 an application for expedited refund, an adjustment of estimated taxes, or other means that are allowed by the Internal Revenue Code. Similarly, research credits that are attributable to the period beginning on October 1, 2000 and ending on September 30, 2001 may not be taken into account in determining any amount required to be paid for any purpose under the Internal Revenue Code prior to October 1, 2001. Extend exceptions provided under subpart F for certain active financing income.—Under the Subpart F rules, certain U.S. shareholders of a controlled foreign corporation (CFC) are subject to U.S. tax currently on certain income earned by the CFC, whether or not such income is distributed to the shareholders. The income subject to current inclusion under the subpart F rules includes ‘‘foreign personal holding company income’’ and insurance income. The U.S. 10-percent shareholders of a CFC also are subject to current inclusion with respect to their shares of the CFC’s foreign base company services income (income derived from services performed for a related person outside the country in which the CFC is organized). For taxable years beginning in 1998 and 1999, certain income derived in the active conduct of a banking, financing, insurance, or similar business is excepted from the Subpart F rules regarding the taxation of foreign personal holding company income and foreign base company services income. This Act extends the exception for two years, with very minor modifications, to apply to taxable years beginning in 2000 and 2001. Extend suspension of net income limitation on percentage depletion from marginal oil and gas wells.—Taxpayers are allowed to recover their investment in oil and gas wells through depletion deductions. For certain properties, deductions may be determined using the percentage depletion method; however, in any year, the amount deducted generally may not exceed 100 percent of the net income from the property. For taxable years beginning after December 31, 1997 and before January 1, 2000, domestic oil and gas production from ‘‘marginal’’ properties is exempt from the 100-percent of net income limitation. This Act extends the exemption to apply to taxable years beginning after December 1, 1999 and before January 1, 2002. 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. This Act extends the credit to apply to individuals who begin work on or after July 1, 1999 and before January 1, 2002. Extend the welfare-to-work tax credit.—The welfareto-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 50 in the first year of employment and 50 percent of the first $10,000 of eligible wages in the second year of employment. Under this Act the credit is extended to apply to individuals who begin work on or after July 1, 1999 and before January 1, 2002. Extend exclusion for employer-provided educational assistance.—Certain amounts paid by an employer for educational assistance provided to an employee 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 job-related. The exclusion, which is limited to undergraduate courses, is extended to apply to courses beginning after May 31, 2000 and before January 1, 2002. Extend and modify wind and biomass tax credit and expand eligible biomass sources.—Taxpayers are provided a 1.5-cent-per-kilowatt-hour tax credit, adjusted for inflation after 1992, for electricity produced from wind or ‘‘closed-loop’’ biomass. Under prior law, the credit applies to electricity produced by a facility placed in service before July 1, 1999, and is allowable for production during the 10-year period after a facility is originally placed in service. This Act extends the credit to apply to facilities placed in service after June 30, 1999 and before January 1, 2002. Electricity produced at a wind facility placed in service during this period does not qualify for the credit, however, if it is sold pursuant to a pre-1987 contract that has not been modified to limit the purchaser’s obligation to acquire electricity at above-market prices. The Act also expands the credit to apply to poultry waste facilities placed in service after December 31, 1999 and before January 1, 2002. 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 June 30, 1999, is extended through September 30, 2001. Refunds of any duty paid between June 30, 1999 and December 17, 1999 are provided upon request of the importer. Extend authority to issue Qualified Zone Academy Bonds.—The Taxpayer Relief Act of 1997 (TRA97) included a provision that allows State and local governments 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 must be used for teacher training, purchases of equipment, curricular development, and rehabilitation and repairs at certain public school facilities. Under TRA97, a nationwide total of $400 million of qualified zone academy bonds was authorized to be issued in each of calendar years 1998 and 1999. Effective December 17, 1999, an additional $400 million of qualified zone academy bonds is authorized to be issued in each of calendar years 2000 and 2001. In addition, unused authority arising in 1998 and ANALYTICAL PERSPECTIVES 1999 may be carried forward for up to three years and unused authority arising in 2000 and 2001 may be carried forward for up to two years. Extend tax credit for first-time D.C. homebuyers.— The tax credit (up to $5,000) provided for the firsttime purchase of a principal residence in the District of Columbia, which was scheduled to expire after December 31, 2000, is extended to apply to residences purchased on or before December 31, 2001. Extend expensing of brownfields remediation costs.— Taxpayers can elect to treat certain environmental remediation expenditures that would otherwise be chargeable to capital account as deductible in the year paid or incurred. The ability to deduct such expenditures is extended for one year, to apply to expenditures paid or incurred before January 1, 2002. Time-Sensitive Provisions Prohibit disclosure of advanced pricing agreements (APAs) and APA background files.—Returns and return information, as defined by the Internal Revenue Service (IRS), are confidential and cannot be disclosed unless authorized by the Internal Revenue Code. In contrast, written determinations issued by the IRS generally are available for public inspection. The APA program is an alternative dispute resolution program conducted by the IRS, which resolves international transfer pricing issues prior to the filing of the corporate tax return. To resolve such issues, the taxpayer submits detailed and confidential financial information, business plans and projections to the IRS for consideration. This Act confirms that APAs and related background information are confidential return information and not written determinations available for public inspection. Effective December 17, 1999, APAs or related background files are prohibited from being released to the public, regardless of whether the APA was executed before or after that date. The Treasury Department also is required to produce an annual report that contains general and statistical information about the APA program, and general descriptions of the APAs concluded during the year. Provide authority to postpone certain tax-related deadlines by reason of year 2000 (Y2K) failures.—The Secretary of the Treasury is permitted to postpone, on a taxpayer-by-taxpayer basis, certain tax-related deadlines for a period of up to 90 days, if he determines that the taxpayer has been affected by an actual Y2K related failure. In order to be eligible for relief, the taxpayer must have made a good faith, reasonable effort to avoid any Y2K related failures. Expand list of taxable vaccines.—Under prior law an excise tax of $.75 per dose is levied on the following vaccines: diphtheria, pertussis, tetanus, measles, mumps, rubella, polio, HIB (haemophilus influenza type B), hepatitis B, rotavirus gastroenteritis, and varicella (chickenpox). This Act adds any conjugate vaccine against streptococcus pneumoniae to the list of taxable vaccines, effective for vaccines sold by a manufacturer or importer after December 17, 1999. 3. 51 FEDERAL RECEIPTS Delay requirement that registered motor fuels terminals offer dyed fuel as a condition of registration.— With limited exceptions, excise taxes are imposed on all highway motor fuels when they are removed from a registered terminal facility, unless the fuel is indelibly dyed and is destined for a nontaxable use. Terminal facilities are not permitted to receive and store nontaxed motor fuels unless they are registered with the IRS. Prior law requires that effective July 1, 2000, in order to be registered, a terminal must offer for sale both dyed and undyed fuel (the ‘‘dyed-fuel mandate’’). Under this Act the effective date of the dyedfuel mandate is postponed until January 1, 2002. Provide that Federal production payments to farmers are taxable in the year received. —A taxpayer generally is required to include an item in income no later than the time of its actual or constructive receipt, unless such amount properly is accounted for in a different period under the taxpayer’s method of accounting. If a taxpayer has an unrestricted right to demand the payment of an amount, the taxpayer is in constructive receipt of that amount whether or not the taxpayer makes the demand and actually receives the payment. Under production flexibility contracts entered into between certain eligible owners and producers and the Secretary of Agriculture, as provided in the Federal Agriculture Improvement and Reform Act of 1996 (FAIR Act), annual payments are made at specific times during the Federal government’s fiscal year. One-half of each annual payment is to be made on either December 15 or January 15 of the fiscal year, at the option of the recipient; the remaining one-half is to be paid no later than September 30 of the fiscal year. The option to receive the payment on December 15 potentially results in the constructive receipt (and thus potential inclusion in income) of one-half of the annual payment at that time, even if the option to receive the amount on January 15 is elected. For fiscal year 1999, as provided under The Emergency Farm Financial Relief Act of 1998, all payments are to be paid at such time or times during the fiscal year as the recipient may specify. This option to receive all of the 1999 payment in calendar year 1998 potentially results in constructive receipt (and thus potential inclusion in income) in that year, whether or not the amounts are actually received. The Omnibus Consolidated and Emergency Supplemental Appropriations Act, 1999, provided that effective for production flexibility contract payments made in taxable years ending after December 31, 1995, the time a production flexibility contract payment is to be included in income is to be determined without regard to the options granted for payment. Effective December 17, 1999, this Act provides that any unexercised option to accelerate the receipt of any payment under a production flexibility contract that is payable under the FAIR Act is to be disregarded in determining the taxable year in which such payment is properly included in gross income. Options to accelerate payments that are enacted in the future are covered by this rule, providing the payment to which they relate is mandated by the Fair Act as in effect on the date of enactment of this Act. Revenue Offset Provisions 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. For any individual with an adjusted gross income (AGI) of more than $150,000 as shown on the return for the preceding taxable year, the 100 percent of last year’s liability safe harbor generally is modified to be a 110 percent of last year’s liability safe harbor. However, under prior law, the 110 percent of last year’s liability safe harbor for individuals with AGI of more than $150,000 was modified for taxable years beginning in 1999 through 2002, as follows: for taxable years beginning in 1999 the safe harbor is 105 percent; for taxable years beginning in 2000 and 2001 the safe harbor is 106 percent, and for taxable years beginning in 2002, the safe harbor is 112 percent. Under this Act the estimated tax safe harbor for individuals with AGI of more than $150,000 is modified as follows: for taxable years beginning in 2000 the safe harbor is 108.6 percent and for taxable years beginning in 2001 the safe harbor is 110.0 percent. Clarify the tax treatment of income and losses on derivatives.—Capital gain treatment applies to gain on the sale or exchange of a capital asset. Gain or loss on other assets (stock in trade or other types of inventory, property used in a trade or business that is real property or subject to depreciation, accounts or notes receivable acquired in the ordinary course of a trade or business, certain copyrights, and U.S. government publications) generally is considered ordinary. This Act adds three categories to the list of assets the gain or loss on which is considered ordinary for Federal income tax purposes: commodities derivatives held by commodities derivatives dealers, hedging transactions, and supplies of a type regularly consumed by the taxpayer in the ordinary course of a taxpayer’s trade or business. In defining a hedging transaction, the Act replaces the ‘‘risk reduction’’ standard with a ‘‘risk management’’ standard with respect to ordinary property held or certain liabilities incurred, and provides that the definition of a hedging transaction includes a transaction entered into primarily to mange such other risks as the Secretary of the Treasury may prescribe in regulations. These changes are effective for any instrument held, acquired or entered into; any transaction entered into; and any supplies held or acquired on or after December 17, 1999. Expand reporting of cancellation of indebtedness income.—Gross income generally includes income from the discharge of indebtedness. If a bank, thrift institu- 52 tion, or credit union discharges $600 or more of any indebtedness of a debtor, the institution must report such discharge to the debtor and the IRS. This Act extends these reporting requirements to additional entities involved in the trade or business of lending (such as finance companies and credit card companies, whether or not they are affiliated with a financial institution), effective for discharges of indebtedness occurring after December 31, 1999. Limit conversion of character of income from constructive ownership transactions with respect to partnership interests.—A pass-thru entity, such as a partnership, generally is not subject to Federal income tax. Instead, each owner includes his/her share of a pass-thru entity’s income, gain, deduction or credit in his/her own taxable income. The character of the income generally is determined at the entity level and flows through to the owners. A taxpayer can enter into a derivatives transaction that is designed to give the taxpayer the economic equivalent of an ownership interest in a partnership but that is not itself a current ownership interest in the partnership. These so-called ‘‘constructive ownership’’ transactions purportedly allow taxpayers to defer income and to convert ordinary income and shortterm capital gain into long-term capital gain. This Act treats long-term capital gain recognized from a constructive ownership transaction as ordinary income to the extent the long-term capital gain recognized from the transaction exceeds the long-term capital gain that could have been recognized had the taxpayer invested in the partnership interest directly. In addition, an interest charge is imposed on the amount of gain that is treated as ordinary income. These changes are effective with respect to transactions entered into on or after July 12, 1999. Generally any contract, option or any other arrangement that is entered into or exercised on or after that date, which extends or otherwise modifies the terms of a transaction entered into prior to such date, will be treated as a transaction entered into on or after July 12, 1999. Extend and modify qualified transfers of excess pension assets used for retiree health benefits.—A pension plan may provide medical benefits to retired employees through a section 401(h) account that is a part of the pension plan. Qualified transfers of excess assets of a defined benefit pension plan (other than a multiemployer plan) to a section 401(h) account are permitted, subject to amount and frequency limitations, use requirements, deduction limitations, and vesting and minimum benefit requirements. This Act extends the ability of employers to transfer excess defined benefit pension plan assets to 401(h) accounts through December 31, 2005. In addition, effective with respect to qualified transfers made after December 17, 1999, the minimum benefit requirement is replaced with a minimum cost requirement. Modify installment method for accrual basis taxpayers.—Generally, an accrual method requires a taxpayer to recognize income when all events have occurred that fix the right to its receipt and its amount ANALYTICAL PERSPECTIVES can be determined with reasonable accuracy. The installment method of accounting provides an exception to these general recognition principles by allowing a taxpayer to defer recognition of income from the disposition of certain property until payment is received. To the extent that an installment obligation is pledged as security for any indebtedness, the net proceeds of the secured indebtedness are treated as a payment on such obligation, thereby triggering the recognition of income. This Act generally prohibits the use of the installment method of accounting for dispositions of property that would otherwise be reported for Federal income tax purposes using an accrual method of accounting. The present-law exceptions regarding the availability of the installment method for use by cash method taxpayers, for dispositions of property used or produced in the trade or business of farming, and for dispositions of timeshares or residential lots are not affected by this change. This Act also modifies the pledge rule to provide that entering into any arrangement that gives the taxpayer the right to satisfy an obligation with an installment note will be treated in the same manner as the direct pledge of the installment note. These changes are effective with respect to sales or other dispositions entered into on or after December 17, 1999. Deny charitable contribution deduction for transfers associated with split-dollar insurance arrangements.— A taxpayer who itemizes deductions generally is allowed to deduct charitable contributions paid during the taxable year. The amount of the deduction allowable for a taxable year with respect to any charitable contribution depends on the type of property contributed, the type of organization to which the property is contributed, and the income of the taxpayer. In general, to be deductible as a charitable contribution, a payment to charity must be a gift made without receipt of adequate consideration and with donative intent. Under a charitable split-dollar insurance arrangement, a taxpayer typically transfers funds to a charity with the understanding that the charity will use the funds to pay premiums on a cash value life insurance policy that benefits both the charity and members of the transferor’s family, either directly or indirectly through a family trust or partnership. This Act eliminates such abuses of the charitable contributions deduction by denying a charitable contribution deduction for any transfer to a charity in connection with a charitable splitdollar insurance transaction. Specifically, the denial of the deduction applies if, in connection with the transfer, the charity directly or indirectly pays, or has previously paid, any premium on any ‘‘personal benefit contract’’ with respect to the transferor, or there is an understanding or expectation that any person will directly or indirectly pay any premium on any ‘‘personal benefit contract’’ with respect to the transferor. A personal benefit contract with respect to the transferor is any life insurance, annuity, or endowment contract for whom the direct or indirect beneficiary under the contract is the transferor, any member of the transferor’s family 3. 53 FEDERAL RECEIPTS or any other person (other than a charitable organization) designated by the transferor. The Act also imposes an excise tax on any participating charity equal to the amount of any premiums paid by the charity on such a ‘‘personal benefit contract’’ in connection with a charitable split-dollar insurance transaction. The deduction is denied for any transfers after February 8, 1999 and the excise tax applies to premiums paid after December 17, 1999. Require basis adjustments when a partnership distributes certain stock to a corporate partner.—Under prior law, generally no gain or loss was recognized on the receipt by a corporation of property distributed in complete liquidation of a subsidiary corporation in which it owned 80-percent of the stock. The basis of property received by the distributee in such a liquidation was the same as it was in the hands of the subsidiary. This Act provides for a reduction in basis of the assets of a corporation if stock in that corporation is distributed by the partnership to a corporate partner that, as a result of the distribution and related transactions, owns 80 percent or more of the stock of such corporation. The amount of the reduction generally equals the amount of the excess of the partnership’s adjusted basis in the stock of the distributed corporation immediately before the distribution, over the corporate partner’s basis in that stock immediately after the distribution, subject to certain limitations. The corporate partner must recognize long-term capital gain to the extent the amount of the basis reduction exceeds the basis of the property of the distributed corporation. This change generally is effective for distributions made after July 14, 1999, except that in the case of a corporation that is a partner in a partnership on July 14, 1999, the provision is effective for distributions by that partnership to the corporation after December 17, 1999 (or, for a corporation that so elects, distributions after June 30, 2001). Modify rules relating to real estate investment trusts (REITs).—REITs generally are restricted to owning passive investments in real estate and certain securities. Under prior law, no single corporation could account for more than five percent of the total value of a REIT’s assets, and a REIT could not own more than 10-percent of the outstanding voting securities of any issuer. Through the use of non-voting preferred stock and multiple subsidiaries, up to 25 percent of the value of a REIT’s assets could consist of subsidiaries that conduct otherwise impermissible activities. Under this Act, the 10-percent vote test is changed to a 10-percent ‘‘vote or value’’ test, meaning that a REIT cannot own more than 10 percent of the outstanding voting securities or more than 10 percent of the total value of securities of a single issuer. In addition, taxable REIT subsidiaries owned by a REIT cannot represent more than 20 percent of the value of a REIT’s assets. For purposes of the 10-percent value test, securities are generally defined to exclude safe harbor debt owned by a REIT. In addition, an exception to the limitation on ownership of securities of a single issuer applies in the case of a ‘‘taxable REIT subsidiary’’ that meets certain requirements. The Act also provides rules for the operation of hotels and health care facilities; defines ‘‘independent contractor’’ for certain purposes; modifies REIT distribution requirements to conform to the rules for regulated investment companies (RICs); modifies earnings and profits rules for RICs and REITs; and replaces the prior law adjusted basis comparison with a fair market comparison, in determining whether certain rents from personal property exceed a 15-percent limit. These provisions generally are effective for taxable years beginning after December 31, 2000, with transition for certain REIT holdings and leases in effect on July 12, 1999. Modify estimated tax rules for closely held REITs.— If a person has a direct interest or a partnership interest in income-producing assets that produce income throughout the year, that person’s estimated tax payments generally must reflect the quarterly amounts expected from the asset. However, a dividend distribution of earnings from a REIT is considered for estimated tax purposes when the dividend is paid. To take advantage of this deferral of estimated taxes, some corporations have established closely held REITS that may make a single distribution for the year, timed such that it need not be taken into account under the estimated tax rules as early as would be the case if the assets were directly held by the controlling entity. Effective for estimated tax payments due on or after November 15, 1999, with respect to a closely held REIT, this Act provides that any person owning at least 10 percent of the vote or value of the REIT is required to accelerate the recognition of year-end dividends attributable to the closely held REIT. Other Provisions Simplify foster child definition under the earned income tax credit (EITC).—This Act clarifies the definition of foster child for purposes of claiming the EITC. Effective for taxable years beginning after December 31, 1999, 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. Allow members of the clergy to revoke exemption from Social Security and Medicare coverage.—Under current law, ministers of a church who are opposed to participating in the Social Security and Medicare programs on religious principles may reject coverage by filing with the IRS before the tax filing date for their second year of work in the ministry. This Act provides an opportunity for members of the clergy to revoke their exemptions from Social Security and Medicare coverage during a 2-year period beginning January 1, 2000. 54 ANALYTICAL PERSPECTIVES ADMINISTRATION PROPOSALS The President’s plan targets tax relief to provide assistance in obtaining higher education for working families, to relieve poverty and revitalize lower-income communities, and to make health care more affordable. The President’s plan also provides relief from the marriage penalty and provides child-care assistance, promotes retirement savings, provides relief from the alternative minimum tax and other simplifications of the tax laws, encourages philanthropy, and offers assistance in bridging the digital divide. The President’s plan also contains measures that will curtail the proliferation of corporate tax shelters, restrict the use of overseas tax havens, and close other loopholes and tax subsidies. PROVIDE TAX RELIEF Expand Educational Opportunities Provide College Opportunity tax cut—Under current law, individuals may claim a Lifetime Learning credit equal to 20 percent of qualified tuition and related expenses up to $5,000 (increasing to $10,000 in 2003) incurred during the year for post-secondary education for the taxpayer, the taxpayer’s spouse, or one or more dependents. The credit phases out for taxpayers filing joint returns with modified AGI from $80,000 to $100,000, and $40,000 to $50,000 for single taxpayers. The phase-out ranges will be adjusted for inflation occurring after 2000. To further assist taxpayers in obtaining post-secondary education throughout their lifetimes, the Administration proposes that the Lifetime Learning credit rate be increased to 28 percent. In addition, the phase-out range for the credit would be increased to $100,000 to $120,000 of modified AGI for joint returns and $50,000 to $60,000 of modified AGI for single taxpayers. To guarantee that all eligible taxpayers receive the full value of this education assistance, taxpayers may elect to deduct qualified tuition and related expenses instead of claiming the credit. Provide incentives for public school construction and modernization.—The Administration proposes to institute a new program of Federal tax assistance for public elementary and secondary school construction or rehabilitation. Under the proposal, State and local governments (including U.S. possessions) would be able to issue up to $22 billion of ‘‘qualified school modernization bonds,’’ $11 billion in each of 2001 and 2002. In addition, $200 million of qualified school modernization bonds in each of 2001 and 2002 would be allocated for the construction and renovation of Bureau of Indian Affairs funded schools. 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. Issuers would be responsible for repayment of principal. These qualified school modernization bonds would be similar to qualified zone academy bonds (QZABs), created by TRA97 and extended by the Ticket to Work and Work Incentives Improvement Act of 1999. QZABs allow bonds to be issued for certain public schools with the interest on the bonds effectively paid by the Federal government in the form of an annual income tax credit. The proceeds of these bonds can be used for teacher training, purchases of equipment, curricular development, and rehabilitation and repair of the school facilities. The Administration proposes to authorize the issuance of additional QZABs of $1.0 billion in 2001 and $1.4 billion in 2002, and to allow the proceeds of these bonds also to be used for school construction. Expand exclusion for employer-provided educational assistance to include graduate education.—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 job-related. The exclusion currently is limited to undergraduate courses beginning before January 1, 2002. The exclusion previously applied to graduate courses that began before July 1, 1996. The Administration proposes to reinstate the exclusion for graduate education for courses beginning on or after July 1, 2000 and before January 1, 2002. Eliminate 60-month limit on student loan interest deduction.—Current law provides an income tax deduction for certain interest paid on a qualified education loan during the first 60 months that interest payments are required, effective for interest due and paid after December 31, 1997. The maximum deduction available is $2,500 for years after 2000 (for years 1998, 1999 and 2000, the limits are $1,000, $1,500 and $2,000, respectively) and the deduction is phased out for taxpayers with AGI between $40,000 and $55,000 (between $60,000 and $75,000 for joint filers). The 60month limitation under current law adds significant complexity and administrative burdens for taxpayers, lenders, loan servicing agencies, and the IRS. Thus, to simplify the calculation of deductible interest payments, reduce administrative burdens, and provide longer-term relief to low- and middle-income taxpayers with large educational debt, the Administration proposes to eliminate the 60-month limitation. This proposal would be effective for interest due and paid on qualified education loans after December 31, 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 pe- 3. FEDERAL RECEIPTS riod 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, 2000. Provide tax relief for participants in certain Federal education programs.—Present law provides tax-free treatment for certain scholarship and fellowship grants used to pay qualified tuition and related expenses, but not to the extent that any grant represents compensation for services. In addition, tax-free treatment is provided for certain discharges of student loans on condition that the individual works for a certain period of time in certain professions for any of a broad class of employers. To extend tax-free treatment to education awards under certain Federal programs, the Administration proposes to amend current law to provide that any amounts received by an individual under the National Health Service Corps (NHSC) Scholarship Program or the Armed Forces Health Professions Scholarship and Financial Assistance Program are ‘‘qualified scholarships’’ excludable from income, without regard to the recipient’s future service obligation. In addition, the proposal would provide an exclusion from income for any repayment or cancellation of a student loan under the NHSC Scholarship Program, the Americorps Education Award Program, or the Armed Forces Health Professions Loan Repayment Program. The exclusion would apply only to the extent that the student incurred qualified tuition and related expenses for which no education credit was claimed during academic periods when the student loans were incurred. The proposal would be effective for awards received after December 31, 2000. Provide Poverty Relief and Revitalize Communities Increase and simplify the Earned Income Tax Credit (EITC).—Low- and moderate-income workers may be eligible for the EITC. For every dollar a lowincome worker earns up to a limit, between 7 and 40 cents are provided as a tax credit. The applicable credit rate depends on the presence and number of children in the worker’s family. Above $13,030 ($5,930 if the taxpayer does not reside with children), the size of the tax credit is gradually phased out. Although the EITC lifts millions out of poverty each year, poverty among children living in larger families remains at unacceptably high levels. Because the credit initially increases as income rises, the EITC rewards marriage for very low-income workers. But the EITC also causes marriage penalties among two-earner couples whose income falls in or above the credit’s phase-out range. Further, while the EITC has been shown, on net, to increase work effort, phasing out the credit results in high marginal tax rates for recipients in the phase-out range. To address these problems, the Administration proposes that the credit rate be increased from 40 percent to 45 per- 55 cent for families with three or more children. If both spouses work and earn at least $725, the credit would begin to phase out at $14,480 ($7,380 if the couple does not reside with children). For taxpayers with two or more children, the phase-out rate would be reduced from 21.06 percent to 19.06 percent. Under current law, nontaxable earned income, such as 401(k) contributions, is included in earned income for purposes of calculating the EITC. To encourage retirement savings, simplify the calculation of earned income, and improve compliance, the Administration is proposing that these nontaxable forms of income would no longer count toward eligibility for the EITC. The proposal would be effective for taxable years beginning after December 31, 1999. A proposed technical correction would clarify that taxpayers are eligible to receive the small credit for workers without qualifying children, if they cannot claim the credit for workers with children because their child does not have a social security number. The proposed change will also clarify that taxpayers may not receive any credit (even the small credit for workers without qualifying children), if their child is not taken into account because another taxpayer who may claim the child has higher modified AGI. Increase and index low-income housing tax credit per-capita cap.—Low-income housing tax credits provide an incentive to build and make available affordable rental housing units to households with low incomes. The amount of the first-year credits that can be awarded in each State is currently limited to $1.25 per capita. That limit has not been changed since it was established in 1986. The Administration proposes to increase the annual State limitation to $1.75 per capita effective for calendar year 2001 and to index that amount for inflation, beginning with calendar year 2002. The proposed increases 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 best meet specific needs. Provide New Markets Tax Credit.—Businesses located in low-income urban and rural communities often lack access to sufficient equity capital. To help attract new capital to these businesses, taxpayers would be allowed a credit against Federal income taxes for certain investments made to acquire stock or other equity interests in a community development investment entity selected by the Treasury Department to receive a credit allocation. Selected community development investment entities would be required to use the investment proceeds to provide capital to businesses located in low-income communities. During the period 20012005, the Treasury Department would authorize selected community development investment entities to issue $15 billion of new stock or equity interests with respect to which credits could be claimed. The credit would be allowed for each year during the five-year period after the stock or equity interest is acquired 56 from the selected community development investment entity, and the credit amount that could be claimed for each of the five years would equal six percent of the amount paid to acquire the stock or equity interest from the community development investment entity. The credit would be subject to current-law general business credit rules, and would be available for qualified investments made after December 31, 2000. Expand Empowerment Zone (EZ) tax incentives and authorize additional EZs.—The Omnibus Budget Reconciliation Act of 1993 (OBRA93) authorized a Federal demonstration project in which nine EZs and 95 empowerment communities were designated in a competitive application process. Among other benefits, businesses located in the nine original EZs are eligible for four Federal tax incentives: an employment wage credit; an additional $20,000 per year of section 179 expensing; a new category of tax-exempt private activity bonds; and ‘‘brownfields’’ expensing for certain environmental remediation expenses. The Taxpayer Relief Act of 1997 (TRA97) authorized the designation of two additional EZs, which generally are eligible for the same tax incentives that are available within the EZs authorized by OBRA93. In addition, TRA97 authorized the designation of another 20 EZs (so-called ‘‘Round II EZs’’) that are eligible for the same tax incentives (other than the employment wage credit) available in the 11 other EZs. To date, the EZ program has promoted significant economic development, but these communities still do not fully share in the nation’s general prosperity. Therefore, the Administration proposes that the EZ program be extended and strengthened by making the employment wage credit available in all existing 31 EZs through 2009. Furthermore, the Administration proposes that, beginning in 2001, an additional $35,000 (rather than $20,000) per year of section 179 expensing be allowed in all EZs, and that enhanced tax-exempt financing benefits for private business activities be available in all EZs. (As described below, the Administration’s budget proposes a permanent extension of the ‘‘brownfields’’ expensing for EZs and other targeted areas.) Finally, the Administration proposes that an additional 10 EZs be designated as of January 1, 2002. Businesses located within these 10 new EZs will be eligible for the full range of tax incentives available in the other EZs. Provide Better America Bonds to improve the environment.—Under current law, State and local governments may issue tax-exempt bonds to finance purely public environmental projects. Certain other environmental projects may also be financed with tax-exempt bonds, but are subject to an overall cap on privatepurpose tax-exempt bonds. The subsidy provided with tax-exempt bonds may not provide a deep enough subsidy to induce State and local governments to undertake beneficial environmental infrastructure projects. The Administration proposes to allow State and local governments (including U.S. possessions and Indian tribal governments) to issue tax credit bonds (similar ANALYTICAL PERSPECTIVES to existing Qualified Zone Academy Bonds) to finance projects to protect open spaces or otherwise to improve the environment. Significant public benefits would be provided by creating more livable urban and rural environments; creating forest preserves near urban areas; protecting water quality; rehabilitating land that has been degraded by toxic or other wastes or destruction of its ground cover; improving parks; and reestablishing wetlands. A total of $2.15 billion of bond authority would be authorized for each of the five years beginning in 2001. The Environmental Protection Agency, in consultation with other agencies, would allocate the bond authority based on competitive applications. The bonds would have a maximum maturity of 15 years and the bond issuer effectively would receive an interest-free loan for the term of the bonds. During that interval, bond holders would receive Federal income tax credits in lieu of interest. Permanently extend the expensing of brownfields remediation costs.—Under TRA97, taxpayers can elect to treat certain environmental remediation expenditures that would otherwise be chargeable to capital accounts as deductible in the year paid or incurred. The provision does not apply to expenditures paid or incurred after December 31, 2001. The Administration proposes that the provision be made permanent. 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 upon ceasing activity as a SSBIC or at any time that it disposes 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. Third, the proposal would make it easier for a SSBIC to meet the qualifying income, distribution of income, and diversification of assets tests to qualify as a tax-favored regulated investment company. 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 taxfree rollover and section 1202 provisions would be effective for sales occurring after the date of enactment. The regulated investment company provisions would be effective for taxable years beginning on or after the date of enactment. 3. 57 FEDERAL RECEIPTS Bridge the Digital Divide Encourage sponsorship of qualified zone academies and technology centers.—Under current law, State and local governments can issue qualified zone academy bonds to fund improvements in certain ‘‘qualified zone academies’’ which provide elementary or secondary education. To encourage corporations to become sponsors of such academies and technology centers, a tax credit would be provided equal to 50 percent of the amount of corporate sponsorship payments made to a qualified zone academy, or a public library or community technology center, located in (or adjacent to) a designated empowerment zone or enterprise community. The credit would be available for corporate cash contributions, but only if a credit allocation has been made with respect to the contribution by the local governmental agency with responsibility for implementing the strategic plan of the empowerment zone or enterprise community. Up to $8 million of credits could be allocated with respect to each of the existing 31 empowerment zones (and each of the 10 additional empowerment zones proposed to be designated under the Administration’s budget); and up to $2 million of credits could be allocated with respect to each of the designated enterprise communities. The credit would be subject to the current-law general business credit rules, and would be effective for sponsorship payments made after December 31, 2000. Extend and expand enhanced deduction for corporate donations of computers.—The current-law enhanced deduction for contributions of computer technology and equipment for elementary or secondary school purposes is scheduled to expire for taxable years beginning after December 31, 2000. The Administration proposes extending this provision through June 30, 2004. In addition, to promote access of all persons to computer technology and training, the enhanced deduction would be expanded to apply to contributions of computer equipment to a public library or community technology center located in a designated empowerment zone or enterprise community, or in a census tract with a poverty rate of 20 percent or more. Provide tax credit for workplace literacy, basic education, and basic computer skills training.— Under current law, employers may deduct the costs of providing workplace literacy, basic education, and basic computer skill programs to employees, but no tax credits are allowed for any employer-provided education. As a result, employers lack sufficient incentive to provide basic education programs, the benefits of which are more difficult for employers to capture through increased productivity than the benefits of jobspecific education. The Administration proposes to allow employers who provide certain workplace literacy, English literacy, basic education, or basic computer training for their eligible employees to claim a credit against Federal income taxes equal to 20 percent of the employer’s qualified expenses, up to a maximum credit of $1,050 per participating employee. Qualified education would be limited to basic instruction at or below the level of a high school degree, English literacy instruction, or basic computer skills. Eligible employees in basic education or computer training generally would not have received a high school degree or its equivalent. Instruction would be provided either by the employer, with curriculum approved by the State Adult Education Authority, or by local education agencies or other providers certified by the Department of Education. The credit would be available for taxable years beginning after December 31, 2000. Make Health Care More Affordable Assist taxpayers with long-term care needs.— Current law provides a tax deduction for certain longterm care expenses. However, the deduction does not assist with all long-term care expenses, especially the costs of informal family caregiving. The Administration proposes to provide a new long-term care tax credit of $3,000. The credit could be claimed by a taxpayer for himself or herself or for a spouse or dependent with long-term care needs. To qualify for the credit, an individual with long-term care needs must be certified by a licensed physician as being unable for at least six months to perform at least three activities of daily living without substantial assistance from another individual due to loss of functional capacity. An individual may also qualify if he or she requires substantial supervision to be protected from threats to his or her own health and safety due to severe cognitive impairment and has difficulty with one or more activities of daily living or certain other age-appropriate activities. For purposes of the proposed credit, the current-law dependency tests would be liberalized, raising the gross income limit and allowing taxpayers to use a residency test rather than a support test. The credit would be phased out in combination with the child credit and the disabled worker credit for taxpayers with 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 credit would be phased in at $1,000 in 2001, $1,500 in 2002, $2,000 in 2003, $2,500 in 2004, and $3,000 in 2005 and subsequent years. Encourage COBRA continuation coverage.—Current law provides a tax preference for employer-provided group health plans, but not for individually purchased health insurance coverage except to the extent that medical expenses exceed 7.5 percent of AGI or the individual has self-employment income. The Administration proposes to make health insurance more affordable for workers in transition and for retiring workers by providing a nonrefundable tax credit for the purchase of COBRA coverage. Individuals would receive a 25-percent tax credit for their own contributions towards COBRA coverage. The proposal would be effec- 58 tive for taxable years beginning after December 31, 2001. Provide tax credit for Medicare buy-in program.—The Administration proposes to make health insurance more affordable for older workers, retirees and displaced workers by providing a 25-percent nonrefundable tax credit for individuals purchasing health insurance through a newly created Medicare buy-in program. Under a separate proposal, all individuals at least sixty-two years of age and under sixty-five years of age, and workers displaced from their jobs who are at least fifty-five years of age and under sixty-two years of age, would be eligible to buy into Medicare. Taxpayers would be eligible for a credit of 25 percent of premiums paid under the Medicare buy-in program prior to age sixty-five. The proposal would be effective for taxable years beginning after December 31, 2001. Provide tax relief for workers with disabilities.— Under current law, disabled taxpayers may claim an itemized deduction for impairment-related work expenses. The Administration proposes to allow disabled workers to claim a $1,000 credit. This credit would help compensate people with disabilities for both formal and informal costs associated with work (e.g., personal assistance to get ready for work or special transportation). In order to be considered a worker with disabilities, a taxpayer must submit a licensed physician’s certification that the taxpayer has been unable for at least 12 months to perform at least one activity of daily living without substantial assistance from another individual. A severely disabled worker could potentially qualify for both the proposed long-term care and disabled worker tax credits. The credit would be phased out in combination with the child credit and the proposed long-term care credit for taxpayers with 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 proposal would be effective for taxable years beginning after December 31, 2000. Provide tax relief to encourage small business health plans.—Small businesses generally face higher costs in establishing and operating health plans than do larger employers. Health benefit purchasing coalitions provide an opportunity for small businesses to offer a greater choice of health plans to their workers and to purchase health insurance at a reduced cost. The formation of these coalitions, however, has been hindered by limited access to capital. The Administration proposes to establish a temporary, special tax rule in order to facilitate the formation of health benefit purchasing coalitions. The special rule would facilitate private foundation grants and loans to fund initial operating expenses of qualified coalitions by treating such grants and loans as being made for exclusively charitable purposes. The special foundation rule would apply to grants and loans made prior to January 1, 2009 ANALYTICAL PERSPECTIVES for initial operating expenses incurred prior to January 1, 2011. In addition, in order to encourage the use of qualified coalitions by small businesses, the Administration proposes a temporary tax credit for small employers that currently do not provide health insurance to their workforces. The credit would equal 20 percent of small employer contributions to employee health plans purchased through a qualified coalition. The credit would be available to employers with at least two, but not more than 50 employees, counting only employees with annual compensation of at least $10,000 in the prior calendar year. The maximum per policy credit amount would be $400 per year for individual coverage and $1,000 per year for family coverage. The credit would be allowed with respect to employer contributions made during the first 24 months that the employer purchases health insurance through a qualified coalition, and would be subject to the overall limitations of the general business credit. The proposed credit would be effective for taxable years beginning after December 31, 2000 for health plans established before January 1, 2009. Encourage development of vaccines for targeted diseases.—-The proposed tax credit would encourage development of new vaccines for diseases that occur primarily in developing countries by providing a market for successful vaccines. The proposal would provide a credit against Federal income taxes for sales of a qualifying vaccine to a qualifying organization. The credit would equal 100 percent of the amount paid by the qualifying organization. A qualifying organization would be a nonprofit organization that purchases and distributes vaccines for developing countries. A qualifying vaccine would be a vaccine for targeted diseases that receives FDA approval as a new drug after the date of enactment. The targeted diseases would include malaria, tuberculosis, HIV/AIDS, and certain other infectious diseases. The credit would be available only if a credit allocation has been made with respect to the sale of a qualifying vaccine to a qualifying organization by the U.S. Agency for International Development (AID). For the period 2002 - 2010, AID would be allowed to designate up to $1 billion of sales as eligible for the credit ($100 million per year for 2002 through 2006 and $125 million per year for 2007 through 2010). Unallocated amounts for any year would be carried over and available for allocation in the ten following years. Strengthen Families and Improve Work Incentives Provide marriage penalty relief and increase standard deduction.—Under current law, the standard deduction for single filers is estimated to be $4,500 in 2001. For married couples who file joint individual returns, the standard deduction will be $7,550, which is less than the combined amount for two single individuals. To reduce marriage penalties, the Administration proposes to increase the standard deduction for twoearner couples to double the amount of the standard 3. 59 FEDERAL RECEIPTS deduction for single filers. The increase would be phased in evenly over five years. When fully phased in, the increase (at 2001 levels) would be $1,450. In addition, beginning in 2005, the Administration proposes to increase the standard deduction by $250 for single filers, $350 for heads of household, and $500 for joint filers. 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, 2000. Increase, expand, 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 AGI of $10,000 or less) to 20 percent (for taxpayers with AGI above $28,000). The Administration believes that the maximum credit rate is too low. Moreover, because it is nonrefundable, many families who have significant child care costs and relatively low incomes are not eligible for the maximum credit. To alleviate the burden of child care costs for these families, the Administration proposes to make the credit refundable. Under the proposal, the maximum credit rate would be increased from 30 percent to 40 percent in 2003, and to 50 percent in 2005 and subsequent years. The credit would become refundable in 2003. Eligibility for the maximum credit rate would be extended to taxpayers with AGI of $30,000 or less. The credit rate would be reduced by one percentage point for every $1,000 of AGI above $30,000 but would not be less than 20 percent. Under current law, no additional tax assistance under the child and dependent care tax credit is provided to families with infants, who require intense and sustained care. Furthermore, parents who themselves care for their infants, instead of incurring out-of-pocket child care expenses, receive no benefit under the child and dependent care tax credit. In order to provide assistance to these families, the Administration proposes to supplement the credit with an additional, nonrefundable credit for all taxpayers with children under the age of one, whether or not they incur out-of-pocket child care expenses. The amount of additional credit would be the applicable credit rate multiplied by $500 for a child under the age of one ($1,000 for two or more children under the age of one). The Administration also proposes to simplify eligibility for the credit by eliminating a complicated household maintenance test. Certain credit parameters would be indexed. The proposal would be effective for taxable years beginning after December 31, 2000. Promote Expanded Retirement Savings, Security, and Portability Provide tax incentives for employer-provided child-care facilities.—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 The Administration proposes further expansions of retirement savings incentives, including initiatives that would expand retirement plan coverage and other workplace-based savings opportunities, particularly for moderate- and lower-income workers not currently covered by employer-sponsored plans. Many of the new provisions are focused on employees of small businesses, a group that currently has low pension coverage. Other proposals enhance the fairness of plans by improving existing retirement plans for employers of all sizes, increase retirement security for women, promote portability, expand workers’ and spouses’ rights to know about their retirement benefits, and simplify pension rules. These provisions generally are effective for taxable years beginning after 2000. Encourage Retirement Savings The Administration proposes two major initiatives designed to encourage retirement savings for moderateand lower-income workers. Establish Retirement Savings Accounts.—Current law tax incentives to save through Individual Retirement Accounts (IRAs) and pensions provide little impetus to saving by moderate- and lower-income workers. The Administration’s proposal would create Retirement Savings Accounts, in which participants’ voluntary contributions are matched by employers or financial institutions. The match will be provided in the form of a tax credit. Participation by financial institutions and taxpayers would be voluntary. Financial institutions could also claim a $10 tax credit to defray the administrative costs of establishing each new account. Under the proposal, eligible taxpayers would qualify for a match. Participants would make voluntary contributions to an account at a participating financial institution or employer-sponsored qualified retirement plan. Workers would receive a basic match of as much as 100 percent for up to $1,000 in contributions ($500 from 2002 to 2004). They would also qualify for a supplemental match of up to $100 for the first $100 contributed to the account. The basic match phases down to 20 percent for taxpayers with AGI in the following ranges: between $25,000 and $50,000 ($20,000 and $40,000 from 2002 to 2004) for married taxpayers filing a joint return, $18,750 to $37,500 ($15,000 to $30,000 from 2002 to 2004) for taxpayers filing a head-of-household return, and $12,500 to $25,000 ($10,000 to $20,000 from 2002 to 2004) for single taxpayers. The supplemental match phases out over the same income ranges. The 20 per- 60 ANALYTICAL PERSPECTIVES cent basic match is available for taxpayers with AGI up to $80,000 ($40,000 from 2002 to 2004) on joint returns, $60,000 ($30,000 from 2002 to 2004) on headof-household returns and $40,000 ($20,000 from 2002 to 2004) on single returns. Taxpayers with at least $5,000 in earnings (which could be joint earnings for married taxpayers filing a joint return) and aged 25 to 60 would be eligible for the match. Withdrawals for certain special purposes would be permitted after five years; withdrawals for other purposes would not be permitted until retirement. The tax treatment would be similar to that afforded deductible IRAs or contributions to employer pensions: contributions would be excludable from income, earnings would not be taxed, but withdrawals would be included in taxable income. The credits would be effective for tax years beginning after December 31, 2001. Provide small business tax credit for automatic contributions for non-highly compensated employees.—Small employers could claim a nonrefundable tax credit equal to 50 percent of qualifying contributions made on behalf of non-highly compensated employees. Qualifying contributions are nonelective contributions to defined contribution plans of at least one percent of pay and nonelective or matching contributions of up to an additional two percent of pay (for a total of three percent of pay). Alternatively, qualifying contributions could be benefits accrued under a non-integrated defined benefit plan if equivalent to a three-percent nonelective contribution (in accordance with regulations that could provide simplified methods for defined benefit plans to qualify for the credit). Contributions must be vested at least as fast as either a three-year cliff or five-year graded schedule, must be subject to withdrawal restrictions, and must be allocated in proportion to pay. Credits claimed for subsequently forfeited contributions would be subject to recapture at a rate of 35 percent. An employer could claim the credit for three years. The credit would be effective for tax years beginning after December 31, 2001 and ending on or before December 31, 2009. Expand Pension Coverage for Employees of Small Business The Administration proposes a number of other incentives to encourage the adoption of retirement plans by small employers, generally those that have 100 or fewer employees with $5,000 or more of compensation in the preceding year. Provide tax credit for plan start up and administrative expenses.—The Administration proposes a 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. The credit would be available for plans established after 1998 and before 2010. Provide for payroll deduction IRAs.—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 saving 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 salary reductions would encourage participation. Provide for the SMART plan.—In addition to tax credits for qualified retirement plans, the Administration is proposing a new small business defined benefit type plan (the ‘‘SMART’’ plan) for calendar years beginning after 2000. The SMART plan 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 the 401(k) SIMPLE plan.—The Administration proposes expanding the small business 401(k) SIMPLE plan and making it significantly more flexible without sacrificing fairness in the allocation of contributions to moderate- and lower-wage employees. The proposal would make three major changes to the existing 401(k) SIMPLE plan nonelective contribution alternative. First, non-highly compensated employees would be permitted to contribute up to $10,500 a year. Second, the employer’s options under a 401(k) SIMPLE plan would be expanded: instead of being required to make a two-percent nonelective employer contribution (with a $6,000 employee contribution limit), employers could opt to make a one-percent, two-percent, three-percent or higher nonelective employer contribution (subject to the requirement that all eligible employees receive the same rate of nonelective contribution). The one-percent 401(k) SIMPLE plan would allow highly compensated employees to contribute up to $3,000 to the plan if the employer made a non-integrated, fully vested, with- 3. FEDERAL RECEIPTS drawal-restricted one-percent automatic contribution on behalf of all employees. The proposal would not change the current-law two-percent 401(k) SIMPLE plan, with its $6,000 contribution limit, except to restrict application of the $6,000 limit to highly compensated employees, allowing others to contribute up to $10,500. In addition, as is the case under current law with the 401(k) nonelective safe harbor, an employer could make a three-percent (or greater) nonelective contribution, permitting all employees, including highly compensated ones, to contribute up to $10,500. Third, employers would have the flexibility to wait until as late as December 1 of the year for which the contribution is made to assess their financial situation for the year and decide on the level of their nonelective contribution. Eliminate IRS user fees for small business plan determination letters.—The Administration proposes the elimination of user fees for requests made after the date of enactment for an initial determination letter from the IRS for a qualified retirement plan maintained by a small business. To obtain the relief, the request must be made during the first five plan years. Permit certain S corporation shareholders and partners to borrow from plans.—S corporation shareholders and partners owning less than 20 percent of the business would be able to borrow from the employer’s qualified retirement plan in which they participate under the same rules that apply to all qualified plan participants for loans first made or refinanced after 2000. Enhance Fairness in Pension Plans The Administration proposes modifications to the vesting rules, the contribution and deduction limits, and the 401(k) safe harbor plan rules to enhance the fairness of pensions to moderate- and lower-income workers. Accelerate vesting for qualified plans.—The Administration proposes accelerating the current-law fiveyear (or seven-year graded) allowable vesting schedule for qualified retirement plans. Given the mobile nature of today’s workforce, particularly of working women, there is a significant risk that many participants will leave employment before fully vesting in their retirement benefits. Under the proposal, plans would be required to provide that an employee would be fully vested after completing three years of service or would vest in annual 20 percent increments beginning after one year of service. In addition, time off under the Family and Medical Leave Act (FMLA) of up to 12 weeks of unpaid leave to care for a new child, to care for a family member who has a serious health condition, or because the worker has a serious health condition would be included in service for determining retirement plan vesting and eligibility to participate in the plan. Modify contribution and annual addition limitations.—The deduction limits for profit sharing plans 61 and the percentage-of-pay limitations of defined contribution plans would be liberalized to ensure that nonhighly compensated employees’ benefits are not inappropriately limited. The general 15-percent deduction limit for stock bonus and profit sharing plans would be increased by the amount of elective contributions on behalf of non-highly compensated employees participating in the plan that exceed, in the aggregate, 15 percent of compensation otherwise paid or accrued on behalf of such non-highly compensated employees. For purposes of determining the employer’s deduction under the combined plan limit that applies when an employer has both a pension plan and a stock bonus or profit sharing plan in which the same employee participates, elective contributions on behalf of non-highly compensated employees would be disregarded. In addition, the 15-percent-of-compensation deduction limit would be further liberalized by treating certain salary reduction amounts as compensation in determining the deduction limits. The proposal also would increase the maximum allowable annual addition for defined contribution plans from 25 percent to 35 percent of compensation. Expand coverage of non-highly compensated employees under 401(k) safe harbor plans.—The Administration would modify the section 401(k) matching formula safe harbor by requiring that, in addition to the matching contribution, either (1) the employer make a contribution of one percent of compensation for each eligible non-highly compensated employee, regardless of whether the employee makes elective contributions, or (2) the plan provide for current and newly hired employees to be automatically enrolled in the 401(k) plan at a three-percent contribution rate (where employees can elect other rates, including zero contribution). The proposal would also permit nonelective contributions to replace matching contributions in the 401(k) matching formula safe harbor. Simplify the definition of highly compensated employee.—The Administration proposes to simplify the definition of highly compensated employee by eliminating the top-paid group election. Under the simplified definition, an employee would be treated as highly compensated if the employee (1) was a five-percent owner at any time during the year or the preceding year, or (2) had compensation in excess of $80,000 (as adjusted) for the preceding year. Clarify the division of Section 457 assets upon divorce.—To make consistent the treatment of retirement benefits upon divorce, the Administration proposes to extend to section 457(b) plans the qualified domestic relations order (QDRO) regime that applies to distributions from a qualified plan made to a spouse, former spouse or alternate payee. Accordingly, the proposal would not tax the employee on distributions from a section 457(b) plan made to an alternate payee pursuant to a QDRO and also clarifies that a section 457(b) 62 ANALYTICAL PERSPECTIVES plan will not be treated as violating the restrictions on distributions when it honors the terms of a QDRO. Offer joint and 75-percent survivor annuity option.—Current law requires certain pension plans to offer to pay pension benefits as a joint and survivor annuity; frequently, the benefit for the surviving spouse is reduced to 50 percent of the monthly benefit paid when both spouses were alive. Under the proposal, plans that are subject to the joint and survivor annuity rules would be required to offer an option that pays a survivor benefit equal to at least 75 percent of the benefit the couple received while both were alive. This option would be especially helpful to women because they tend to live longer than men and because many aged widows have incomes below the poverty level. Promote Retirement Savings Portability The Administration proposes significant changes to promote the portability and encourage the preservation of retirement savings. Encourage pension asset preservation by default rollover to IRA.—The direct rollover rules would be modified to encourage preservation of retirement assets by making a direct rollover the default option for eligible rollover distributions from a qualified retirement plan, section 403(b) annuity or governmental section 457(b) plan. The new rule would apply where a participant is entitled to an eligible rollover distribution from a qualified retirement plan, 403(b) annuity or governmental section 457(b) plan, the distribution is greater than $1,000, and the distribution is subject to nonconsensual cashout under the plan (i.e, does not exceed $5,000 or is made after normal retirement age). In these circumstances, the distribution would be required to be directly rolled over to an eligible retirement plan (including an IRA), unless the participant affirmatively elects to receive the distribution in cash. For convenience, the rollover IRA could be designated when the employee becomes a participant in the plan; alternatively, it could be designated at termination of employment. If the participant fails to designate a rollover plan or IRA and does not affirmatively elect to receive the distribution in cash, then involuntary cashout amounts could be transferred to an IRA designated by the payor (for the benefit of the participant) or, at the election of the plan sponsor, retained in the plan. Expand permitted rollovers of employer-provided retirement savings.—Under current law, rollovers are not allowed between qualified retirement plans, section 403(b) tax-sheltered annuities and governmental section 457(b) plans. The Administration proposes that an eligible rollover distribution from a qualified retirement plan, a section 403(b) tax-sheltered annuity, or a governmental section 457(b) plan could be rolled over to a traditional IRA, a qualified retirement plan, a section 403(b) annuity, or a governmental section 457(b) plan. Amounts distributed from a governmental section 457(b) plan would be subject to the early withdrawal tax to the extent the distribution consists of amounts attributable to rollovers from another type of plan. A governmental section 457(b) plan would be required to separately account for such amounts. To facilitate the preservation of the retirement savings of participants in governmental section 457(b) plans and to rationalize the treatment of different types of broad-based retirement plans, the Administration also proposes to extend the direct rollover and withholding rules to governmental section 457(b) plans. These plans, like qualified plans, would be required to provide written notification to participants regarding eligible rollover distributions (but would not be required to accept rollovers). Finally, the proposal would allow eligible rollover distributions to be rolled over from a qualified trust sponsored by a previous employer to a Federal employee’s Thrift Savings Plan (TSP) account. Permit consolidation of retirement savings.—The Administration’s proposal would allow individuals to consolidate their IRA funds and their workplace retirement savings in a single fund. Individuals who have IRAs with deductible IRA contributions would be permitted to transfer funds from their IRAs to their qualified defined contribution retirement plan, 403(b) taxsheltered annuity or governmental section 457(b) plan, provided that the retirement plan trustee could qualify as an IRA trustee. In addition, the proposal would allow individuals to roll over after-tax IRA or employer plan contributions to their new employer’s defined contribution plan or to an IRA if the plan or IRA provider agrees to track and report the after-tax portion of the rollover for the individual. Finally, surviving spouses would be permitted to roll over distributions to a qualified plan, 403(b) annuity or governmental section 457(b) plan. Allow purchase of service credits in governmental defined benefit plans.—Employees of State and local governments, particularly teachers, often move between states and school districts in the course of their careers. Under State law, they often can purchase service credits in their State defined benefit pension plans for time spent in another state or district and earn a pension reflecting a full career of employment in the state in which they conclude their career. Under current law, these employees cannot make a taxfree transfer of the money they have saved in their 403(b) plan or governmental 457(b) plan to purchase these credits and often lack other resources to use for this purpose. Under the proposal, State and local government employees would be able to use funds from these retirement savings plans to purchase service credits through a direct transfer without first having to take a taxable distribution of these amounts. Allow immediate participation in Federal Thrift Savings Plan (TSP).—Under the Administration’s proposal, all waiting periods for Federal employees’ participation in TSP (including matching and nonelective 3. FEDERAL RECEIPTS contributions) would be eliminated for new hires and rehires. Improve Pension Security The Administration proposes a number of changes to improve pension security in defined benefit plans. Modify pension plan deduction rules.—For defined benefit plans, the change in the full funding limitation based on current liability would be phased in more quickly, so that this limitation would be 170 percent of current liability for years beginning after December 31, 2003. In addition, the ten-percent excise tax on nondeductible contributions would not apply to the extent a contribution is nondeductible solely as a result of the current liability full funding limit. The special deduction rule for terminating plans would be modified so that, at plan termination, all contributions needed to satisfy the plan’s liabilities would be immediately deductible. In the case of a plan with fewer than 100 participants, liabilities attributable to recent benefit increases for highly compensated employees would be disregarded for this purpose. Simplify full funding limitation for multiemployer plans.—The limit on deductible contributions based on a specified percentage of current liability would be eliminated for multiemployer defined benefit plans. Therefore, the annual deduction for contributions to such a plan would be limited to the amount by which the plan’s accrued liability exceeds the value of the plan’s assets. Modify defined benefit limit rules for multiemployer plans.—Defined benefit limits applicable to multiemployer defined benefit plans would be modified to eliminate the 100-percent-of-compensation limit (but not the $135,000 limit) for such plans. In addition, the special early retirement provisions for determining the defined benefit limit that currently apply to defined benefit plans sponsored by governments, tax-exempt organizations and merchant marine would be expanded to include multiemployer plans. Finally, the rule requiring aggregation of benefits provided from a single employer for purposes of the defined benefit limit would be modified so as not to require aggregation of a multiemployer defined benefit plan and a single employer defined benefit plan for purposes of the 100-percentof-compensation limit. Increase Disclosure and Right to Know The Administration proposes to improve disclosure to workers and their spouses. Improve disclosure for plan amendments that significantly reduce future benefit accruals.—The Administration’s proposal would strengthen the existing disclosure requirements that apply when a pension plan is amended to significantly reduce the rate of future benefit accrual. The proposal would require that the notice summarize the important terms of the amend- 63 ment, including identification of the effective date of the amendment, a statement that the amendment is expected to significantly reduce the rate of future benefit accrual, a general description of how the amendment significantly reduces the rate of future benefit accrual, and a description of the class or classes of participants to whom the amendment applies. Participants must receive the notice at least 45 days before the effective date of the plan amendment. If the plan has at least 100 active participants, the plan administrator would also be required to provide affected participants an enhanced advance notice of the amendment that describes, and illustrates using specific examples, the impact of the amendment on representative affected participants; to make available the formulas and factors used in those examples in order to permit similar calculations to be made; and to make available a followup individualized benefit statement estimating the participant’s projected retirement benefits. Regulations could exempt certain amendments, such as amendments that do not make a fundamental change in a plan’s formula. Pension ‘‘right-to-know’’ proposals.—The Administration’s proposal would enhance workers’ and spouses’ rights to know about their pension benefits by, 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. Provide AMT Relief for Families and Simplify the Tax Laws Provide adjustments for personal exemptions and the standard deduction in the individual alternative minimum tax (AMT).—The Administration is concerned that the AMT imposes financial and compliance burdens upon taxpayers that have few preference items and were not the originally intended targets. In particular, the Administration is concerned that the individual AMT may act to erode the benefits of dependent personal exemptions and standard deductions that are intended to provide relief for middleincome taxpayers—especially those with larger families. For example, under current law, a couple with five children and $70,000 of income that claims the standard deduction would be subject to the AMT in 2000. In response, the Administration proposes to phase out the tax preference status of dependent exemptions under the AMT; that is, when fully phased in, claiming children as personal exemptions on a tax return would not cause a taxpayer to be subject to the AMT. For tax years 2000 through 2007, only the first two dependent exemptions would be AMT preference items; in 2008 and 2009, only the first exemption would be a preference; in 2010 and thereafter, dependent exemptions would no longer be treated as an AMT preference. The Administration also proposes to allow taxpayers who claim the standard deduction for regular income tax purposes to claim the same standard deduction for AMT purposes for tax years 2000 and 2001. That provi- 64 sion would complement the provision enacted in 1999 that allows the use of personal credits against the AMT through 2001. Simplify and increase standard deduction for dependent filers.—Currently, the standard deduction for tax filers who can be claimed as dependents by another taxpayer is the smaller of the standard deduction for single taxpayers ($4,400 for tax year 2000) or the special standard deduction for dependent filers. The special standard deduction is the larger of (1) $700 (for tax year 2000) or (2) the individual’s earned income plus $250 (for tax year 2000). The current provision requires dependents to file a tax return if they have at least $250 of interest and dividends from their savings and their earnings plus income from savings is at least $700. To simplify the standard deduction and increase it for dependent filers, the Administration proposes that, beginning in 2000, the standard deduction for dependent filers would be the individual’s earned income plus $700 (indexed after 2000), but not more than the regular standard deduction. This proposal would reduce the number of dependent filers required to file a tax return by 400,000 and simplify filing for other dependents with earned income. Replace support test with residency test (limited to children).—Under current law, taxpayers must provide over half the support of individuals claimed as dependents on their tax return. Under the proposal, taxpayers would be allowed to claim their children as dependents by meeting a residency test instead of a support test. If the child is 18 or younger (23 or younger if a full-time student) and is the taxpayer’s son, daughter, stepchild, or grandchild, then the support test may be waived if the taxpayer lives with the child for over half the year. A twelve-month test would apply to foster children. If more than one taxpayer could claim the child as a dependent under the proposed rule, the taxpayer with the highest AGI would be entitled to the dependency exemption. The proposal would be effective for taxable years beginning after December 31, 2000. Index maximum exclusion for capital gains on sale of principal residence.—Under current law, taxpayers can generally exclude up to $250,000 ($500,000 for married taxpayers filing joint returns) of gain on the sale of a principal residence. To be eligible for the full exclusion, the taxpayer must have owned the residence and occupied it as a principal residence for at least two of the five years preceding the sale. A taxpayer may claim the deduction only once in any twoyear period. Under the proposal, the maximum exclusion amounts would be indexed for inflation effective January 1, 2001. The proposal will prevent inflation from subjecting more taxpayers to tax when they sell their homes, and will prevent more taxpayers from having to maintain complex records regarding the cost of their homes. ANALYTICAL PERSPECTIVES Provide tax credit to encourage electronic filing of individual income tax returns.—Under current law, tax return preparation costs of individuals, including any costs of electronic filing, may be deducted only by taxpayers who itemize deductions and then only to the extent that such costs, in combination with most other miscellaneous itemized deductions, exceed two percent of AGI. The proposal would provide a temporary, refundable tax credit for the electronic filing of individual income tax returns. The credit would be for tax years 2001 through 2006 and would be $10 for each electronically filed return, and $5 for each TeleFile return (which are filed by entering information through the keypads of telephones). The credit would encourage taxpayers to try electronic return or Telefile submission, which reduces taxpayer errors and the need for subsequent contacts between the taxpayer and the IRS and which permits taxpayers to receive their tax refunds faster. The credit would help the IRS achieve the goal set in the 1998 IRS Restructuring and Reform Act of having 80 percent of 2006 returns filed electronically. No later than tax year 2002, the IRS would be required to offer one or more options to the public, through contract arrangements with the private sector, for preparing and filing individual income tax returns over the Internet at no cost to the taxpayer. Clarify the tax treatment of disabled workers in a sheltered workshop.—The Administration’s proposal would provide a limited exclusion from the definition of ‘‘employment’’ for certain services rendered by disabled individuals in a sheltered workshop program effective the date of enactment. The exclusion would be limited to service (1) performed for a period of no more than 18 months under a minimum wage exemption certificate issued by the Department of Labor and (2) provided in a sheltered workshop operated by a section 501(c)(3) organization or a State or local government. However, organizations could voluntarily agree to provide coverage, pursuant to an agreement with the Social Security Administration. Corresponding changes would be made to the Social Security Act. Simplify, retarget and expand expensing for small business.—In place of depreciation, a taxpayer with a sufficiently small amount of annual investment may elect to deduct up to $20,000 of the cost of qualifying property (generally depreciable tangible property) placed in service in taxable year 2000. The deductible amount rises to $24,000 in 2001 and 2002, and to $25,000 in 2003 and subsequent taxable years. The Administration proposes to increase the amount of investment that can be expensed to $25,000 in taxable year 2001; thereafter, this amount would be increased for inflation in increments of $1,000. In addition, the Administration proposes certain modifications to better target the applicability of expensing, to allow the deduction to be claimed at the entity level for flow-through businesses, and to make certain computer software eligible for expensing. 3. FEDERAL RECEIPTS 65 Provide 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 selfemployed individuals. The proposal would be effective for taxable years beginning after December 31, 2000. tributions 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 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. Clarify rules relating to certain disclaimers.— Under current law, if a person refuses to accept (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 effective for income tax purposes. The proposal would apply to disclaimers made after the date of enactment. Expand declaratory judgment remedy for noncharitable organizations seeking determinations of tax-exempt status. —Under current law, organizations seeking tax-exempt status as charities are allowed to seek a declaratory judgment as to their tax status if their application is denied or delayed by the IRS. A noncharity (an organization not described in section 501(c)(3)) that applies to the IRS for recognition of its tax-exempt status faces potential tax liability if its application ultimately is denied by the IRS. This creates uncertainty for the noncharity, particularly when the IRS determination is delayed for a significant period of time. To reduce this uncertainty, the declaratory judgment procedure available to charities under current-law section 7428 would be expanded, so that if the application of any organization seeking tax-exempt status under section 501(c) is pending with the IRS for more than 270 days, and the organization has exhausted all administrative remedies available within the IRS, then the organization could seek a declaratory judgment as to its tax-exempt status from the United States Tax Court. The proposal would be effective for applications for recognition of tax-exempt status filed after December 31, 2000. Simplify the foreign tax credit limitation for dividends from 10/50 companies.—TRA97 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 ‘‘lookthrough’’ 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 the application of the foreign tax credit limitation significantly 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, 1999. Provide interest treatment for dividends paid by certain 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 dis- Simplify the active trade or business requirement for tax-free spin-offs.—In order to satisfy the active trade or business requirement for tax-free spinoffs, split-offs, and split-ups, the distributing corporation and the controlled corporation both must be engaged in the active conduct of a trade or business. If a corporation is not itself active, it may satisfy the active trade or business test indirectly, but only if substantially all of its assets consist of stock and securities of a controlled corporation that is engaged in an active trade or business. Because the substantially all standard is much higher than that required if the corporation is active itself, a taxpayer often must engage in predistribution restructurings that it otherwise would not have undertaken. There is no clear policy reason that the standards for meeting the active trade or business requirement should differ depending upon whether a corporation is considered to be active on a direct or indirect basis. Therefore, the Administration proposes to simplify the requirement by removing the substantially all test and generally allowing an affiliated group to satisfy the active trade or business requirement as long as the affiliated group, taken as a whole, is considered active. This proposal would be effective for transactions after the date of enactment. 66 Modify translation of foreign withholding taxes by accrual basis taxpayers.—Under current law, taxpayers who take foreign income taxes into account when accrued generally are required to translate such taxes into dollars by using the average exchange rate for the taxable year to which such taxes relate. This rule was intended to be a simplification measure that would reduce the need for accrual basis taxpayers to redetermine the amount of foreign tax credits claimed with respect to foreign taxes accrued prior to the date of payment. This rule may not clearly reflect income, however, in the case of foreign withholding taxes paid by an accrual basis taxpayer, because such taxes are never accrued prior to the date the tax is paid (regardless of the taxpayer’s method of accounting). Moreover, certain taxpayers that receive income subject to withholding taxes (such as regulated investment companies with a taxable year that differs from the calendar year) may find it impossible to comply with current law. The proposal would provide that foreign withholding taxes are to be translated at the spot rate on the date of payment, regardless of the method of accounting of the taxpayer. The proposal would be effective for taxable years beginning after the date of enactment. Eliminate duplicate penalties for failure to file annual reports.—Employer penalties for failure to file an annual report would be simplified by eliminating the Internal Revenue Code penalties for a plan to which ERISA applies. Certain other ERISA reporting penalties would be modified or eliminated. Clarify foreign tax credit rules to provide the circumstances under which a domestic corporation that owns a foreign corporation through a partnership will be eligible for the deemed-paid credit.—A domestic corporation that is a U.S. shareholder of a controlled foreign corporation (CFC) can claim deemed-paid foreign tax credits with respect to foreign taxes paid by the CFC on the subpart F income that the U.S. shareholder currently includes in income to the same extent that it would be so allowed if the subpart F inclusion were treated as an actual dividend distribution. To be eligible for the deemed-paid credit on an actual dividend distribution, a domestic corporation must own 10% or more of the voting stock of the foreign corporation from which it receives the dividend. Under current law, it is not clear how to apply the deemed-paid foreign tax credit rules when a foreign corporation is owned through a partnership. The proposal would provide that the deemed-paid credit is available to a domestic corporation that, through a partnership, owns 10% or more of the voting stock of a foreign corporation from which it receives its proportionate share of dividend income. This rule would apply to both foreign and U.S. partnerships. For purposes of this provision, a foreign partnership would be treated as a tier under the rule that allows the deemed-paid credit only with respect to taxes paid by foreign corporations that are not below the sixth tier. ANALYTICAL PERSPECTIVES Encourage Philanthropy Allow deduction for charitable contributions by non-itemizing taxpayers.—To provide an incentive for taxpayers who use the standard deduction to make large charitable contributions, the Administration proposes a deduction for substantial charitable contributions made by taxpayers who do not itemize their deductions. Under current law, individual taxpayers who itemize their deductions generally may claim a deduction (subject to certain percentage limitations) for contributions made to qualified charitable organizations. However, individual taxpayers who elect the standard deduction (so-called ‘‘non-itemizers’’) may not claim a deduction for charitable contributions, although the standard deduction theoretically includes an allowance for moderate amounts of charitable giving. The proposal would allow taxpayers who are non-itemizers to deduct 50 percent of their charitable contributions in excess of $1,000 ($2,000 for married taxpayers filing jointly) for taxable years beginning after December 31, 2000 and before January 1, 2006. For taxable years beginning after December 31, 2005, non-itemizers would be allowed to deduct 50 percent of their charitable contributions in excess of $500 ($1,000 for married taxpayers filing jointly). Simplify and reduce the excise tax on foundation investment income.—Under current law, private foundations generally are subject to a two-percent excise tax on their net investment income. In some cases, the excise tax rate is reduced to one percent, provided that current-year grantmaking by the foundation is determined under a complex formula to not fall below the average level of the foundation’s grantmaking in the five preceding taxable years (with certain adjustments). This complex formula creates a perverse incentive for foundations not to significantly increase their grantmaking for charitable purposes in any particular year, because if a foundation does so, it becomes more difficult for the foundation to qualify for the reduced one-percent excise tax rate in subsequent years. Accordingly, the Administration proposes that the excise tax on private foundation investment income be simplified by reducing the general two-percent excise tax rate to a 1.25-percent excise tax rate that would apply in all cases. The complex formula for determining whether a foundation is maintaining its historic level of charitable grantmaking, and the special excise tax rate available to only some foundations, would be repealed. Thus, private foundations would not suffer adverse excise tax consequences if they respond to charitable needs by significantly increasing their grantmaking in a particular year. The proposal would be effective for taxable years beginning after December 31, 2000. Increase limit on charitable donations of appreciated property.—Under current law, charitable contributions made by individuals who do not claim the standard deduction are deductible for income tax purposes, up to certain limits depending on the type of 3. 67 FEDERAL RECEIPTS property donated and whether the donee organization qualifies as a public charity or private foundation. Contributions made by an individual to a public charity generally are deductible in an amount not exceeding 50 percent of the individual’s AGI for the current year (with any remaining amount carried over for up to five taxable years). In the case of contributions made by an individual to a private foundation, a 30-percent AGI limitation generally applies. However, in the case of donated stock and other non-cash contributions, a 30percent AGI limitation applies to gifts to public charities, and a 20-percent AGI limitation applies to gifts to private foundations. These special contribution limits for non-cash gifts create unnecessary complexity and could discourage gifts of valuable or unique property to charitable organizations. Therefore, the Administration proposes that the special contribution limits for non-cash gifts be repealed, effective for contributions made after December 31, 2000. Clarify public charity status of donor advised funds.—-In recent years, there has been an explosive growth in so-called ‘‘donor advised funds’’ maintained by charitable corporations. These funds generally permit a donor to claim a current charitable contribution deduction for amounts contributed to a charity and to provide ongoing advice regarding the investment or distribution of such amounts, which are maintained by the charity in a separate fund or account. In the absence of clear guidelines, donor advised funds potentially may be used to provide donors with the benefits normally associated with private foundations (such as control over grantmaking), without the regulatory safeguards that apply to private foundations. Therefore, the Administration proposes that current-law rules be clarified so that a charitable corporation which, as its primary activity, operates donor advised funds may qualify as a publicly supported organization only if: (1) there is no material restriction or condition that prevents the corporation from freely and effectively employing the contributed assets in furtherance of its exempt purposes; (2) distributions from donor advised funds are made only to public charities (or private operating foundations); and (3) the corporation distributes annually for charitable purposes an amount equal to at least five percent of the fair market value of the corporation’s aggregate investment assets. The proposal also would clarify that, for purposes of the section 4958 excise tax on certain excess benefit transactions, a person who provides advice with respect to a particular donor advised fund maintained by a public charity is treated as having substantial influence with respect to that particular fund. 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 equip- ment. 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, and natural gas heat pumps. The credit would equal 20 percent of the amount of qualified investment, subject to caps of $500 per kilowatt for fuel cells, $500 per unit for electric heat pump water heaters, and $1,000 per unit for natural gas heat pumps. The credit would be available for the four-year period beginning January 1, 2001 and ending December 31, 2004. Provide tax credit for 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 $1,000 or $2,000 depending upon the home’s energy efficiency. The $1,000 credit would be available for homes purchased between January 1, 2001 and December 31, 2003 that reduce energy usage by at least 30 percent relative to the standard under the 1998 International Energy Conservation Code (IECC). The $2,000 credit would be available for homes purchased between January 1, 2001 and December 31, 2005 that reduce energy usage by at least 50 percent relative to the IECC standard. Transportation Extend electric vehicle tax credit and provide tax credit for hybrid vehicles.—Under current law, a 10-percent tax credit up to $4,000 is provided for the cost of a qualified electric vehicle. The full amount of the credit is available for purchases prior to 2002. The credit begins to phase down in 2002 and is not available after 2004. The Administration proposes to extend the present $4,000 credit through 2006 and to allow the full amount of the credit to be available for qualified electric vehicles through 2006. The Administration also proposes to provide a tax credit of up to $3,000 for purchases of a qualified hybrid vehicle after December 31, 2002 and before January 1, 2007. A qualified hybrid vehicle is a road vehicle that can draw propulsion energy from both of the following on-board sources of stored energy: a consumable fuel and a rechargeable battery. The amount of the credit would depend upon the vehicle’s design performance. The credit would be available for all qualifying light vehicles including cars, minivans, sport utility vehicles, and light trucks. Industry Provide 15-year depreciable life for distributed power property.—Distributed power technologies can be more energy efficient and generate fewer greenhouse gases than conventional generation methods. To promote the use of these technologies, the Administration proposes to simplify and rationalize the current system for assigning cost recovery periods to certain depre- 68 ANALYTICAL PERSPECTIVES ciable property by assigning a single 15-year recovery period to qualifying distributed power property. Distributed power property would include depreciable assets used by a taxpayer to produce electricity for use in a nonresidential or residential building that is used in the taxpayer’s trade or business. Such property also would include depreciable assets used to generate electricity for primary use in an industrial manufacturer’s process or plant activity, provided such assets had a rated total capacity in excess of 500 kilowatts. Qualifying property could be used to produce thermal energy or mechanical power for use in a heating or cooling application. However, at least 40 percent of the total useful energy produced in a commercial or residential setting must consist of electrical power. When used in an industrial setting, at least 40 percent of produced energy must be used in the taxpayer’s manufacturing process or plant activity. In addition, a taxpayer would be required to have a reasonable expectation that no more than 50 percent of the produced electricity would be sold to, or used by, unrelated persons. The proposal would apply to assets placed in service after the date of enactment. Clean Energy Sources Extend and modify the tax credit for producing electricity from certain sources.—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 January 1, 2002, after which it expires. The Administration proposes to extend the current credit for wind and closed-loop biomass for two and one-half years, to facilities placed in service before July 1, 2004, and to expand eligible biomass to include certain biomass from forest-related resources, agricultural sources and other sources for facilities placed in service after December 31, 2000 and before January 1, 2006. Biomass facilities that were placed in service before July 1, 1999 would be eligible for a credit of 1.0 cent per kilowatt hour for electricity produced from the newly eligible sources from January 1, 2001 through December 31, 2003. A 0.5-cent-per-kilowatt-hour tax credit would also be allowed for cofiring biomass in coal plants from January 1, 2001 through December 31, 2005. In addition, electricity produced from methane from certain facilities would be eligible for the following credits: (1) 1.5 cent per kilowatt hour for methane produced from landfills not subject to EPA’s 1996 New Source Performance Standards/Emissions Guidelines (NSPS/EG), or (2) 1.0 cent per kilowatt hour for methane produced from landfills subject to NSPS/EG. The credit would apply to facilities placed in service after December 31, 2000 and before January 1, 2006. Provide tax credit for solar energy systems.—Current law provides a 10-percent business energy invest- ment tax credit for qualifying equipment that uses 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 a new tax credit for purchasers of roof-top photovoltaic systems and solar water heating systems located on or adjacent to the building for uses other than heating swimming pools. 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. The credit would apply only to equipment placed in service after December 31, 2000 and before January 1, 2006 for solar water heating systems, and after December 31, 2000 and before January 1, 2008 for rooftop photovoltaic systems. (Taxpayers would choose between the proposed tax credit and the current-law tax credit for each investment.) Electricity Restructuring Revise tax-exempt bond rules for electric power facilities.—To encourage restructuring the nation’s electric power industry so that consumers benefit from competition, rules relating to the use of tax-exempt bonds to finance electric power facilities would be modified. To encourage public power systems to implement retail competition, outstanding bonds issued to finance transmission facilities would continue their tax-exempt status if private use resulted from allowing nondiscriminatory open access to those facilities. Outstanding bonds issued to finance generation or distribution facilities would continue their tax-exempt status if the issuer implements retail competition. To support fair competition within the restructured industry, interest on newly issued bonds to finance electric generation or transmission facilities would not be exempt. Distribution facilities could continue to be financed with tax-exempt bonds. These changes would be effective upon enactment. Modify taxation of contributions to nuclear decommissioning funds.—Under current law, deductible contributions to nuclear decommissioning funds are limited to the amount included in the taxpayer’s cost of service for ratemaking purposes. For deregulated utilities, this limitation may result in the denial of any deduction for contributions to a nuclear decommissioning fund. The Administration proposes to repeal the limitation for taxable years beginning after December 31, 2000. As under current law, deductible contributions would not be permitted to exceed the amount the IRS determines to be necessary to provide for level funding of an amount equal to the taxpayer’s decommissioning costs. Modify International Trade Provisions Extend and modify Puerto Rico economic-activity tax credit.—The Puerto Rico and possessions tax credit was repealed in 1996. However, both the incomebased credit and the economic-activity-based credit remain available for certain business operations con- 3. 69 FEDERAL RECEIPTS ducted in taxable years beginning before January 1, 2006, subject to base-period caps. To provide a more efficient tax incentive for the economic development of Puerto Rico and to continue the shift from an incomebased credit to an economic-activity-based credit that was begun in 1993, the proposal would modify the phase-out of the economic-activity-based credit for Puerto Rico by (1) opening it to newly established business operations during the phase-out period, effective for taxable years beginning after December 31, 1999, and (2) extending the phase-out period through taxable years beginning before January 1, 2009. 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 September 30, 2001, through June 30, 2004. The Administration also is proposing to: (1) enhance trade benefits, through December 31, 2010, for subsaharan African countries undertaking strong economic reforms; (2) grant, through September 30, 2004, duty-free treatment to certain imports from the Southeast Europe countries and territories of Albania, Bosnia and Herzegovina, Bulgaria, Croatia, the Former Yugoslav Republic of Macedonia, Romania, Slovenia, Kosovo and Montenegro; and (3) provide, through December 31, 2004, expanded trade benefits mainly on textiles and apparel to Caribbean Basin countries that meet new eligibility criteria. These proposals will help Caribbean Basin countries prepare for a future free trade agreement with the United States and respond to the effects of Hurricanes George and Mitch, and will help the countries of Southeast Europe rebuild and reintegrate their economies and work toward achieving lasting political stability in the region. Levy tariff on certain textiles and apparel products produced in the Commonwealth of the Northern Mariana Islands (CNMI).—The Administration is proposing a tariff on textile and apparel products that are 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. Miscellaneous Provisions Make first $2,000 of severance pay exempt from income tax.—Under current law, payments received by 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 equal to 95 percent of his or her prior compensation. Third, the total severance payments received by the employee must not exceed $75,000. The exclusion would be effective for severance pay received in taxable years beginning after December 31, 2000 and before January 1, 2004. Exempt Holocaust reparations from Federal income tax.—The Internal Revenue Code defines gross income as ‘‘gross income from whatever source derived,’’ except for certain items specifically exempt or excluded by statute. Although the United States - Federal Republic of Germany Income Tax Convention and a series of rulings issued by the IRS provide that certain Holocaust-related reparations are exempt from Federal income tax, there is no explicit statutory exception from gross income for amounts received by Holocaust victims or their heirs. In recent years, several countries and companies within those countries have acknowledged that they have not made adequate compensation or restitution to victims or their heirs for the deprivations inflicted upon them during the Nazi Holocaust, and have agreed to establish funds or to make direct payments of cash or property to such individuals. To provide clarity and relief for Holocaust victims and their families, the Administration proposes a statutory exemption from gross income for any amount received by an individual or heir of an individual from Holocaust-related funds and settlements, including in compensation for or recovery of property confiscated in connection with the Holocaust. The proposal would be effective for amounts received on or after January 1, 2000. No inference is intended as to the tax treatment of amounts received prior to that date. ELIMINATE UNWARRANTED BENEFITS AND ADOPT OTHER REVENUE MEASURES The President’s plan closes tax shelters and other loopholes, curtails unwarranted corporate tax subsidies, improves tax compliance and adopts other revenue measures. Limit Benefits of Corporate Tax Shelter Transactions The Administration continues to be concerned about the use and proliferation of corporate tax shelters and their effect upon both the corporate tax base and the integrity of the tax system as a whole. The primary goals of corporate tax shelters are to manufacture tax benefits that can be used to offset unrelated income of the taxpayer or to create tax-favored or tax-exempt economic income. The growing use of corporate tax shelters was further described by the Treasury Department in its White Paper entitled, The Problem of Corporate Tax Shelters: Discussion, Analysis and Legislative Proposals, issued in July 1999. The paper concludes that corporate tax shelters are best addressed by increasing disclosure of corporate tax shelter activities, increasing and strengthening the substantial understatement penalty, codifying the judicially-created economic substance doctrine, and providing consequences to all parties to the transaction 70 (e.g., promoters, advisors, and tax-indifferent, accommodating parties.) The Administration proposes several general remedies to curb the growth of corporate tax shelters that focus on these four themes. In addition, the Administration proposes to modify the treatment of certain specific transactions that provide sheltering potential. No inference is intended as to the treatment of any of these transactions under current law. Increase disclosure of certain transactions.— Greater disclosure of corporate tax shelter transactions will discourage some corporations from engaging in such activity and would aid the IRS in identifying questionable transactions and enforcing current law. The Administration proposes to require disclosure of certain reportable transactions. Disclosure would be required if a transaction possesses certain objective characteristics common to corporate tax shelter transactions. Disclosure would be made on a short form or statement that provides the essence of the transaction, is filed with the IRS National Office and with the tax return by the due date of the return, and is signed by a corporate officer with the appropriate knowledge of the transaction. Significant monetary and procedural remedies would be imposed upon failure to provide the required disclosure. The proposal would be effective for transactions entered into after the date of first committee action. Modify substantial understatement penalty for corporate tax shelters.—The current 20-percent substantial understatement penalty imposed on corporate tax shelter items can be avoided if the corporate taxpayer had reasonable cause for the tax treatment of the item and acted in good faith. In order to change the cost-benefit analysis of entering a corporate tax shelter, the Administration proposes to increase the substantial understatement penalty on corporate tax shelter items to 40 percent. In order to encourage disclosure, the penalty will be reduced to 20 percent if the corporate taxpayer provides the requisite disclosure of the transaction. The 20-percent penalty for disclosed transactions could be avoided by a showing that the taxpayer reasonably believed that it had a strong chance of sustaining its tax position and acted in good faith. The proposal would be effective for transactions entered into after the date of first committee action. Codify the economic substance doctrine.—The ‘‘economic substance’’ doctrine is a longstanding, judicially-created standard providing that in order for a transaction to be respected for tax purposes, it must be imbued with economic substance. The economic substance doctrine requires an analysis and balancing of the claimed tax benefits from a transaction with the pre-tax profit of the transaction. The Administration proposes codifying the economic substance standard. Under the proposal, a transaction will not be respected for tax purposes if the present value of the expected economic profit from the transaction is insignificant ANALYTICAL PERSPECTIVES compared to the present value of the expected tax benefits. Similar rules would apply to financing transactions. The proposal would apply to transactions entered into on or after the date of first committee action. Tax income from corporate tax shelters involving tax-indifferent parties.—The Federal income tax system has many participants who are indifferent to tax consequences (e.g., foreign persons, tax-exempt organizations, and Native American tribal organizations). Many corporate tax shelters rely on tax-indifferent participants who absorb taxable income generated by the shelters so that corresponding losses or deductions can be allocated to taxable participants. The proposal would provide that any income received by a tax-indifferent person with respect to a corporate tax shelter would be taxable to the extent the person is trading on its special tax status. The proposal would be effective for transactions entered into on or after the date of first committee action. Impose a penalty excise tax on certain fees received by promoters and advisors..—Users of corporate tax shelters often pay large fees to promoters and advisors with respect to the shelter transactions. The proposal would impose a 25-percent penalty excise tax on fees received in connection with the promotion of corporate tax shelters and the rendering of certain tax advice related to corporate tax shelters. The proposal would be effective for payments made on or after the date of first committee action. Require accrual of income on forward sale of corporate stock.—There is little substantive difference between a corporate issuer’s current sale of its stock for deferred payment and an issuer’s forward sale of the same stock. In both cases, a portion of the deferred payment compensates the issuer for the time-value of money during the term of the contract. Under current law, the issuer must recognize the time-value element of the deferred payment as interest if the transaction is a current sale for deferred payment but not if the transaction is a forward contract. Under the proposal, the issuer would be required to recognize the timevalue element of the forward contract as well. The proposal would be effective for forward contracts entered into after the date of first committee action. Modify treatment of ESOP as S corporation shareholder.—Pursuant to provisions enacted in 1996 and 1997, an employee stock ownership plan (ESOP) may be a shareholder of an S corporation and the ESOP’s share of the income of the S corporation is not subject to tax until distributed to the plan beneficiaries. The Administration proposes to require ESOPs that are not broad based to pay tax on S corporation income (including capital gains on the sale of stock) as the income is earned and to allow the ESOP a deduction for distributions of such income to plan beneficiaries. The deduction would apply only to the extent distributions exceed all prior undistributed amounts 3. FEDERAL RECEIPTS that were previously not subject to unrelated business income tax. The proposal would be effective for taxable years beginning on or after the date of first committee action. In addition, the proposal would be effective for acquisitions of S corporation stock by an ESOP after such date and for S corporation elections made on or after such date. Limit dividend treatment for payments on certain self-amortizing stock.—Under current law, distributions of property by a corporation to its shareholders are treated as dividends to the extent of the current or accumulated earnings and profits of the corporation. The Treasury Department previously became aware of certain abusive transactions involving socalled ‘‘fast-pay’’ stock. Under a typical fast-pay arrangement, a corporation that is subject to tax only at the shareholder level (a conduit entity) issues preferred stock to one class of investors and common stock to a second class of investors. The preferred stock is economically self-amortizing because the distributions made with respect to the stock (although treated entirely as dividends under current law) represent in part a return of the investors’ investment and in part a return on their investment. While The Treasury Department has issued regulations that recharacterize a fast-pay arrangement involving certain domestic conduit entities, legislation limiting the dividend characterization on self-amortizing stock (including self-amortizing stock issued by foreign conduit entities) may be a more comprehensive solution. The proposal would provide that, in the case of a distribution with respect to self-amortizing stock issued by a conduit entity (including a foreign conduit entity), the amount treated as a dividend shall not exceed the amount of the distribution that would have been characterized as interest had the self-amortizing stock been a debt instrument. The proposal would be effective for distributions with respect to self-amortizing stock made after the date of enactment. Prevent serial liquidation of U.S. subsidiaries of foreign corporations.—When a domestic corporation distributes a dividend to a foreign corporation, it is subject to U.S. withholding tax. In contrast, if a domestic corporation distributes earnings in a subsidiary liquidation under section 332, the foreign shareholder generally is not subject to any withholding tax. Relying on section 332, some foreign corporations have used holding companies to avoid the withholding tax. They establish U.S. holding companies to receive taxfree dividends from operating subsidiaries, and then liquidate the holding companies, thereby avoiding the withholding tax. Subsequently, they re-establish the holding companies to receive future dividends. The proposal would impose withholding tax on any distribution made to a foreign corporation in complete liquidation of a U.S. holding company if the holding company was in existence for less than 5 years. The proposal would also achieve a similar result with respect to serial terminations of U.S. branches. The proposal would be ef- 71 fective for liquidations and terminations occurring on or after the date of enactment. Prevent capital gains avoidance through basis shift transactions involving foreign shareholders.—A distribution in redemption of stock generally is treated as a dividend if it does not result in a meaningful reduction in the shareholder’s proportionate interest in the distributing corporation, measured with reference to certain constructive ownership rules, including option attribution. If an amount received in redemption of stock is treated as a distribution of a dividend, the basis of the remaining stock generally is increased to reflect the basis of the redeemed stock. The basis of the remaining stock is not increased, however, to the extent that the basis of the redeemed stock was reduced or eliminated pursuant to the extraordinary dividend rules. In certain circumstances, these rules require a corporate shareholder to reduce the basis of stock with respect to which a dividend is received by the nontaxed portion of the dividend, which generally equals the amount of the dividend that is offset by the dividends received deduction. To prevent taxpayers from attempting to offset capital gains by generating artificial capital losses through basis shift transactions involving foreign shareholders, the Administration proposes to treat the portion of a dividend that is not subject to current U.S. tax as a nontaxed portion. Similar rules would apply in the event that the foreign shareholder is not a corporation. The proposal would be effective for distributions on or after the date of first committee action. Prevent mismatching of deductions and income inclusions in transactions with related foreign persons.—Current law provides that if any debt instrument having original issue discount (OID) is held by a related foreign person, any portion of such OID shall not be allowable as a deduction to the issuer until paid. Section 267 and the regulations thereunder apply similar rules to other expenses and interest owed to related foreign persons. These general rules are modified, however, so that a deduction is allowed when the OID is includible in the income of a foreign personal holding company (FPHC), controlled foreign Department corporation (CFC), or passive foreign investment company (PFIC). The Treasury Department has learned of certain structured transactions (involving both U.S. payors and U.S.-owned foreign payors) designed to allow taxpayers inappropriately to take advantage of the current rules by accruing deductions to related FPHCs, CFCs or PFICs, without the U.S. owners of such related entities taking into account for U.S. tax purposes an amount of income appropriate to the accrual. This results in an improper mismatch of deductions and income. The proposal would provide that deductions for amounts accrued but unpaid to related foreign CFCs, PFICs or FPHCs would be allowable only to the extent the amounts accrued by the payor are, for U.S. tax purposes, reflected in the income of the direct or indirect U.S. owners of the related foreign 72 person. The proposal would contain an exception for certain short term transactions entered into in the ordinary course of business. The Secretary of Treasury would be granted regulatory authority to provide exceptions from these rules. The proposal would be effective for amounts accrued on or after the date of first committee action. Prevent duplication or acceleration of loss through assumption of certain liabilities.—Generally, if as part of a transaction in which one or more persons contribute property in exchange for the stock of a corporation that they control immediately thereafter, the corporation also assumes a liability of a transferor, the transferor’s basis in the stock of the controlled corporation is reduced by the amount of the liability assumed. To facilitate the incorporation of certain businesses that have liabilities that have not yet given rise to a deduction, special rules apply to provide that the assumption of such liabilities does not reduce the transferor’s basis in the stock of the controlled corporation. Relying on these special rules and other authority, some taxpayers have attempted to accelerate or duplicate deductions for certain losses by separating liabilities from the associated business or assets, contributing them to a corporation, and selling stock in that corporation at a purported loss. The Administration proposes that if the basis of stock received by a transferor as part of a tax-free exchange with a controlled corporation exceeds its fair market value, then the basis of the stock received would be reduced (but not below the fair market value) by the amount of a fixed or contingent liability that is assumed by the controlled corporation and that did not otherwise reduce the transferor’s basis in the corporation’s stock. Except as provided by the Secretary of Treasury , the proposal would not apply where the trade or business or substantially all the assets associated with the liability are also transferred to the controlled corporation. Regulations would be issued to prevent the acceleration or duplication of losses through the assumption of liabilities in transactions involving partnerships, and may also be issued to modify the rules of this proposal as applied to S corporations. The proposal and the regulations addressing transactions involving partnerships would be effective for assumptions of liability on or after October 19, 1999. Regulations addressing transactions involving S corporations would be effective on or after October 19, 1999, or such later date as may be prescribed by such rules. Amend 80/20 company rules.—Interest or 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 three-year period preceding the year of the payment 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/ ANALYTICAL PERSPECTIVES 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 limit the amount of interest and dividends exempt from withholding to the amount of foreign active business income received by the U.S. corporation during the 3-year testing period. The proposal would apply to interest or dividends paid or accrued more than 30 days after the date of enactment. Modify corporate-owned life insurance (COLI) rules.—In general, interest on 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, 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 still permit leveraged businesses to fund significant amounts of deductible interest and other expenses with tax-exempt or tax-deferred inside buildup on contracts insuring employees, officers, directors, and shareholders. The Administration proposes to repeal the exception under the COLI proration rules for contracts insuring employees, officers or directors (other than certain contracts insuring 20-percent owners) of the business. The proposal also would conform the key person exception for disallowed interest deductions attributable to indebtedness with respect to life insurance contracts to the modified 20-percent owner exception in the COLI proration rules. The proposal would be effective for taxable years beginning after date of enactment. Require lessors of tax-exempt-use property to include service contract options in lease term.— Under current law, a lessor of tax-exempt-use property is allowed depreciation deductions computed on a straight-line basis over a period of not less than 125 percent of the term of the lease. The existing depreciation rules do not consider service contracts, which can be structured to resemble leases. In recent years, lessors have attempted to accelerate depreciation deductions by structuring transactions that have a relatively short lease followed by a service contract. The proposal would require lessors to include the term of service contracts in the lease term for purposes of determining the depreciation period. The proposal would be effective for leases entered into after the date of enactment. Financial Products Require banks to accrue interest on short-term obligations.—Under current law, a bank (regardless of its accounting method) must accrue as ordinary income interest, including original issue discount, on 3. FEDERAL RECEIPTS short-term obligations. Some court cases have held that banks that use the cash receipts and disbursements method of accounting do not have to accrue stated interest and original issue discount on short-term loans made in the ordinary course of the bank’s business. The Administration believes it is inappropriate to treat these short-term loans differently than other short-term obligations held by the bank. The Administration’s proposal would clarify that banks must accrue interest and original issue discount on all short-term obligations, including loans made in the ordinary course of the bank’s business, regardless of the banks’ overall accounting method. The proposal would be effective for obligations acquired (including originated) on or after the date of enactment. No inference is intended regarding the current-law treatment of these transactions. Require current accrual of market discount by accrual method taxpayers.—Under current law, a taxpayer that holds a debt instrument with market discount is not required to include the discount in income as it accrues, even if the taxpayer uses an accrual method of accounting. Under the proposal, a taxpayer that uses an accrual method of accounting would be required to include market discount in income as it accrues. The proposal would also cap the amount of market discount on distressed debt instruments. The proposal would be effective for debt instruments acquired on or after the date of enactment. Modify and clarify certain rules relating to debtfor-debt exchanges.—Under current law, an issuer can inappropriately accelerate interest deductions by refinancing a debt instrument in a debt-for-debt exchange at a time when the issuer’s cost of borrowing has declined. The proposal would spread the issuer’s net deduction for bond repurchase premium in a debtfor-debt exchange over the term of the new debt instrument using constant yield principles. In addition, the proposal would modify the measurement of the net income or deduction in debt-for-debt exchanges involving contingent payment debt instruments. Finally, the proposal would modify the measurement of taxable boot to the holder in debt-for-debt exchanges that are part of corporate reorganizations. The proposal would apply to debt-for-debt exchanges occurring on or after the date of enactment. Modify and clarify the straddle rules.—A ‘‘straddle’’ is the holding of two or more offsetting positions with respect to actively-traded personal property. If a taxpayer enters into a straddle, the taxpayer must defer the recognition of loss from the ‘‘loss leg’’ of the straddle until the taxpayer recognizes the offsetting gain from the ‘‘gain leg’’ of the straddle. Further, the taxpayer must capitalize the net interest and carrying charges properly attributable to the straddle. The proposal would modify and clarify a number of provisions under the straddle rules. In particular, to match the timing of straddle losses with related gains, the proposal would provide that loss realized on one leg of a straddle would 73 be capitalized into the other leg of the straddle. This capitalization would operate as an ordering rule eliminating the need for an identification rule when the legs are of different sizes. In addition, to ensure that the loss on a straddle leg is properly measured, the proposal would require taxpayers that physically settle certain derivatives contracts to determine the amount of the loss subject to deferral under the straddle rules immediately before the physical settlement. The proposal would also repeal the current-law exception from the straddle rules for certain offsetting positions in stock. Finally, the proposal would clarify that a debt instrument issued by a taxpayer may itself be a leg in a straddle and would clarify the situations in which interest and carrying charges are considered properly allocable to a straddle and, therefore, must be capitalized. The proposal would be effective for certain losses incurred and certain straddles entered into on or after the date of first committee action. Provide generalized rules for all stripping transactions.—Under current law, it may be possible to separate the right to receive income from the ownership of underlying income-producing property (other than debt). In many cases, the tax treatment of income-stripping transactions does not clearly reflect the parties’ economic income from the transactions. As a result, it is possible for taxpayers to structure income-stripping transactions that exploit deficiencies of current law. The proposal would eliminate these planning opportunities by treating income-stripping transactions as loans. Under this approach, the owner of the property would be required to account for income from the property in the period in which it was earned. The proposal would be effective for income-stripping transactions entered into after the date of first committee action. Require ordinary treatment for certain dealers of commodities and equity options.—Under current law, certain dealers of commodities and equity options treat the income from their day-to-day trading or dealing activities as giving rise to capital gain. Dealers of other property typically treat the income from their day-to-day dealing activities as giving rise to ordinary income. The proposal would require commodities and equity-option dealers to treat the income from their day-to-day activities as giving rise to ordinary income, not capital gain. The proposal would be effective for tax years beginning after the date of enactment. Prohibit tax deferral on contributions of appreciated property to swap funds.—A swap fund is an investment partnership that is designed to allow taxpayers holding large blocks of appreciated stock to diversify their stock investments without recognizing gain and paying tax. Typically, a fund is established into which wealthy individuals transfer their stock. In exchange for the transferred stock, these individuals receive an interest in the fund. Under current law, these individuals do not have to recognize gain if more than 20 percent of the fund’s assets are comprised of non- 74 ANALYTICAL PERSPECTIVES marketable securities. The proposal would prohibit the deferral of gain where the fund is a passive investment vehicle. The proposal would be effective for transfers occurring on or after the date of enactment. Corporate Provisions Conform control test for tax-free incorporations, distributions, and reorganizations.—For tax-free incorporations, tax-free distributions, and reorganizations, ‘‘control’’ is defined as the ownership of 80 percent of the voting stock and 80 percent of the number of shares of all other classes of stock of the corporation. This test is easily manipulated by allocating voting power among the shares of a corporation, allowing corporations to retain control of a corporation but sell a significant amount of the value of the corporation. In contrast, the necessary ‘‘ownership’’ for tax-free liquidations, qualified stock purchases, and affiliation is at least 80 percent of the total voting power of the corporation’s stock and at least 80 percent of the total value of the corporation’s stock. The Administration proposes to conform the control requirement for tax-free incorporations, distributions, and reorganizations with that used for determining affiliation. This proposal is effective for transactions on or after the date of enactment. Treat receipt of tracking stock in certain distributions and exchanges as the receipt of property.—‘‘Tracking stock’’ is an economic interest that is intended to relate to and track the economic performance of one or more separate assets of the issuer, and gives its holder a right to share in the earnings or value of less than all of the corporate issuer’s earnings or assets. Tracking stock issued by a corporation represents an economic interest different than non-tracking stock of the issuer. Under the proposal, the receipt of tracking stock in a distribution made by a corporation with respect to its stock and tracking stock received in exchange for other stock in the issuing corporation would be treated as the receipt of property by the shareholders. Under this proposal, the Secretary of Treasury would have authority to treat tracking stock as nonstock (debt, a notional principal contract, etc.) or as stock of another entity as appropriate to prevent avoidance. No inference is intended regarding the tax treatment of tracking stock under current law. This proposal is effective for tracking stock issued on or after the date of enactment. Require consistent treatment and provide basis allocation rules for transfers of intangibles in certain nonrecognition transactions.—No gain or loss will be recognized if one or more persons transfer property to a controlled corporation (or partnership) solely in exchange for stock in the corporation (or a partnership interest). Where there is a transfer of less than ‘‘all substantial rights’’ to use property, the Internal Revenue Service’s position is that such transfer will not qualify as a tax-free exchange. However, the Claims Court rejected the Service’s position in E.I. Du Pont de Nemours and Co. v. U.S., holding that any transfer of something of value could be a ‘‘transfer’’ of ‘‘property.’’ The inconsistency between the positions has resulted in whipsaw of the government. The Administration proposes to provide that a transfer of an interest in intangible property constituting less than all of the substantial rights of the transferor will not fail to qualify for tax-free treatment solely because the transferor does not transfer all rights, title and interest in an intangible asset, and the transferor must allocate the basis of the intangible between the retained rights and the transferred rights based upon respective fair market values. Consistent reporting by the transferor and the transferee would be required. This proposal is effective for transfers after the date of enactment. Modify tax treatment of certain reorganizations involving portfolio stock.—If a target corporation owns stock in the acquiring corporation and wants to combine with the acquiring corporation in a downstream reorganization, the target corporation transfers its assets to the acquiring corporation and the shareholders of the target corporation receive stock of the acquiring corporation in exchange for their target corporation stock. Alternatively, if the acquiring corporation owns stock in the target corporation, the target corporation can merge upstream, transfer its assets upstream, or merge sideways into a subsidiary of the acquiring corporation with the other shareholders of target receiving acquiring corporation stock. Under current law, all of these reorganizations qualify for tax-free treatment. Under the proposal, where a target corporation holds less than 20 percent of the stock of an acquiring corporation and the target corporation combines with the acquiring corporation in a reorganization in which the acquiring corporation is the survivor, the target corporation must recognize gain, but not loss, as if it distributed the acquiring corporation stock that it held immediately prior to the reorganization. Alternatively, where an acquiring corporation owns less than 20 percent of a target corporation and the target corporation combines with the acquiring corporation or a subsidiary of the acquiring corporation, the acquiring corporation must recognize gain, but not loss, as if it had sold its target corporation stock immediately before the reorganization. Nonrecognition treatment would continue to apply to other assets transferred by the target corporation and to the target corporation shareholders. This proposal is effective for transactions on or after the date of enactment. Modify definition of nonqualified preferred stock.—Subject to certain exceptions, in otherwise taxfree transactions, the receipt of nonqualified preferred stock is treated as money or other property and, thus, gain may be recognized. Under current law, nonqualified preferred stock is defined as stock which is ‘‘limited and preferred as to dividends and does not participate in corporate growth to any significant extent.’’ Taxpayers may be taking positions that are in- 3. FEDERAL RECEIPTS consistent with the policy of the nonqualified preferred stock provisions (i.e., nonrecognition treatment is inappropriate where taxpayers receive relatively secure instruments in exchange for relatively risky instruments), by including illusory participation rights or including terms that taxpayers argue create an ‘‘unlimited’’ dividend. The proposal would clarify the definition of preferred stock to eliminate taxpayer arguments that stock issued is nominally participating or unlimited as to dividends. The proposal would apply to transactions that occur after the date of first committee action. Modify estimated tax provision for deemed asset sales—Taxpayers can make an election to treat certain sales of stock as sales of assets. This election may be made up to 8 1/2 months after the stock sale. Taxpayers may be taking the position that they do not have to pay any estimated taxes until after the 8 1/2 month period has expired and rely on current law as providing that there will be no penalty for nonpayment. The proposal would clarify the estimated tax provisions to require that estimated taxes be paid based upon gain from either the stock sale or the deemed asset sale. The proposal would apply to transactions that occur after the date of first committee action. Modify treatment of transfers to creditors in divisive reorganizations.—In order to separate businesses in a tax-free spin-off, a corporation (distributing) will not recognize gain or loss on the contribution of property to a controlled corporation solely in exchange for stock or securities of the controlled corporation. Under current law, if the distributing corporation also receives other property or money, it will not recognize gain as long as it distributes the property or money to its creditors in connection with the reorganization. The amount of property or money that may be distributed to creditors without gain to the distributing corporation is unlimited. Thus, taxpayers may avoid gain that otherwise would be recognized if liabilities are assumed by the controlled corporation that exceed the basis of assets contributed. The proposal would limit the amount of property or money that the distributing corporation can distribute to creditors without gain to the amount of basis of the assets contributed to the controlled corporation in the reorganization. In addition, the proposal would provide that acquisitive reorganizations would no longer be subject to gain recognition where liabilities are assumed in excess of the basis of assets transferred. The proposal would be effective for transactions on or after the date of enactment. Passthroughs Provide mandatory basis adjustments for partners that have a significant net built-in loss in partnership property.—Currently, a partner’s share of basis in partnership property is adjusted in the case of a distribution of partnership property or a sale of a partnership interest only if the partnership has a special election in effect. The electivity of these provi- 75 sions has created numerous opportunities for abuse by taxpayers. Accordingly, the Administration proposes that the basis adjustment rules would be made mandatory with respect to any partner (treating related persons as one person), whose share of net built-in loss in partnership property is equal to the greater of $250,000 or ten percent of the partner’s total share of partnership assets (measured by reference to fair market value). In calculating the ten-percent threshold, property acquired by the partnership with a principal purpose of allowing a partner or partners to avoid the limitation would be disregarded. The proposal would be effective for distributions and transfers of partnership interest after the date of enactment. Modify treatment of closely held REITs.—When originally enacted, the real estate investment trust (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 is 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 50 percent or more of the total combined voting power of all classes of voting stock or 50 percent or more of the total value of all shares of all classes of stock. For purposes of determining a person’s stock ownership, rules similar to current-law rules would apply and stapled entities would be treated as one person. The proposal would be effective for entities electing REIT status for taxable years beginning on or after the date of first committee action. Apply regulated investment company (RIC) excise tax to undistributed profits of REITs.—As a result of legislation passed in 1999, a REIT, like a RIC, is only required to distribute 90 percent of its REIT taxable income in order to maintain REIT status. A RIC is subject to a four-percent excise tax on the excess of the required distribution for a calendar year over the distributed amount for such calendar year. 76 The required distribution is equal to the sum of 98 percent of the RIC’s ordinary income for the calendar year and 98 percent of the RIC’s capital gain net income for the one-year period ending on October 31 of such calendar year. REITs are subject to a similar rule, except that the required distribution is equal to the sum of 85 percent of the REIT’s ordinary income for the calendar year and 95 percent of the REIT’s capital gain net income for such calendar year. In order to conform the treatment of REITs and RICs, the Administration proposes to modify the definition of required distribution for REITs, requiring a distribution of 98 percent of ordinary and capital gain income in order to avoid the four-percent excise tax. The proposal would be effective for calendar years beginning after December 31, 2000. Allow RICs a dividends paid deduction for redemptions only in cases where the redemption represents a contraction in the RIC.—Under current law, a RIC is allowed a dividends paid deduction for dividends paid to shareholders. If a RIC redeems a shareholder’s stock, the RIC can generally treat a portion of the redemption payment as a dividend for purpose of computing the dividends paid deduction. In situations where the redemption represents a contraction in the size of the RIC, this treatment ensures that the remaining shareholders of the RIC are taxed on no more than their pro rata share of the RIC’s income. In situations where the redemption is accompanied by near simultaneous investments in the RIC by other investors, the RIC is in essentially the same position it would be in had the redeeming shareholder sold its shares in the RIC directly to the new investors. In this case, it is inappropriate to give the RIC a dividends paid deduction for the redemption. The proposal, therefore, allows a RIC to claim a dividends paid deduction with respect to a redemption only if the redemption represents a net contraction in the size of the RIC. The proposal would be effective for taxable years beginning after the date of enactment. Require Real Estate Mortgage Investment Conduits (REMICs) to be secondarily liable for the tax liability of REMIC residual interest holders.—A REMIC is a statutory pass-through vehicle designed to facilitate the securitization of mortgages. A REMIC holds mortgages and issues one or more classes of debt instruments, called REMIC regular interests, that are entitled to the cash flows from the underlying mortgages. A REMIC also issues a REMIC residual interest. The holder of the REMIC residual interest must include in income the taxable income of the REMIC. In many cases, when it is issued the REMIC residual interest has a negative value because the reasonably anticipated net tax liability associated with holding the residual is greater than the value of the cash flows on the residual. Many holders of REMIC residual interests do not pay their tax liabilities when due. To ensure that the tax on REMIC residuals is paid when due, the proposal would require a REMIC to be secondarily liable for ANALYTICAL PERSPECTIVES the tax liability of its residual interest. Under the proposal, if the tax on the residual was not paid when due, the REMIC would be required to pay the tax. Similar rules would apply with respect to Financial Asset Securitization Investment Trusts (FASITs). The proposal would be effective for REMICs and FASITs created after the date of enactment. Tax Accounting Deny change in method treatment to tax-free formations.—Generally, a taxpayer that desires to change its method of accounting must obtain the consent of the IRS Commissioner. In addition, in certain reorganization transactions a corporation acquiring assets generally is required to use the method of accounting used for those assets by the distributor or transferor corporation. Under current law, this carryover rule does not apply to tax-free contributions to a corporation or to a partnership. Consequently, taxpayers who transfer assets to a subsidiary or a partnership in such transactions may avail themselves of a new method of accounting without obtaining the consent of the IRS Commissioner. The Administration proposes to expand the transactions to which the carryover of method of accounting rules and the regulations thereunder apply to include tax-free contributions to corporations or partnerships, effective for transfers on or after the date of enactment. Deny deduction for punitive damages.—The current deductibility of most punitive damage payments undermines the role of such damages in discouraging and penalizing certain undesirable actions or activities. The Administration proposes to disallow any deduction for punitive damages paid or incurred by the taxpayer, whether upon a judgment or in settlement of a claim. Where the liability for punitive damages is covered by insurance, such damages paid or incurred by the insurer would be included in the gross income of the insured person. The insurer would be required to report such payments to the insured person and to the IRS. The proposal would apply to damages paid or incurred on or after the date of enactment. 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 or 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 similar 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 3. FEDERAL RECEIPTS LCM and subnormal goods methods effective for taxable years beginning after the date of enactment. Disallow interest on debt allocable to tax-exempt obligations.—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 tax-exempt 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. Require capitalization of mutual fund commissions.—An expenditure that results in significant future benefits generally must be capitalized in order to match the expenditure with the revenues of the taxable period to which it is properly attributable. Under current securities law, a distributor of mutual fund shares may be compensated by the fund over a period of years or by the investors on redemption with respect to ‘‘Class B’’ shares it distributes. However, the distributor typically will pay an up-front commission to a broker to sell Class B shares to an investor. In order to more accurately match the income and expenses of mutual fund distributors, the Administration proposes that commissions paid to a broker by a distributor would be capitalized and recovered over six years (the period investors would have to hold shares without incurring a fee on redemption). The proposal would be effective for commissions paid or incurred in taxable years ending after the date of enactment. No inference is intended with respect to the treatment of distributor’s commissions under current law. Cost Recovery Provide consistent amortization periods for intangibles.—Under current law, start-up and organiza- 77 tional expenditures are amortized at the election of the taxpayer over a period of not less than five years. Current law requires certain acquired intangible assets (goodwill, trademarks, franchises, patents, etc.) to be amortized over 15 years. The Administration believes that, to encourage the formation of new businesses, a fixed amount of start-up and organizational expenditures should be currently deductible. Thus, the proposal would allow a taxpayer to elect to deduct up to $5,000 each of start-up or organizational expenditures. However, for each taxpayer, the $5,000 amount is reduced (but not below zero) by the amount by which the cumulative cost of start-up or organizational expenditures exceeds $50,000. Start-up and organizational expenditures not currently deductible would be amortized over a 15-year period consistent with the amortization period for acquired intangible assets. The proposal generally would be effective for start-up and organizational expenditures incurred in taxable years beginning on or after the date of enactment. Clarify recovery period of utility grading costs. —A taxpayer is allowed as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear, and obsolescence of property that is used in a trade or business or held for the production of income. For most tangible property placed in service after 1986, the amount of the depreciation deduction is determined under the modified accelerated cost recovery system (MACRS) using a statutorily prescribed depreciation method, recovery period, and placed in service convention. The recovery period may be determined by reference to the statutory recovery period or to the list of class lives provided by the Treasury Department. Electric and gas utility clearing and grading costs incurred to extend distribution lines and pipelines have not been assigned a class life. By default, such assets have a seven-year recovery period under MACRS. The Administration believes that applying the default rule to electric and gas utility clearing and grading costs is inappropriate. For example, the electric utility transmission and distribution lines and the gas utility trunk pipelines benefitted by the clearing and grading costs have MACRS recovery periods of 20 years and 15 years, respectively. The proposal would assign depreciable electric and gas utility clearing and grading costs incurred to locate transmission and distribution lines and pipelines to the class life assigned to the benefitted assets, giving these costs a recovery period of 20 years and 15 years, respectively. The proposal would be effective for electric and gas utility clearing and grading costs incurred on or after the date of enactment. Apply rules generally applicable to acquisitions of intangible assets to acquisitions of professional sports franchises.—In general, the purchase price allocated to most intangible assets (including franchise rights) acquired in connection with the acquisition of a trade or business must be capitalized and amortized over a 15-year period. These rules were enacted in 1993 to minimize disputes regarding the proper treatment 78 ANALYTICAL PERSPECTIVES of acquired intangible assets. Special rules apply to intangible assets acquired in connection with a professional sports franchise. The 15-year amortization rules do not apply and special allocation rules apply to the purchase price. In order to provide consistent treatment among different trades or businesses and to minimize disputes regarding intangible assets acquired in connection with a professional sports franchise, the Administration proposes to repeal the special rules applicable to professional sports franchise acquisitions and apply the rules generally applicable to most intangible assets. The proposal would be effective for acquisitions after the date of enactment. Insurance Require recapture of policyholder surplus accounts.—Between 1959 and 1984, stock life insurance companies deferred tax on a portion of their profits. These untaxed profits were added to a policyholders surplus account (PSA). In 1984, Congress precluded life insurance companies from continuing to defer tax on future profits through PSAs. However, companies were permitted to continue to defer tax on their existing PSAs, and to pay tax on the previously untaxed profits in the PSAs only in certain circumstances. There is no remaining justification for allowing these companies to continue to defer tax on profits they earned between 1959 and 1984. Most pre-1984 policies have terminated, because pre-1984 policyholders have surrendered their pre-1984 contracts for cash, ceased paying premiums on those contracts, or died. The Administration proposes that companies generally would be required to include in their gross income over five years their PSA balances as of the beginning of the first taxable year starting after the date of enactment. Modify rules for capitalizing policy acquisition costs of life insurance companies.—Under current law, insurance companies capitalize varying percentages of their net premiums for certain types of insurance contracts, and generally amortize these amounts over 10 years (5 years for small companies). These capitalized amounts are intended to serve as proxies for each company’s commissions and other policy acquisition expenses. However, data reported by insurance companies to State insurance regulators each year indicate that the insurance industry is capitalizing substantially less than its actual policy acquisition costs, which results in a mismatch of income and deductions. The Administration proposes that insurance companies be required to capitalize modified percentages of their net premiums for certain lines of business. This change would be treated as a change in the insurance company’s method of accounting. The modified percentages would more accurately reflect the ratio of actual policy acquisition expenses to premiums and the typical useful lives of the contracts. To ensure that companies never are required to capitalize more under this proxy approach than they would capitalize under normal tax accounting rules, companies that have low policy acqui- sition costs generally would be permitted to capitalize their actual policy acquisition costs. 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 companies 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, banks and brokerage firms, 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 25 percent. Modify rules that apply to sales of life insurance contracts.—The sale of a life insurance contract insuring a person who is neither terminally nor chronically ill results in taxable income to the seller equal to the difference between the sales price and the seller’s basis in the contract. Buyers generally are not required to report information to the IRS on these transactions. The buyer, who receives the death benefit when the insured dies, generally is liable for tax on his profit from the transaction under the ‘‘transfer for value’’ rules. However, the life insurance company generally is not required to report the death benefit payment. Moreover, the rule that the buyer’s profits are taxable can be circumvented. The proposal would modify the transfer for value rules so they could no longer be circumvented. The proposal also would modify the reporting rules to require the buyer of a life insurance contract with a large death benefit to report information on the sale to the IRS, to the issuer of the life insurance contract, and to the seller of the life insurance contract. In addition, the proposal would modify the reporting rules to require that payment of death benefits under such previously-sold contracts be reported to the IRS and to the payee. The proposal would be effective for sales of life insurance contracts and payments of death benefits after the date of enactment. Modify rules that apply to tax-exempt property casualty insurance companies.—Under current law, an insurance company with up to $350,000 of premium income is tax-exempt, regardless of the amount of investment income it has. Another provision allows cer- 3. 79 FEDERAL RECEIPTS tain small insurance companies to elect to be taxed only on their net investment income. Premiums of companies in the same controlled group are combined for purposes of determining whether an entity is eligible for tax exemption. An excise tax is imposed on premiums paid to foreign companies with respect to policies insuring U.S. risks. Current law allows foreign insurance companies to elect to be taxed as domestic companies if they meet certain requirements. These rules have been used by U.S. persons to shift assets into tax-free or tax-preferred affiliated insurance companies, which often are located in tax havens and issue ‘‘insurance’’ that is generated directly or indirectly by the U.S. person. The proposal would modify current law, beginning the first taxable year after date of enactment, so that all items of gross income of all affiliated companies would be aggregated in determining whether an insurance company qualifies for tax-exempt status. Also, tax-exempt status would not be available to foreign insurance companies beginning the first taxable year after the date of enactment. Conforming amendments would be made to the current-law election to be taxed on investment income. The proposal also would modify current law so that the election to be taxed as a U.S. corporation would not be available to a foreign company formed after the date of first Committee action, and would not be available beginning in the second year after the date of enactment for any other foreign company that would otherwise qualify for a tax exemption under current law. Exempt Organizations Subject investment income of trade associations to tax.—Trade associations described in section 501(c)(6) are generally exempt from Federal income tax, but are subject to tax on their unrelated business income. To eliminate the current-law bias in favor of trade association members’ making and deducting advance payments to fund future collective activities of the trade association, the proposal would subject trade associations to unrelated business income tax on their net investment income in excess of $10,000 for any taxable year. As under current-law rules for certain other tax-exempt organizations, investment income would not be subject to tax under the proposal to the extent that it is set aside for a specified charitable purpose. In addition, any gain from the sale of property used directly in the performance of the trade association’s exempt function would not be subject to tax under the proposal to the extent that the sale proceeds are used to purchase replacement exempt-function property. The proposal would be effective for taxable years beginning after December 31, 2000. Impose penalty for failure to file an annual information return.—To encourage voluntary compliance and assist the IRS in its enforcement efforts, the proposal would impose a penalty on split-interest trusts (such as charitable remainder trusts, charitable lead trusts, and pooled income funds) that fail to file an annual information return on Form 5227. Form 5227 contains information regarding the trust’s financial activities and whether the trust is subject to certain excise taxes. Under the proposal, any failure to file Form 5227 would be subject to a penalty of $20 per day (up to a maximum of $10,000 per return) or, in the case of any trust with income in excess of $250,000, $100 per day (up to a maximum of $50,000 per return). In addition, any trustee who knowingly fails to file Form 5227, unless such failure is not willful and is due to reasonable cause, would be jointly and severally liable for the amount of the penalty. The proposal would be effective for any return the due date for which is after the date of enactment. Estate and Gift Restore phaseout of unified credit for large estates.—Prior to TRA97, the benefit of both the estate tax graduated rate brackets below fifty-five percent and the unified credit were phased out by imposing a fivepercent surtax on estates with a value above $10 million. When TRA97 increased the unified credit amount, the phase out of the unified credit was inadvertently omitted. The Administration proposes to restore the surtax in order to phase out the benefits of the unified credit as well as the graduated estate tax brackets. The proposal would be effective for decedents dying after the date of enactment. Require consistent valuation for estate and income tax purposes.—The basis of property acquired from a decedent generally is its fair market value on the date of death. Property included in the gross estate of a decedent is valued also at its fair market value on the date of death. Recipients of lifetime gifts generally take a carryover basis in the property received. The Administration proposes to impose a duty of consistency on heirs receiving property from a decedent, requiring such heirs to use the value as reported on the estate tax return as the basis for the property for income tax purposes. Estates would be required to notify heirs (and the IRS) of such values. In addition, donors making lifetime gifts would be required to notify the recipients of such gifts (and the IRS) of the donor’s basis in the property at the time of the gift, as well as any gift tax paid with respect to the gift. This proposal would be effective for gifts made after, and decedents dying after, the date of enactment. Require basis allocation for part sale, part gift transactions.—In a part gift, part sale transaction, the donee/purchaser takes a basis equal to the greater of the amount paid by the donee or the donor’s adjusted basis at the time of the transfer. The donor/seller uses adjusted cost basis in computing the gain or loss on the sale portion of the transaction. The Administration proposes to rationalize basis allocation in a part gift, part sale transaction by requiring the basis of the property to be allocated ratably between the gift portion and the sale portion based on the fair market value 80 of the property on the date of transfer and the consideration paid. This proposal would be effective for transactions entered into on or after the date of enactment. Conform treatment of surviving spouses in community property States.—If joint property is owned by spouses in a non-community property state, a surviving spouse receives a stepped-up basis only in the half of the property owned by the deceased spouse. In contrast, when a spouse dies owning community property, the surviving spouse is entitled to a steppedup basis not only in the half of the property owned by the deceased spouse, but also in the half of the property already owned by the surviving spouse prior to the decedent’s death. The Administration proposes to eliminate the stepped-up basis in the part of the community property owned by the surviving spouse prior to the deceased spouse’s death. The half of the community property owned by the deceased spouse would continue to be entitled to a stepped-up basis upon death. This treatment will be consistent with the treatment of joint property owned by spouses in a noncommunity property State. This proposal would be effective for decedents dying 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 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. 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 non-business assets. The proposal would be effective for gifts made after, and decedents dying after, the date of enactment. 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 ANALYTICAL PERSPECTIVES a trust. The Administration proposes to repeal this personal residence trust 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. Modify requirements for annual exclusion for gifts.—Currently, annual gifts of present interests of up to $10,000 (in 2000) per donor per donee 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. Two recent cases expanded on the Crummey rule by holding that the annual exclusion is available, even where the person holding the withdrawal power is not a primary beneficiary of the trust. The Administration proposes to modify the annual exclusion rule as it applies to gifts and trusts so that a transfer to a trust would qualify only if: (1) during the life of the individual who is the beneficiary of the trust, no portion of the corpus or income of the trust may be distributed to or for the benefit of any person other than the beneficiary, and (2) the trust does not terminate before the beneficiary dies, the assets of the trust will be includible in the gross estate of the beneficiary. A withdrawal right would not be sufficient to create a present interest. This proposal would be effective for gifts completed after December 31, 2000. A grandfather rule would allow continued use of Crummey powers in existing irrevocable trusts, but only to the extent that the Crummey powers are held by primary noncontingent beneficiaries. Pensions Increase elective withholding rate for nonperiodic distributions from deferred compensation plans. —The Administration proposes increasing the current 10-percent elective withholding rate for nonperiodic distributions (such as certain lump sums) from pensions, IRAs and annuities to 15 percent, which more closely approximates the taxpayer’s income tax liability for the distribution effective for distributions after 2001. The withholding would not apply to eligible rollover distributions. Increase excise tax for excess IRA contributions.—Excess IRA contributions are currently subject to an annual 6-percent tax rate. With high investment returns, this annual 6-percent rate may be insufficient to discourage contributions in excess of the current limits for IRAs. The Administration proposes increasing from 6 percent to 10 percent the excise tax on excess contributions to IRAs for taxable years after the year the excess contribution is made. Thus, the 6-percent rate would continue to apply for the year of the excess contribution and the higher annual rate would only 3. 81 FEDERAL RECEIPTS apply if the excess amounts are not withdrawn from the IRA. This increase would be effective for taxable years beginning after 2000. Limit pre-funding of welfare benefits for 10 or more employer plans.—Current law generally limits the ability of employers to claim a deduction for amounts used to prefund welfare benefits. An exception is provided for certain arrangements where 10 or more employers participate because it is believed that such relationships involve risk-sharing similar to insurance which will effectively eliminate any incentive for participating employers to prefund benefits . However, as a practical matter, it has proven difficult to enforce the risk-sharing requirements in the context of certain arrangements. The Administration proposes limiting the 10 or more employer plan funding exception to medical, disability, and group-term life insurance benefits because these benefits do not present the same risk of prefunding abuse. Thus, effective for contributions paid after the date of first committee action, the existing deduction rules of the Internal Revenue Code would apply to prevent an employer who contributes to a 10 or more employer plan from claiming a current deduction for supplemental unemployment benefits, severance pay or life insurance (other than group-term life insurance) benefits to be paid in future years. Subject signing bonuses to employment taxes.— Bonuses paid to individuals for signing a first contract of employment are ordinary income in the year received. The Administration proposes to clarify that these amounts are treated as wages for purposes of income tax withholding and FICA taxes effective after date of enactment. No inference is intended with respect to the application of prior law withholding rules to signing bonuses. Clarify employment tax treatment of choreworkers.—Choreworkers, individuals paid by State agencies to provide domestic services for disabled and elderly individuals, often provide services for more than one disabled or elderly individual. The Administration’s proposal would clarify that State agencies, and not the disabled or elderly individual receiving the services, are responsible for withholding and employment taxes for choreworkers effective for wages paid after 2000. For this purpose, all wages paid by the State agency to a choreworker are treated as paid by a single employer. Prohibit IRAs from investing in foreign sales corporations.—Foreign sales corporations (FSCs) are foreign corporations whose income is partially subject to US tax. IRAs were never intended to be able to invest in FSCs. The proposal would prohibit an IRA from investing in a FSC effective after the date of first committee action. Compliance 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. Require withholding on certain gambling winnings.—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. Require information reporting for private separate accounts.—Direct investments generally result in taxable income each year of dividends and interest, plus taxable gain or loss for changes in the value of the securities in the year that such securities are sold. In contrast, investments held through insurance contracts—called separate accounts—generally give rise to tax-free or tax-deferred income unless the policyholder has too much control over the contract’s investments. Insurance companies sometimes create private separate accounts through which only one or a small group of policyholders may invest their funds. These policyholders generally exercise investor control, and thus are liable for income tax each year on the investment income earned. However, the IRS has no efficient way to identify which insurance contracts’ funds are invested through private separate accounts. The Administration proposal would require insurance companies to report each insurance contract with funds invested through private separate accounts, and the policyholder taxpayer identification number and earnings for such contract. The proposal would be effective for taxable years beginning after the date of enactment. 82 ANALYTICAL PERSPECTIVES 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 five 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. Miscellaneous Modify deposit requirement for Federal Unemployment Act (FUTA).—Beginning in 2005, 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. Reinstate Oil Spill Liability Trust Fund 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 September 30, 2001 and before October 1, 2010. 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. 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 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. 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 40-percent excise tax on the difference between the amount paid by the purchaser to the injured person and the undiscounted value of the purchased payment stream 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 on or 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. Require taxpayers to include rental income of residence in income without regard to the period of rental.—Under current law, rental income is generally includable in income and the deductibility of expenses attributable to the rental property is subject to certain limitations. An exception to this general treatment applies if a dwelling is used by the taxpayer as a residence and is rented for less than 15 days during the taxable year. The income from such a rental is not included in gross income and no expenses arising from the rental are deductible. The Administration proposes to repeal this 15-day exception. The proposal would apply to taxable years beginning after December 31, 2000. Eliminate installment payment of heavy vehicle use tax.—An annual tax is imposed on the use of heavy (at least 55,000 pounds) highway vehicles. The tax year is July 1 through June 30 and the tax return is generally due on August 31 of the year to which it relates. A taxpayer may, however, elect to pay the tax in installments. The installment option generally permits payment of one quarter of the tax on each of the following dates: August 31, December 31, March 31, and 3. 83 FEDERAL RECEIPTS June 30. States are required to obtain evidence, before issuing tags for a vehicle, that the use tax return has been filed and any tax due with the return (generally only the first installment) has been paid. To foster compliance, the Administration proposes to eliminate the installment option for taxable years beginning after June 30, 2002. Thus, heavy vehicle owners would be required to pay the entire tax with their returns and would be unable to obtain State tags without providing proof of full payment. Require recognition of gain on sale of principal residence if acquired in a tax-free exchange within five years of sale.—Gain of up to $250,000 ($500,000 in the case of a joint return) from the sale or exchange of property is excluded from income if, during the fiveyear period ending on the date of the sale or exchange, the property has been owned and used by the taxpayer as the taxpayer’s principal residence for periods aggregating two years or more. No gain or loss is recognized if property held for use in a trade or business or for investment is exchanged solely for other like-kind property held for use in a trade or business or for investment. The current-law exclusion for principal residences, in combination with the tax-free like-kind exchange provision, allows planning opportunities for taxpayers who wish to liquidate real property held for use in a trade or business or for investment. Such planning opportunities are beyond the intended scope of the principal residence exclusion. The Administration proposes to require recognition of gain on the sale of property that has been owned and used by the taxpayer as the taxpayer’s principal residence for periods aggregating two years or more if the property was acquired in a tax-free like-kind exchange within five years of the sale. The proposal would be effective for sales after the date of enactment. International Identified Tax Havens The Administration is concerned about the use of tax havens. Tax havens facilitate tax avoidance and evasion and many of them, through strict confidentiality rules, substandard regulatory regimes, and uncooperative information exchange practices, inhibit our law enforcement capabilities. The Administration proposes several remedies to reduce the attractiveness of, and increase access to information about activity in, certain tax havens identified by the Secretary of the Treasury (‘‘Identified Tax Havens’’). To identify tax havens that will be subject to these rules, the Secretary of the Treasury will use criteria including, but not limited to, whether a jurisdiction imposes no or nominal taxation, either generally or on specific classes of capital income, has strict confidentiality rules and practices, and has ineffective information exchange practices. Require reporting of all payments to identified tax havens—The proposal would provide that all pay- ments to entities, including corporations, partnerships and disregarded entities, branches, trusts, accounts or individuals resident or located in Identified Tax Havens must be reported on the taxpayer’s annual return unless: (1) information regarding the payment would be available to the IRS upon request or otherwise, or (2) the payment is less than $10,000. Failure to report a covered payment would result in the imposition of a penalty equal to 20 percent of the amount of the payment. Special rules would apply to certain financial services businesses that would permit reporting certain payments on an aggregate basis. An anti-abuse rule would require aggregation of related payments for purposes of determining whether a payment is under $10,000. The proposal would be effective for payments made after the date of enactment. Impose limitations on certain tax attributes and income flowing through Identified Tax Havens.— Current rules deny foreign tax credits for taxes paid to (1) countries whose governments the U.S. does not recognize, (2) countries with respect to which the U.S. has severed diplomatic relations, or (3) countries that the State Department cites as supporting international terrorism. In addition, the foreign tax credit limitation and other rules are applied separately to income attributable to such countries. The proposal would apply similar rules to Identified Tax Havens. In addition, the proposal would reduce by a factor (similar to the international boycott factor) a taxpayer’s (1) otherwise allowable foreign tax credit or FSC benefit attributable to income from an Identified Tax Haven, and (2) the income, attributable to an Identified Tax Haven, that is otherwise eligible for deferral. This reduction of tax benefits would be based on a fraction the numerator of which is the sum of the taxpayer’s income and gains from an Identified Tax Haven and the denominator of which is the taxpayer’s total non-U.S. income and gains. The proposal would be effective for taxable years beginning after the date of enactment. Mark-to-Market Proposals Modify treatment of built-in losses and other attributes trafficking.—Under current law, a taxpayer that becomes subject to U.S. taxation may take the position that it determines its beginning bases in its assets under U.S. tax principles as if the taxpayer had historically been subject to U.S. tax. Other tax attributes are computed similarly. A taxpayer may thus ‘‘import’’ built-in losses or other favorable tax attributes incurred outside U.S. taxing jurisdiction to offset income or gain that would otherwise be subject to U.S. tax. To prevent this ability to import ‘‘built-in’’ losses or other favorable attributes, the proposal would eliminate tax attributes (including built-in items) and markto-market bases when an entity or an asset becomes relevant for U.S. tax purposes. The proposal would be effective for transactions in which assets or entities become relevant for U.S. tax purposes on or after the date of enactment. 84 ANALYTICAL PERSPECTIVES Simplify taxation of property that no longer produces income effectively connected with a U.S. trade or business.—Under current law, a foreign person is subject to tax in the United States on net income that is effectively connected with a U.S. trade or business (‘‘ECI’’). If a foreign person transfers property from a U.S. trade or business to its foreign office, the United States retains the right to tax all of the gain realized from a subsequent disposition of the property if the disposition occurs within ten years of the time the property ceased to be used in the U.S. trade or business. The United States also retains, for ten years, the right to tax deferred income from an asset attributable to a U.S. trade or business. These rules are difficult to administer and may in some cases result in the United States taxing gain that economically accrued after the property was removed from U.S. taxing jurisdiction. The proposal would mark to market property (including rights to deferred income) at the time that the property ceases to be used in, or attributable to, a U.S. trade or business. The proposal would be effective for property that ceases to be used in, or attributable to, a U.S. trade or business after the date of enactment. Prevent avoidance of tax on U.S.-accrued gains (expatriation).—-Under current rules, persons renouncing U.S. citizenship for tax-avoidance purposes are subject to U.S. taxation for ten years after renunciation. Although these rules were modified in 1996, they are still easily avoided and impose significant administrative burdens on both taxpayers and the Government. The proposal would simplify and toughen the taxation of expatriates by repealing the current regime and imposing a one-time tax on accrued gains at the time of expatriation. Also, if an expatriate subsequently makes a gift or bequest to a U.S. person, the proposal would treat the gift as gross income to the U.S. recipient, taxable at the highest marginal rate applicable to gifts and bequests. In addition, the proposal would amend a 1996 law (the ‘‘Reed Amendment’’), which requires the Attorney General to deny re-entry to a taxmotivated expatriate, to coordinate it with the tax proposal, and improve the enforceability of both the tax proposal and the Reed Amendment. The proposal would apply for individuals expatriating on or after the date of first committee action. Other International Provisions Expand ECI rules to include certain foreign source income.—-Under current rules, only certain enumerated types of foreign source income of a nonresident (rents, royalties, interest, dividends and sales of inventory property) can be treated as effectively connected with a U.S. trade or business (‘‘ECI’’) and thus subject to net basis taxation. Economic equivalents of such enumerated types of foreign source income, such as interest equivalents (including letter of credit fees) and dividend equivalents, cannot constitute ECI under any circumstances. Moreover, some excluded foreign source income can in large part be attributable to busi- ness activities that take place in the United States. For example, a foreign satellite corporation with an office, satellite ground station or other fixed place of business in the United States may earn income with respect to the leasing of a satellite. Under current rules, such foreign source income would not be subject to U.S. tax as ECI even if it is attributable to the foreign corporation’s U.S. office. The proposal would expand the categories of foreign source income that could constitute ECI to include interest equivalents and dividend equivalents and to include other income that is attributable to an office or other fixed place of business in the U.S. The proposal would be effective for taxable years beginning after date of enactment. Limit basis step-up for imported pensions.— Under current law, a nonresident alien individual who anticipates receiving a distribution from a foreign pension plan may, under certain circumstances, establish U.S. residency, receive the distribution, claim a high basis in the plan distribution, and pay little or no U.S. tax on the distribution. Moreover, as a result of certain existing U.S. tax treaties, the individual may pay no foreign tax on the distribution. The proposal would prevent individuals from utilizing internal law and U.S. tax treaties to produce double non-taxation on foreign pension plan distributions. The proposal would modify the Internal Revenue Code to give an individual basis in a foreign pension plan distribution only to the extent the individual previously has been subject to tax (either in the United States or the foreign jurisdiction) on the amounts being distributed. The proposal would be effective for distributions occurring on or after the date of enactment. Replace sales-source rules.—If inventory is manufactured in the United States and sold abroad, Treasury regulations provide that 50 percent of the income from such sales is treated as earned in production activities and 50 percent in sales activities. The income from the production activities is sourced on the basis of the location of assets held or used to produce the income. The income from the sales activities (the remaining 50 percent) is sourced based on where title to the inventory transfers. If inventory is purchased in the United States and sold abroad, 100 percent of the sales income generally is deemed to be foreign source. These rules generally produce more foreign source income for United States tax purposes than is subject to foreign tax. This generally increases the U.S. exporters’ foreign tax credit limitation and allows U.S. exporters that operate in high-tax foreign countries to credit against their U.S. tax liability foreign income taxes levied in excess of the U.S. income tax rate. The proposal would require that the allocation between production and sales 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 3. FEDERAL RECEIPTS 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. tax treaty obligations that allow a credit for taxes paid or accrued on certain oil or gas income. Recapture overall foreign losses when controlled foreign corporation (CFC) stock is disposed.— Under the interest allocation rules of section 864(e), the value of stock in a CFC is added to the value of directly-owned foreign assets, and then compared to the value of domestic assets of a corporation (or a group of affiliated U.S. corporations) for purposes of determining how much of the corporation’s interest deductions should be allocated against foreign income and how much against domestic income. If these deductions against foreign income result in (or increase) an overall foreign loss which is then applied against U.S. income, section 904(f) recapture rules require subsequent foreign income or gain to be recharacterized as domestic. Recapture can take place when a taxpayer disposes of directly-owned foreign assets, for example. However, there may be no recapture when a shareholder disposes of stock in a CFC. The proposal would correct that asymmetry by providing that property subject to the recapture rules upon disposition under section 904(f)(3) would include stock in a CFC. The proposal would be effective on or after the date of enactment. Modify foreign office material participation exception applicable to inventory sales attributable 85 to nonresident’s U.S. office.—In the case of a sale of inventory property that is attributable to a nonresident’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. 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 taxable years beginning after December 31, 1999 and before January 1, 2011. 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, 2010. These taxes expired on December 31, 1995. Convert a portion of the excise taxes deposited in the Airport and Airway Trust Fund to costbased user fees assessed for Federal Aviation Administration (FAA) services.—The excise taxes that are levied on domestic air passenger tickets and flight segments, international departures and arrivals, and domestic air cargo are proposed to be reduced over time as more efficient, cost-based user fees for air traffic services are phased in beginning in fiscal year 2001. The Administration proposes to phase in implementation of the new fees over two years and raise sufficient revenue (excise taxes plus new fees) to support expected FAA operational and capital needs in the subsequent year. Increase excise tax on tobacco products and levy a youth smoking assessment on tobacco manufacturers. —Under current law, the 34-cents-per-pack excise tax on cigarettes is scheduled to increase by 5cents-per-pack effective January 1, 2002. The Adminis- 86 ANALYTICAL PERSPECTIVES tration proposes to accelerate the scheduled 5-centsper-pack increase in the excise tax on cigarettes and to increase the tax by an additional 25-cents-per-pack effective October 1, 2000. Tax rates on other taxable tobacco products will increase proportionately. In addition, beginning after 2003, the Administration proposes to levy an assessment on tobacco manufacturers if the youth smoking rate is not reduced by 50 percent. ground mining and 35 cents per ton for coal produced by surface mining, or 10 percent of the value of the coal at the mine. Amounts collected will be used to continue abandoned coal mine reclamation. The coal mining states and Indian Tribes have identified over $4.2 billion in remaining restoration needs. Each year, states, Indian Tribes and Federal agencies identify additional needs. Recover State bank supervision and regulation expenses (receipt effect).—The Administration proposes to require the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve to recover their respective costs for supervision and regulation of Statechartered banks and bank holding companies. 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 recoveries. Replace Harbor Maintenance Tax with the Harbor Services User Fee (receipt effect).—The Administration proposes to replace the ad valorem Harbor Maintenance Tax with a cost-based user fee, the Harbor Services User Fee. The user fee will finance construction and operation and maintenance of harbor activities performed by the Army Corps of Engineers, the costs of operating and maintaining the Saint Lawrence Seaway, and the costs of administering the fee. Through appropriation acts, the fee will raise an average of $980 million annually through FY 2005, which is less than would have been raised by the Harbor Maintenance Tax before the Supreme Court decision that the ad valorem tax on exports was unconstitutional. Maintain Federal Reserve surplus transfer to the Treasury.—In FY 2000, the Federal Reserve System transferred $3.752 billion from its capital account surplus funds to the Treasury. The Administration proposes in FY 2001 that the Federal Reserve System maintain the capital account surplus fund at the posttransfer level. Restore premiums for the United Mine Workers of America Combined Benefit Fund.—The Administration proposes legislation to restore the previous calculation of premiums charged to coal companies that employed the retired miners that have been assigned to them. By reversing the court decision of National Coal v. Chater, this legislation will restore a premium calculation that supports medical cost containment. Extend abandoned mine reclamation fees.—The abandoned mine reclamation fees, which are scheduled to expire on September 30, 2004, are proposed to be extended through September 30, 2014. These fees, which are levied on coal operators, generally are the lesser of 15 cents per ton for coal produced by under- Revise Army Corps of Engineers regulatory program fees.—The Army Corps of Engineers has not changed the fee structure of its regulatory program since 1977. The Administration proposes to pursue reasonable changes that would reduce the fees paid from many applicants and increase recovery from commercial applicants. Roll back Federal employee retirement contributions.—The Administration proposes to roll back to pre1999 levels the higher retirement contributions required of Federal employees by the Balanced Budget Act of 1997. The rollback is proposed to take effect in January 2001. Provide government-wide buyout authority (receipt effect).—The Administration proposes to provide government-wide buyout authority, which will lower employee contributions to the civil service retirement fund. 3. 87 FEDERAL RECEIPTS Table 3–3. EFFECT OF PROPOSALS ON RECEIPTS (In millions of dollars) Estimate 2000 Provide tax relief: Expand educational opportunities: Provide College Opportunity tax cut ...................................................................................... Provide incentives for public school construction and modernization .................................. Expand exclusion for employer-provided educational assistance to include graduate education ................................................................................................................................... Eliminate 60-month limit on student loan interest deduction ................................................ Eliminate tax when forgiving student loans subject to income contingent repayment ........ Provide tax relief for participants in certain Federal education programs ........................... 2001 2002 2003 2004 2005 2001–2005 .............. .............. –395 –36 –2,009 –174 –2,323 –419 –3,103 –739 –3,262 –1,020 –11,092 –2,388 –66 .............. .............. .............. –275 –23 .............. –3 –90 –80 .............. –7 ................ –87 ................ –7 ................ –89 ................ –7 ................ –93 ................ –6 –365 –372 ................ –30 Subtotal, expand educational opportunities ....................................................................... –66 –732 –2,360 –2,836 –3,938 –4,381 –14,247 Provide poverty relief and revitalize communities: Increase and simplify the Earned Income Tax Credit (EITC) 1 ............................................ Increase and index low-income housing tax credit per-capita cap ...................................... Provide New Markets Tax Credit ........................................................................................... Extend Empowerment Zone (EZ) tax incentives and authorize additional EZs .................. Provide Better America Bonds to improve the environment ................................................. Permanently extend the expensing of brownfields remediation costs .................................. Expand tax incentives for specialized small business investment companies (SSBICs) .... Bridge the Digital Divide ......................................................................................................... .............. .............. .............. .............. .............. .............. –* .............. –2,293 –6 –30 –36 –8 .............. –* –107 –1,936 –55 –222 –167 –41 –98 –* –272 –1,967 –168 –515 –333 –112 –152 –* –344 –1,992 –306 –743 –452 –214 –146 –* –289 –2,001 –448 –940 –568 –315 –140 –* –207 –10,189 –983 –2,450 –1,556 –690 –536 –* –1,219 Subtotal, provide poverty relief and revitalize communities ............................................. .............. –2,480 –2,791 –3,591 –4,142 –4,619 –17,623 Make health care more affordable: Assist taxpayers with long-term care needs 2 ....................................................................... Encourage COBRA continuation coverage ............................................................................ Provide tax credit for Medicare buy-in program .................................................................... Provide tax relief for workers with disabilities 2 ..................................................................... Provide tax relief to encourage small business health plans ............................................... Encourage development of vaccines for targeted diseases ................................................. .............. .............. .............. .............. .............. .............. –109 .............. .............. –18 –1 .............. –1,150 –41 –5 –128 –9 .............. –1,681 –858 –105 –143 –22 ................ –2,427 –1,149 –140 –158 –35 ................ –3,028 –1,286 –164 –165 –38 ................ –8,395 –3,334 –414 –612 –105 ................ Subtotal, make health care more affordable 2 ................................................................... .............. –128 –1,333 –2,809 –3,909 –4,681 –12,860 Strengthen families and improve work incentives: Provide marriage penalty relief and increase standard deduction ....................................... Increase, expand, and simplify child and dependent care tax credit 2 ................................. Provide tax incentives for employer-provided child-care facilities ........................................ .............. .............. .............. –248 –121 –42 –843 –589 –88 –1,536 –922 –121 –2,130 –1,288 –140 –4,637 –1,643 –148 –9,394 –4,563 –539 Subtotal, strengthen families and improve work incentives 2 ........................................... .............. –411 –1,520 –2,579 –3,558 –6,428 –14,496 .............. .............. –657 –2,185 –2,290 –4,034 –9,166 .............. .............. –157 –648 –1,878 –3,074 –5,757 –1 .............. .............. .............. .............. –18 –44 –25 214 –53 –35 –65 –61 137 –207 –61 –66 –108 104 –288 –92 –68 –161 66 –377 –135 –70 –236 29 –450 –341 –313 –591 550 –1,375 Promote expanded retirement savings, security, and portability: Establish Retirement Savings Accounts ................................................................................ Provide small business tax credit for automatic contributions for non-highly compensated employees ........................................................................................................................... Provide tax credit for plan start up and administrative expenses; provide for payroll deduction IRAs ....................................................................................................................... Provide for the SMART plan .................................................................................................. Enhance the 401(k) SIMPLE plan ......................................................................................... Accelerate vesting for qualified plans .................................................................................... Other changes affecting retirement savings, security and portability ................................... Subtotal, promote expanded retirement savings, security and portability ........................ –1 74 –1,045 –3,252 –4,800 –7,970 –16,993 Provide AMT relief for families and simplify the tax laws: Provide adjustments for personal exemptions and the standard deduction in the individual alternative minimum tax (AMT) ............................................................................... Simplify and increase standard deduction for dependent filers ............................................ Replace support test with residency test (limited to children) .............................................. Provide tax credit to encourage electronic filing of individual income tax returns 2 ............ Simplify, retarget and expand expensing for small business ............................................... Simplify the foreign tax credit limitation for dividends from 10/50 companies ..................... Other simplification ................................................................................................................. –72 –7 .............. .............. .............. –80 –1 –377 –42 –66 .............. –217 –168 –17 –544 –29 –97 –192 –206 –102 –23 –996 –33 –102 –207 –19 –46 –27 –1,312 –51 –107 –208 –86 10 –30 –1,650 –37 –112 –209 –135 27 –35 –4,879 –192 –484 –816 –663 –279 –132 Subtotal, provide AMT relief for families and simplify the tax laws 2 ............................... –160 –887 –1,193 –1,430 –1,784 –2,151 –7,445 Encourage philanthropy: Allow deduction for charitable contributions by non-itemizing taxpayers ............................. Simplify and reduce the excise tax on foundation investment income ................................ Increase limit on charitable donations of appreciated property ............................................ .............. .............. .............. –516 –49 –7 –1,062 –70 –47 –733 –71 –29 –765 –73 –20 –817 –75 –12 –3,893 –338 –115 88 ANALYTICAL PERSPECTIVES Table 3–3. EFFECT OF PROPOSALS ON RECEIPTS—Continued (In millions of dollars) Estimate 2000 2001 2002 2003 2004 2005 2001–2005 Clarify public charity status of donor advised funds ............................................................. * * * * * * * Subtotal, encourage philanthropy ...................................................................................... .............. –572 –1,179 –833 –858 –904 –4,346 Promote energy efficiency and improve the environment: Provide tax credit for energy-efficient building equipment .................................................... Provide tax credit for new energy-efficient homes ................................................................ Extend electric vehicle tax credit and provide tax credit for hybrid vehicles ....................... Provide 15-year depreciable life for distributed power property ........................................... Extend and modify the tax credit for producing electricity from certain sources ................. Provide tax credit for solar energy systems .......................................................................... .............. .............. .............. .............. .............. .............. –18 –82 .............. –1 –91 –9 –35 –150 –4 –1 –173 –19 –49 –194 –182 –2 –220 –25 –71 –134 –700 –3 –231 –34 –28 –73 –1,192 –3 –261 –45 –201 –633 –2,078 –10 –976 –132 Subtotal, promote energy efficiency and improve the environment ................................. Electricity restructuring ................................................................................................................ .............. .............. –201 3 –382 11 –672 20 –1,173 30 –1,602 41 –4,030 105 Modify international trade provisions: Extend and modify Puerto Rico economic-activity tax credit ................................................ Extend GSP and modify other trade provisions 3 .................................................................. Levy tariff on certain textiles/apparel produced in the CNMI 3 ............................................. .............. –10 .............. –35 –454 .............. –67 –858 169 –101 –940 169 –134 –884 169 –166 –248 169 –503 –3,384 676 Subtotal, modify international trade provisions 3 ............................................................... –10 –489 –756 –872 –849 –245 –3,211 Miscellaneous provisions: Make first $2,000 of severance pay exempt from income tax ............................................. Exempt Holocaust reparations from Federal income tax ...................................................... .............. –4 –43 –17 –174 –18 –180 –19 –138 –15 ................ ................ –535 –69 Subtotal, miscellaneous provisions .................................................................................... –4 –60 –192 –199 –153 ................ –604 Subtotal, provide tax relief 2 3 ......................................................................................... Refundable credits ........................................................................................................... –241 .............. –5,883 –23 –12,740 –679 –19,053 –736 –25,134 –2,218 –32,940 –2,343 –95,750 –5,999 Total gross tax relief including refundable credits 3 ................................................... –241 –5,906 –13,419 –19,789 –27,352 –35,283 –101,749 .............. 1 .............. .............. 12 1,872 5 15 22 20 1,392 10 47 37 19 1,357 15 67 39 19 1,351 21 88 40 19 1,374 26 104 42 18 7,346 77 321 180 95 71 328 121 65 45 26 585 .............. 4 .............. .............. 62 34 21 176 108 36 46 340 112 37 53 417 117 38 54 489 122 40 56 548 521 185 230 1,970 .............. –42 6 –239 11 –175 17 –157 24 –157 30 –160 88 –888 46 2,322 1,992 2,041 2,129 2,226 10,710 6 1 9 14 7 16 .............. 13 63 7 73 30 18 29 2 34 21 13 74 34 22 31 5 41 4 19 71 33 21 31 8 39 5 25 70 34 19 31 10 38 5 31 70 35 18 31 11 39 98 95 358 166 98 153 36 191 28 108 158 153 149 151 719 1 17 11 41 49 53 51 66 61 53 71 64 55 77 67 57 83 54 257 346 299 Eliminate unwarranted benefits and adopt other revenue measures: Limit benefits of corporate tax shelter transactions: Increase disclosure of certain transactions, modify substantial understatement penalty for corporate tax shelters, codify the economic substance doctrine, tax income from shelters involving tax-indifferent parties and impose a penalty excise tax on certain fees received by promotors and advisors ................................................................................. Require accrual of income on forward sale of corporate stock ........................................... Modify treatment of ESOP as S corporation shareholder .................................................... Limit dividend treatment for payments on certain self-amortizing stock .............................. Prevent serial liquidation of U.S. subsidiaries of foreign corporations ................................. Prevent capital gains avoidance through basis shift transactions involving foreign shareholders ................................................................................................................................ Prevent mismatching of deductions and income in transactions with related foreign persons ..................................................................................................................................... Prevent duplication or acceleration of loss through assumption of certain liabilities .......... Amend 80/20 company rules ................................................................................................. Modify corporate-owned life insurance (COLI) rules ............................................................. Require lessors of tax-exempt-use property to include service contract options in lease term ..................................................................................................................................... Interaction ................................................................................................................................ Subtotal, limit benefits of corporate tax shelter transactions ............................................ Other proposals: Require banks to accrue interest on short-term obligations ................................................. Require current accrual of market discount by accrual method taxpayers .......................... Modify and clarify certain rules relating to debt-for-debt exchanges ................................... Modify and clarify the straddle rules ...................................................................................... Provide generalized rules for all stripping transactions ........................................................ Require ordinary treatment for certain dealers of commodities and equity options ............ Prohibit tax deferral on contributions of appreciated property to swap funds ..................... Conform control test for tax-free incorporations, distributions, and reorganizations ............ Treat receipt of tracking stock in certain distributions and exchanges as the receipt of property ............................................................................................................................... Require consistent treatment and provide basis allocation rules for transfers of intangibles in certain nonrecognition transactions ....................................................................... Modify tax treatment of certain reorganizations involving portfolio stock ............................. Modify definition of nonqualified preferred stock ................................................................... 3. 89 FEDERAL RECEIPTS Table 3–3. EFFECT OF PROPOSALS ON RECEIPTS—Continued (In millions of dollars) Estimate 2000 Modify estimated tax provision for deemed asset sales ....................................................... Modify treatment of transfers to creditors in divisive reorganizations .................................. Provide mandatory basis adjustments for partners that have a significant net built-in loss in partnership property ....................................................................................................... Modify treatment of closely held REITs ................................................................................. Apply RIC excise tax to undistributed profits of REITs ........................................................ Allow RICs a dividends paid deduction for redemptions only in cases where the redemption represents a contraction in the RIC ........................................................................... Require REMICs to be secondarily liable for the tax liability of REMIC residual interest holders ................................................................................................................................ Deny change in method treatment to tax-free formations .................................................... Deny deduction for punitive damages ................................................................................... Repeal lower-of-cost-or-market inventory accounting method .............................................. Disallow interest on debt allocable to tax-exempt obligations .............................................. Require capitalization of mutual fund commissions .............................................................. Provide consistent amortization periods for intangibles ........................................................ Clarify recovery period of utility grading costs ...................................................................... Apply rules generally applicable to acquisitions of tangible assets to acquisitions of professional sports franchises ................................................................................................. Require recapture of policyholder surplus accounts ............................................................. Modify rules for capitalizing policy acquisition costs of life insurance companies .............. Increase the proration percentage for P&C insurance companies ....................................... Modify rules that apply to sales of life insurance contracts ................................................. Modify rules that apply to tax-exempt property casualty insurance companies .................. Subject investment income of trade associations to tax ....................................................... Impose penalty for failure to file an annual information return ............................................ Restore phaseout of unified credit for large estates ............................................................. Require consistent valuation for estate and income tax purposes ...................................... Require basis allocation for part sale, part gift transactions ................................................ Conform treatment of surviving spouses in community property States .............................. Include QTIP trust assets in surviving spouse’s estate ........................................................ Eliminate non-business valuation discounts .......................................................................... Eliminate gift tax exemption for personal residence trusts ................................................... Modify requirements for annual exclusion for gifts ............................................................... Increase elective withholding rate for nonperiodic distributions from deferred compensation plans ............................................................................................................................ Increase excise tax for excess IRA contributions ................................................................. Limit pre-funding of welfare benefits for 10 or more employer plans .................................. Subject signing bonuses to employment taxes ..................................................................... Clarify employment tax treatment of choreworkers ............................................................... Prohibit IRAs from investing in foreign sales corporations ................................................... Tighten the substantial understatement penalty for large corporations ................................ Require withholding on certain gambling winnings ............................................................... Require information reporting for private separate accounts ................................................ Increase penalties for failure to file correct information returns ........................................... Modify deposit requirement for FUTA .................................................................................... Reinstate Oil Spill Liability Trust Fund tax 3 .......................................................................... Repeal percentage depletion for non-fuel minerals mined on Federal and formerly Federal lands ............................................................................................................................ Impose excise tax on purchase of structured settlements ................................................... Require taxpayers to include rental income of residence in income without regard to the period of rental ................................................................................................................... Eliminate installment payment of heavy vehicle use tax 3 .................................................... Require recognition of gain on sale of principal residence if acquired in a tax-free exchange within five years of the sale ................................................................................. Limit benefits of transactions with ‘‘Identified Tax Havens’’ ................................................. Modify treatment of built-in losses and other attributes trafficking ....................................... Simplify taxation of property that no longer produces income effectively connected with a U.S. trade or business ....................................................................................................... Prevent avoidance of tax on U.S.-accrued gains (expatriation) ........................................... Expand ECI rules to include certain foreign source income ................................................ Limit basis step-up for imported pensions ............................................................................. Replace sales-source rules .................................................................................................... Modify rules relating to foreign oil and gas extraction income ............................................. Recapture overall foreign losses when CFC stock is disposed ........................................... Modify foreign office material participation exception applicable to inventory sales attributable to nonresident’s U.S. office ..................................................................................... 2001 2002 2003 2004 2005 2001–2005 .............. 3 314 15 90 18 –23 19 –15 20 –8 21 358 93 –41 .............. .............. 50 1 .............. 52 4 1 55 8 1 60 12 1 58 17 1 275 42 4 .............. 99 489 457 429 405 1,879 .............. 3 16 .............. 4 .............. .............. 12 5 59 92 459 11 23 –216 40 17 59 130 447 18 111 –220 65 29 59 137 371 24 98 34 82 42 61 144 372 30 83 259 91 55 63 151 154 35 64 445 99 148 301 654 1,803 118 379 302 377 2 .............. .............. .............. .............. .............. .............. .............. .............. 1 .............. 3 .............. .............. .............. .............. 43 65 536 48 13 12 180 .............. 33 5 2 19 .............. 271 –1 .............. 73 174 1,820 82 35 22 309 24 70 10 3 42 2 575 –1 20 113 285 2,191 98 39 23 325 23 78 14 4 59 2 600 ................ 20 141 522 2,413 115 43 24 341 22 83 18 5 75 2 636 5 22 139 782 1,328 133 48 25 358 21 106 21 5 92 2 618 14 20 509 1,828 8,288 476 178 106 1,513 90 370 68 19 287 8 2,700 17 82 .............. .............. .............. .............. .............. 3 .............. .............. .............. .............. .............. .............. .............. 1 92 5 48 16 26 20 5 6 .............. .............. 47 12 156 3 64 29 44 1 10 15 .............. 253 3 13 159 3 64 30 45 1 14 15 ................ 261 3 14 151 3 63 32 41 1 18 9 ................ 264 3 14 150 2 63 33 37 1 21 10 1,583 266 56 54 708 16 302 140 193 24 68 55 1,583 1,044 .............. 6 94 7 96 5 97 2 99 ................ 101 –2 487 12 .............. .............. 4 .............. 11 378 12 27 12 30 13 32 52 467 .............. .............. 1 10 36 78 13 52 136 11 40 143 11 36 151 11 35 161 56 199 669 * 3 .............. 2 .............. .............. 1 * 28 22 26 320 5 1 * 58 38 33 570 69 * * 107 39 34 600 112 * * 155 41 36 630 118 * * 212 42 38 660 124 * * 560 182 167 2,780 428 1 1 7 10 11 11 11 50 90 ANALYTICAL PERSPECTIVES Table 3–3. EFFECT OF PROPOSALS ON RECEIPTS—Continued (In millions of dollars) Estimate 2000 Subtotal, other proposals 3 2001 2002 2003 2004 2005 2001–2005 ................................................................................................. 143 3,542 7,221 7,635 8,565 9,478 36,441 Subtotal, eliminate unwarranted benefits and adopt other revenue measures 3 ........ Net tax relief including refundable credits 3 ..................................................................... 189 –52 5,864 –42 9,213 –4,206 9,676 –10,113 10,694 –16,658 11,704 –23,579 47,151 –54,598 Other provisions that affect receipts: Reinstate environmental tax on corporate taxable income 4 ..................................................... Reinstate Superfund excise taxes 3 ............................................................................................ Convert Airport and Airway Trust Fund taxes to a cost-based user fee system 3 .................. Increase excise tax on tobacco products and levy a youth smoking assessment on tobacco manufacturers 3 ....................................................................................................................... Recover State bank supervision and regulation expenses (receipt effect) 3 ............................ Maintain Federal Reserve surplus transfer to the Treasury ...................................................... Restore premiums for United Mine Workers of America Combined Benefit Fund .................. Extend abandoned mine reclamation fees 3 .............................................................................. Replace Harbor Maintenance tax with the Harbor Services User Fee (receipt effect) 3 ......... Revise Army Corps of Engineers regulatory program fees 3 .................................................... Roll back Federal employee retirement contributions ............................................................... Provide Government-wide buyout authority (receipt effect) ...................................................... .............. 152 .............. 725 707 724 432 762 1,399 438 772 1,500 434 785 1,522 437 797 1,522 2,466 3,823 6,667 446 .............. .............. .............. .............. .............. .............. .............. .............. 4,084 78 3,752 11 .............. –549 5 –427 –9 3,738 82 .............. 10 .............. –602 5 –619 –18 3,532 86 ................ 10 ................ –647 5 –160 –9 10,140 90 ................ 9 ................ –681 5 ................ ................ 9,700 95 ................ 9 218 –718 5 ................ ................ 31,194 431 3,752 49 218 –3,197 25 –1,206 –36 Total, other provisions 3 4 .................................................................................................... 598 9,101 5,189 5,527 12,304 12,065 44,186 * $500,000 or less 1 The proposal to increase and simplify the Earned Income Tax Credit has both receipts and outlay effects. The receipts effect for the proposal is –$305 million, –$304 million, –$314 million, –$326 million and –$339 million for fiscal years 2001–2005, respectively. The outlay effect is $2,003 million, $1,936 million, $1,967 million, $1,992 million and $2,001 million for fiscal years 2001–2005, respectively. 2 Amounts shown are the effect on receipts. 3 Net of income offsets 4 Net of deductibility for income tax purposes 3. 91 FEDERAL RECEIPTS Table 3–4. RECEIPTS BY SOURCE (In millions of dollars) Source 1999 Actual Estimate 2000 2001 2002 2003 2004 2005 Individual income taxes (federal funds): Existing law ............................................................................................................................ 879,480 951,945 Proposed Legislation (PAYGO) ........................................................................................ .................. –359 Legislative proposal, discretionary offset ......................................................................... .................. .................. 978,249 –5,634 –205 1,005,714 –10,125 –397 1,040,248 –14,215 –424 1,086,039 –19,554 –432 1,143,081 –25,821 –432 Total individual income taxes ................................................................................................ 951,586 972,410 995,192 1,025,609 1,066,053 1,116,828 Corporation income taxes: Federal funds: Existing law ....................................................................................................................... 184,670 192,285 Proposed Legislation (PAYGO) .................................................................................... .................. 110 Legislative proposal, discretionary offset ..................................................................... .................. .................. 189,594 3,942 119 190,189 4,405 102 191,800 3,105 110 196,090 205,076 3,150 .................. 119 131 193,655 194,696 195,015 199,359 Total Federal funds corporation income taxes ..................................................................... 879,480 184,670 192,395 205,207 Trust funds: Hazardous substance superfund ...................................................................................... 10 .................. .................. .................. .................. .................. .................. Proposed Legislation (PAYGO) .................................................................................... .................. .................. 1,115 664 674 668 673 Total corporation income taxes ............................................................................................. 184,680 192,395 194,770 195,360 195,689 200,027 205,880 383,559 60,909 132,268 408,583 68,180 136,515 427,322 72,573 143,695 446,421 75,805 150,290 465,244 79,003 156,694 484,401 82,259 163,258 511,676 86,890 172,612 1,515 2,629 1,639 2,621 1,674 2,661 1,697 2,699 1,719 2,736 1,740 2,773 1,762 2,803 Total employment and general retirement ............................................................................ 580,880 617,538 647,925 676,912 705,396 734,431 775,743 On-budget .......................................................................................................................... Off-budget .......................................................................................................................... 136,412 444,468 140,775 476,763 148,030 499,895 154,686 522,226 161,149 544,247 167,771 566,660 177,177 598,566 Unemployment insurance: Deposits by States 1 ......................................................................................................... 19,894 21,453 23,327 24,529 25,594 26,273 Proposed Legislation (PAYGO) .................................................................................... .................. .................. .................. .................. .................. .................. Federal unemployment receipts 1 .................................................................................... 6,475 6,668 6,873 7,010 7,127 7,260 Proposed Legislation (PAYGO) .................................................................................... .................. .................. .................. .................. .................. .................. Railroad unemployment receipts 1 ................................................................................... 111 67 54 97 123 124 27,411 1,297 7,405 286 102 Total unemployment insurance ............................................................................................. 36,501 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 ....................................................................... 26,480 28,188 30,254 31,636 32,844 33,657 Other retirement: Federal employees’ retirement—employee share ............................................................ 4,400 4,221 Proposed Legislation (non-PAYGO) ............................................................................. .................. .................. Proposed Legislation (PAYGO) .................................................................................... .................. .................. Non-Federal employees retirement 2 ............................................................................... 73 74 4,269 –9 –427 68 4,194 –18 –619 63 3,547 3,197 3,028 –9 .................. .................. –160 .................. .................. 51 46 43 Total other retirement ............................................................................................................ 4,473 4,295 3,901 3,620 3,429 3,243 3,071 Total social insurance and retirement receipts ................................................................... 611,833 650,021 682,080 712,168 741,669 771,331 815,315 On-budget .............................................................................................................................. Off-budget .............................................................................................................................. 167,365 444,468 173,258 476,763 182,185 499,895 189,942 522,226 197,422 544,247 204,671 566,660 216,749 598,566 Excise taxes: Federal funds: Alcohol taxes ..................................................................................................................... 7,386 Proposed Legislation (PAYGO) .................................................................................... .................. Tobacco taxes ................................................................................................................... 5,400 Proposed Legislation (PAYGO) .................................................................................... .................. Transportation fuels tax .................................................................................................... 849 Telephone and teletype services ...................................................................................... 5,185 Ozone depleting chemicals and products ........................................................................ 105 Other Federal fund excise taxes ...................................................................................... 368 7,267 –32 6,742 594 787 5,500 73 2,174 7,150 7,158 7,120 7,091 7,080 32 .................. .................. .................. .................. 7,158 7,844 8,013 7,938 7,869 5,446 4,985 4,709 4,018 3,756 808 793 811 817 836 5,821 6,142 6,471 6,833 7,231 73 22 9 .................. .................. 2,200 2,114 1,997 1,987 2,030 92 ANALYTICAL PERSPECTIVES Table 3–4. RECEIPTS BY SOURCE—Continued (In millions of dollars) Source 1999 Actual Proposed Legislation (PAYGO) .................................................................................... .................. Estimate 2000 2001 2002 2003 2004 2005 38 –74 –65 –69 –73 –77 28,614 28,993 29,061 28,611 28,725 Total Federal fund excise taxes ........................................................................................... 19,293 23,143 Trust funds: Highway ............................................................................................................................. Proposed Legislation (PAYGO) .................................................................................... Airport and airway ............................................................................................................. Legislative proposal, discretionary offset ..................................................................... Aquatic resources .............................................................................................................. Black lung disability insurance ......................................................................................... Inland waterway ................................................................................................................ Hazardous substance superfund ...................................................................................... Proposed Legislation (PAYGO) .................................................................................... Oil spill liability .................................................................................................................. Proposed Legislation (PAYGO) .................................................................................... Vaccine injury compensation ............................................................................................ Leaking underground storage tank ................................................................................... 39,299 .................. 10,391 .................. 374 596 104 11 .................. .................. .................. 130 216 34,311 .................. 9,222 .................. 336 577 104 .................. 204 173 .................. 131 183 Total trust funds excise taxes ............................................................................................... 51,121 45,241 48,062 50,792 51,713 53,141 54,687 Total excise taxes .................................................................................................................... 70,414 68,384 76,676 79,785 80,774 81,752 83,412 Estate and gift taxes: Federal funds ......................................................................................................................... 27,782 Proposed Legislation (PAYGO) ........................................................................................ .................. 30,482 4 31,975 329 34,172 721 35,494 777 37,831 846 36,151 878 Total estate and gift taxes ...................................................................................................... 30,486 32,304 34,893 36,271 38,677 37,029 Customs duties: Federal funds ......................................................................................................................... 17,727 20,149 Proposed Legislation (PAYGO) ........................................................................................ .................. –13 Trust funds ............................................................................................................................. 609 739 Proposed Legislation (PAYGO) ........................................................................................ .................. .................. Legislative proposal, discretionary offset ......................................................................... .................. .................. 21,405 –569 797 –30 –732 23,430 –880 870 –30 –803 25,262 –990 932 –30 –863 26,554 –917 978 –30 –908 27,921 –71 1,030 –30 –958 Total customs duties ............................................................................................................... 18,336 20,871 22,587 24,311 25,677 27,892 MISCELLANEOUS RECEIPTS: 3 Miscellaneous taxes .............................................................................................................. Proposed youth smoking assessment (PAYGO) ................................................................. United Mine Workers of America combined benefit fund .................................................... Proposed Legislation (PAYGO) ........................................................................................ Deposit of earnings, Federal Reserve System .................................................................... Legislative proposal, discretionary offset ......................................................................... Defense cooperation .............................................................................................................. Fees for permits and regulatory and judicial services ......................................................... Proposed Legislation (PAYGO) ........................................................................................ Legislative proposal, discretionary offset ......................................................................... Fines, penalties, and forfeitures ............................................................................................ Gifts and contributions .......................................................................................................... Refunds and recoveries ........................................................................................................ 101 .................. 148 .................. 25,917 .................. .................. 6,572 .................. .................. 2,738 186 –733 119 121 124 126 129 .................. .................. .................. .................. 7,379 142 138 132 127 122 .................. 11 10 10 9 32,452 25,664 30,196 31,296 32,489 .................. 3,856 109 115 120 6 6 6 6 6 7,509 7,965 8,726 9,549 10,378 .................. –2 –7 –7 .................. .................. 7 7 7 7 2,188 2,157 1,966 1,977 1,977 281 188 156 150 148 –192 –191 –190 –190 –190 132 7,280 118 9 33,662 126 6 10,972 290 7 1,979 149 –190 Total miscellaneous receipts ................................................................................................. 34,929 42,505 39,920 41,235 43,166 52,574 54,540 Total budget receipts .............................................................................................................. On-budget .............................................................................................................................. Off-budget .............................................................................................................................. 1,827,454 1,382,986 444,468 1,956,252 1,479,489 476,763 2,019,031 1,519,136 499,895 2,081,220 1,558,994 522,226 2,147,489 1,603,242 544,247 2,236,091 1,669,431 566,660 2,340,896 1,742,330 598,566 27,782 20,875 35,148 35,597 36,229 36,870 37,622 .................. 383 32 35 37 9,645 10,173 10,630 11,333 12,115 965 1,866 1,999 2,030 2,030 341 376 380 395 401 591 606 619 628 636 107 109 111 114 116 .................. .................. .................. .................. .................. 942 1,016 1,031 1,046 1,063 .................. .................. .................. .................. .................. .................. 338 348 351 355 134 137 139 141 110 189 191 195 198 202 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. 4. USER FEES AND OTHER COLLECTIONS In addition to collecting taxes and other receipts by the exercise of its sovereign powers, which is discussed in the previous chapter, the Federal Government collects income from the public from market-oriented activities. Examples of these collections include the sale of postage stamps and electricity, fees for admittance to national parks, premiums for deposit insurance, and rents and royalties for the right to extract oil from the Outer Continental shelf. Depending on the laws that authorize the collections, they can be credited directly to expenditure accounts as ‘‘offsetting collections,’’ where they are usually available for expenditure without further action by Congress, or they are credited to receipt accounts as ‘‘offsetting receipts,’’ which may be appropriated to expenditure accounts through action by the Congress. The budget refers to them as offsetting collections and offsetting receipts, because they are subtracted from gross outlays rather than added to taxes on the receipts side of the budget. 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. 1 Offsetting collections and receipts include most user fees, which are discussed below, as well as some amounts that are not user fees. Table 4–1 summarizes these transactions. For 2001, total offsetting collections and receipts from the public are estimated to be $214.8 billion, and total user fees are estimated to be $148.6 billion. The following section discusses user fees and the Administration’s user fee proposals. The subsequent section displays more information on offsetting collections and receipts. The offsetting collections and receipts by agency are also displayed in Table 20–1, ‘‘Outlays to the Public, Net and Gross,’’ which appears in Chapter 20 of this volume. TABLE 4–1. GROSS OUTLAYS, USER FEES, OTHER OFFSETTING COLLECTIONS AND RECEIPTS FROM THE PUBLIC, AND NET OUTLAYS (In billions of dollars) Estimate Actual 1999 2000 2001 1,910.3 2,001.6 2,049.8 137.0 70.3 137.6 74.4 147.2 67.6 Subtotal, offsetting collections and receipts from the public ... 207.3 212.0 214.8 Net outlays ................................................ 1,703.0 1,789.6 1,835.0 Gross outlays ............................................ Offsetting collections and receipts from the public: User fees 1 ........................................ Other ................................................. 1 Total user fees are shown below. They include user fees that are classified on the receipts side of the budget in addition to the amounts shown on this line. For additional details of total user fees, see Table 4–2. ‘‘Total User Fee Collections.’’ Total user fees: Offsetting collections and receipts from the public .......................................................... Receipts .......................................................... 137.0 1.0 137.6 1.1 147.2 1.5 Total user fees .................................................... 138.0 138.7 148.6 USER FEES I. Introduction and Background The Federal Government may charge user fees to those who benefit directly from a particular activity or those subject to regulation. According to the definition of user fees used in this chapter, Table 4–2 shows that user fees were $138.0 billion in 1999, and are estimated to increase to $138.7 billion in 2000 and to $148.6 billion in 2001, growing to an estimated $176.4 billion in 2005, including the user fee proposals proposed in this budget, which are shown in Table 4–3. This table shows that the Administration is proposing to increase user fees by an estimated $3.8 billion in 2001, growing to an estimated $7.7 billion in 2005. 1 Showing collections from business-type transactions as offsets on the spending side of the budget follows the concept recommended by the 1967 Report of the President’s Commis- Definition. The term ‘‘user fee’’ as defined here is fees, charges, and assessments levied on a class directly benefiting from, or subject to regulation by, a government program or activity, and to be utilized solely to support the program or activity. In addition, the payers of the fee must be limited 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 it is charged, including directly associated agency functions, not for unrelated programs or activities and not for the broad purposes of the Government or an agency. sion on Budget Concepts. The concept is discussed in Chapter 24: ‘‘Budget System and Concepts and Glossary’’ in this volume. 93 94 ANALYTICAL PERSPECTIVES 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 federally-owned buildings and facilities —Flood insurance premiums —Sales of commemorative coins User fees are earmarked to fund 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 different from general revenue, because they are not collected from the general public or broad segments of the public (e.g., income taxes or customs duties) and they are not used for the general purposes of government (e.g., 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 depends on fees, instead of 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. • Examples of business-type or market-oriented user fees include fees for the sale of postal services (the sale of stamps), electricity (e.g., sales by the Tennessee Valley Authority), payments for Medicare voluntary supplemental medical insurance, life insurance premiums for veterans, recreation fees for parks, NASA fees for shuttle services, the sale of weather maps and related information by the Department of Commerce, the sale of commemorative coins, and fees for the sale of books. • Examples of regulatory and licensing user fees include fees for regulating the nuclear energy industry, bankruptcy filing fees, immigration fees, food inspection fees, passport fees, and patent and trademark fees. User fees do not include all offsetting collections and receipts, such as the interest and repayments received from credit programs; proceeds from the sale of loans and other financial investments; interest, dividends, and other earnings; cost sharing contributions; the sale of timber, minerals, oil, commodities, and other natural resources; proceeds from asset sales (property, plant, and equipment); Outer Continental Shelf receipts; or spectrum auction proceeds. Neither do they include earmarked taxes (such as taxes paid to social insurance programs or excise taxes), or customs duties, fines, penalties, and forfeitures. poses, such as establishing policy for charging prices to the public for goods and services regardless of whether the proceeds are earmarked. Alternative definitions could, for example: • be narrower than the one used here, by excluding regulatory fees and analyzing them as a separate category. • be broader than the one used here, by: —eliminating the requirement that fees be earmarked. The definition would then include fees that go to the general fund in addition to those that are earmarked to finance the related activity. —including the sale of resources as well as goods and services, such as natural resources (e.g., timber, oil, or minerals) and property, plant, and equipment. —interpreting more broadly whether a program has private beneficiaries, or whether the proceeds are earmarked to benefit directly those paying the fee. A broader interpretation might include beneficiary- or liability-based excise taxes. 3 Alternative definitions. The definition used in this chapter is useful because it identifies goods, services, and regulations financed by earmarked collections and receipts. 2 Other definitions may be used for other pur- can be under the jurisdiction of other committees. See the Congressional Record, January 3, 1991, p. H31, item 8. 3 Beneficiary- and liability-based taxes are terms taken from the Congressional Budget Office, The Growth of Federal User Charges, August 1993, and updated in October 1995. Examples of beneficiary-based taxes include taxes on gasoline, which finance grants to States for highway construction, or taxes on airline tickets, which finance air traffic control activities and airports. An example of a liability-based tax is the excise tax that helps fund the hazardous substance superfund in the Environmental Protection Agency. This tax is paid by industry groups to finance environmental cleanup activities related to the industry activity but not necessarily caused by the payer of the fee. 2 The definition used here is similar to one the House of Representatives uses as a guide for purposes of committee jurisdiction. The definition helps differentiate between taxes, which are under the jurisdiction of the Ways and Means Committee, and fees, which What is the purpose of user fees? The purpose of user fees is to improve the efficiency and equity of certain Government activities, and to reduce the bur- 4. USER FEES AND OTHER COLLECTIONS den on the taxpayer to finance activities whose benefits accrue to a relatively limited number of people. • User fees that are set to cover the costs of production of goods and services can provide efficiency in the allocation of resources within the economy. They allocate goods and services to those who value them the most, and they signal to the government how much of the goods or services it should provide. Prices in private, competitive markets serve the same purposes. • User fees for goods and services that do not have special social benefits improve equity, or fairness, by requiring that those who benefit from an activity are the same people who pay for it. The public often perceives user fees as fair because those who benefit from the good or service pay for it in whole or in part, and those who do not benefit do not pay. When should the Government charge a fee? Discussions of whether to finance spending with a tax or a fee often focus on whether the benefits of the activity are to the public in general or to a limited group of people. As a general rule, if the benefits accrue to the public in general, then the program should be financed by taxes paid by the public; in contrast, if the benefits accrue to a limited number of private individuals or groups, then the program should be financed by fees paid by the private beneficiaries. For Federal programs where the benefits are entirely public or entirely private, applying this rule is relatively easy. For example, according to this rule, the benefits from national defense accrue to the public in general and should be (and are) financed by taxes. In contrast, the benefits of electricity sold by the Tennessee Valley Authority accrue exclusively to those using the electricity, and should be (and are) financed by user fees. In many cases, however, an activity has benefits that accrue to both public and to private groups, and it may be difficult to identify how much of the benefits accrue to each. Because of this, it can be difficult to know how much of the program should be financed by taxes and how much by fees. For example, the benefits from recreation areas are mixed. Fees for visitors to these areas are appropriate because the visitors benefit directly from their visit, but the public in general also benefits because these areas protect the Nation’s natural and historical heritage now and for posterity. As a further complication, where a fee may be appropriate to finance all or part of an activity, some consideration must be given to the ease of administering the fee. What should be the amount of the fee? For programs that have private beneficiaries, the amount of the fee should depend on the costs of producing the goods or services and the portion of the program that is for private benefits. If the benefit is primarily private, and any public benefits are incidental, the Admin- 95 istration supports fees that cover the full cost to the Government, including both direct and indirect costs. 4 The Administration is working to put cost accounting systems in place across the Government that would make the calculation of full cost more feasible. The difficulties in measuring full cost are associated in part with allocating to an activity the full costs of capital, retirement benefits, and insurance, as well as other Federal costs that may appear in other parts of the budget. Guidance in the Statement of Federal Financial Accounting Standards No. 4, Managerial Cost Accounting Concepts and Standards for the Federal Government (July 31, 1995), should underlie cost accounting in the Federal Government. Classification of user fees in the budget. As shown in Table 4–1, most user fees are classified as offsets to outlays on the spending side of the budget, but a few are classified on the receipts side of the budget. An estimated $1.5 billion in 2001 are classified this way and are included in the totals described in Chapter 3. ‘‘Federal Receipts.’’ They are classified as receipts because they are regulatory fees collected by the Federal Government by the exercise of its sovereign powers. The remaining user fees, an estimated $147.2 billion in 2001, are classified as offsetting collections and receipts on the spending side of the budget. Some of these are collected by the Federal Government by the exercise of its sovereign powers and would normally appear on the receipts side of the budget, but are required by law to be classified as offsetting collections or receipts. • An estimated $107.0 billion of user fees for 2001 are credited directly to expenditure accounts, and are generally available for expenditure when they are collected, without further action by the Congress. • An estimated $40.1 billion for 2001 are deposited in offsetting receipt accounts, and generally are not available to be spent unless appropriated by the Congress each year. As a further classification, the following Tables 4–2 and 4–3 identify the fees as discretionary or mandatory. These classifications are terms from the Budget Enforcement Act of 1990 as amended and are used frequently in the analysis of the budget. ‘‘Discretionary’’ in this chapter refers to fees generally controlled through annual appropriations acts and under the jurisdiction of the appropriations committees in the Congress. These fees offset discretionary spending under the discretionary caps. ‘‘Mandatory’’ refers to fees controlled by permanent laws and under the jurisdiction of the authorizing committees. These fees are subject to rules of paygo, whereby changes in law affecting mandatory programs and receipts cannot result in a net cost. Mandatory spending is sometimes referred to as direct spending. 4 Policies for setting user charges are promulgated in OMB Circular No. A–25: ‘‘User Charges’’ (July 8, 1993). These policies are required regardless of whether or not the proceeds are earmarked to finance the related activity. 96 ANALYTICAL PERSPECTIVES These and other classifications are discussed further in this volume in Chapter 24, ‘‘Budget System and Concepts and Glossary.’’ II. Current User Fees As shown in Table 4–2, ‘‘Total User Fee Collections,’’ total user fee collections (including those proposed in this budget) are estimated to be $148.6 billion in 2001, increasing to $176.4 billion in 2005. User fee collections by the Postal Service, Medicare premiums, and foreign military sales are the largest and are estimated to be more than two-thirds of all existing user fee collections in 2001. User fee collections are used to offset outlays in both the discretionary and mandatory parts of the budget. Discretionary user fee collections are estimated to be $16.6 billion in 2001. The Administration is proposing to make collections from Federal Aviation Administration (FAA) cost-based user fees, the new harbor services fee, and proposed fees for the Federal Deposit Insurance Corporation available to offset discretionary spending. III. User Fee Proposals The Administration is proposing the new or increased user fees shown in Table 4–3: ‘‘User Fee Proposals.’’ These proposals would increase user fee collections by an estimated $3.8 billion in 2001, increasing to $7.7 billion in 2005. A. User Fee Proposals to Offset Discretionary Spending 1. Proposals for Discretionary User Fees a. Offsetting collections deposited in appropriation accounts Department of Agriculture Food Safety and Inspection Service meat, poultry, and egg inspection fees.—This budget proposes a new user fee for the Food Safety and Inspection Service. Under the proposed fee the meat, poultry and egg industries would be required to reimburse the Federal government for the cost of the salaries and benefits and other direct costs for all in-plant 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 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. Animal and Plant Health Inspection Service (APHIS).—The budget proposes to establish fees to cover the cost of providing animal welfare inspections to recipients of APHIS services such as animal research centers, humane societies, and kennels. Fees would also be established to cover the cost of issuing biotechnology certificates to firms that manufacture products derived through biotechnological innovation. Grain Inspection, Packers and Stockyards Administration (GIPSA) licensing fees.—The budget proposes to charge the grain industry for GIPSA’s costs to review and maintain standards (such as grain quality and classification) that are used by the 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. Department of Commerce National Oceanic and Atmospheric Administration (NOAA), navigational assistance fees.—The Administration proposes to levy 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. Fisheries management fees.—The budget proposes to levy a fee to recover a portion of the costs of providing fisheries management and enforcement services. Department of Health and Human Services Food and Drug Administration (FDA) fees.—The budget seeks $19 million in new fees to finance FDA activities for the review of new medical devices and food additives, and for food export certifications. These fees will be used to augment current funding for these activities. Health Care Financing Administration (HCFA).— These proposals would establish fees for a variety of activities associated with the Medicare program, including: Managed care application and renewal fees.—The Administration proposes to charge managed care organizations a fee to cover the cost of reviewing initial applications and renewing annual contracts with Medicare. Proceeds from this fee would be used to offset funding for Federal administrative expenses related to managed care organization applications and renewals. Provider initial certification fees.—The Administration proposes to levy a fee on providers (e.g., home health agencies and skilled nursing facilities) 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 funding. 97 4. USER FEES AND OTHER COLLECTIONS Table 4–2. TOTAL USER FEE COLLECTIONS (In millions of dollars) Estimates 1999 actual 2000 2001 2002 2003 2004 2005 .............. 553 172 248 .............. 675 188 255 965 .............. 215 281 1,866 .............. 217 286 1,999 .............. 220 287 2,030 .............. 223 293 2,030 .............. 225 298 973 1,118 1,461 2,369 2,506 2,546 2,553 167 1,021 7,345 508 186 1,123 6,438 631 735 1,304 6,366 655 735 1,304 6,347 645 737 1,319 6,347 643 741 1,352 6,347 641 746 1,382 6,347 619 316 235 343 365 83 1,906 577 848 173 97 85 102 442 756 591 144 338 260 314 411 104 1,935 603 956 191 111 119 111 447 176 634 150 657 250 590 451 464 1,854 496 875 200 165 114 121 454 .............. 650 199 657 250 590 451 888 1,854 496 875 200 165 114 121 454 .............. 650 187 664 252 596 456 897 1,876 501 875 202 167 114 122 459 .............. 658 188 681 260 611 468 921 1,923 515 875 207 171 114 125 471 .............. 674 191 696 264 625 478 942 1,965 525 875 212 175 114 128 481 .............. 689 195 16,104 15,238 16,600 16,983 17,073 17,288 17,458 883 257 2,889 1,111 276 2,489 1,586 275 2,697 1,557 275 3,162 1,633 275 3,234 1,697 275 3,195 1,727 275 3,140 21,570 610 1,300 460 1,813 1,696 40 1,416 11,624 6,093 860 350 61,957 6,818 244 21,744 575 1,498 824 1,871 1,651 41 1,545 10,560 6,620 374 308 63,998 6,590 287 23,169 586 1,483 1,083 1,922 1,724 1,007 1,756 10,760 7,140 590 326 67,421 6,718 315 25,631 604 1,488 1,013 2,001 1,720 1,004 1,868 10,890 7,677 664 300 70,000 6,826 326 28,214 621 1,516 1,087 2,074 1,686 1,002 1,986 10,920 8,286 1,014 321 72,750 7,078 313 30,854 629 1,524 1,160 2,150 1,643 1,038 2,121 11,020 8,909 1,548 347 74,100 7,419 329 33,694 637 1,531 1,233 2,229 1,606 1,056 2,266 11,150 9,539 2,336 388 75,650 7,565 339 Subtotal, mandatory offsetting collections and receipts ............................................................... 120,880 122,362 130,558 137,006 144,010 149,958 156,361 Subtotal, offsetting collections and receipts .......................................................................................... 136,984 137,600 147,158 153,989 161,083 167,246 173,819 TOTAL, User fees .................................................................................................................................. 137,957 138,718 148,619 156,358 163,589 169,792 176,372 Receipts Proposed FAA user fees to replace excise taxes 1 ............................................................................... Harbor maintenance and inland waterway fees 2 ................................................................................... Agricultural quarantine inspection fees ................................................................................................... Other governmental receipt user fees .................................................................................................... Subtotal, governmental receipts ........................................................................................................ Offsetting Collections and Receipts from the Public Discretionary Department of Agriculture: Food safety inspection and other fees .................................................. Department of Commerce: Patent and trademark, fees for weather services, and other fees ...... Department of Defense: Commissary and other fees ....................................................................... Department of Energy: Federal Energy Regulation Commission and other fees ............................ Department of Health and Human Services: Food and Drug Administration, Health Care Financing Administration, and other fees ................................................................................................. Department of the Interior: Bureau of Land Management and other fees ....................................... Department of Justice: Antitrust and other fees ................................................................................ Department of State: Visa, passport, and other fees ........................................................................ Department of Transportation: Coast Guard and other fees ............................................................ Department of the Treasury: Sale of commemorative coins and other fees ................................... Department of Veterans Affairs: Medical care and other fees ......................................................... National Aeronautics and Space Administration: Reimbursement for the use of NASA services .. Federal Communications Commission: Regulatory and other fees .................................................. Federal Trade Commission: Regulatory and other fees ................................................................... Legislative Branch: Library of Congress and copyright fees ............................................................. National Credit Union Administration: Stock subscription fees ......................................................... Nuclear Regulatory Commission: Regulatory fees ............................................................................ Panama Canal Commission: Fees for use of the canal ................................................................... Securities and Exchange Commission: Regulatory fees ................................................................... All other agencies, discretionary user fees ........................................................................................ Subtotal, discretionary offsetting collections and receipts ........................................................... Mandatory Department of Agriculture: Federal crop insurance and other fees .................................................. Department of Defense: Commissary surcharge and other fees ...................................................... Department of Energy: Proceeds from the sale of energy and other fees: ..................................... Department of Health and Human Services: Medicare Part B insurance premiums, and other fees .................................................................................................................................................. Department of the Interior: Recreation and other fees ..................................................................... Department of Justice: Immigration and other fees .......................................................................... Department of Labor: Insurance premiums to guarantee private pensions and other fees ............ Department of the Treasury: Customs, bank regulation, and other fees ......................................... Department of Veterans Affairs: Veterans life insurance and other fees ......................................... Corps of Engineers: Harbor services and other fees ........................................................................ Federal Emergency Management Agency: Flood insurance fees .................................................... International Assistance Programs: Foreign military sales ................................................................ Office of Personnel Management: Federal employee health and life insurance fees ..................... Federal Deposit Insurance Corporation: Deposit insurance fees ...................................................... National Credit Union Administration: Credit union share insurance and other fees ...................... Postal Service: Fees for postal services (e. g., sale of stamps) ...................................................... Tennessee Valley Authority: Proceeds from the sale of energy ....................................................... All other agencies, mandatory user fees ........................................................................................... 1 Gross revenue increase from proposed fees. Current aviation excise taxes, which are not user fees, will gradually be converted to cost-based user fees. While considered governmental receipts, the following proceeds from the fees, net of income tax offsets, would be made available to offset discretionary spending: FAA collections available for spending ................................................................................................................................................................................................. 2 The 1999 2000 ............ ............ 2001 724 2002 2003 2004 2005 1,399 1,499 1,522 1,522 Budget proposes to convert proceeds to offsetting collections for the Corps of Engineers. While the fee collection will be mandatory, proceeds from the fee will be made available to offset discretionary spending. 2000–05 6,667 98 ANALYTICAL PERSPECTIVES Table 4–3. USER FEE PROPOSALS (estimated collections in millions of dollars) 2001 2002 2003 2004 2005 2001–2005 A. USER FEE PROPOSALS TO OFFSET DISCRETIONARY SPENDING 1. Proposals for Discretionary User Fees a. Offsetting collections deposited in appropriation accounts Department of Agriculture Food Safety Inspection Service fees .......................................................................................................................... Animal and Plant Health Inspection Service .............................................................................................................. Grain Inspection, Packers and Stockyards Administration ......................................................................................... 534 11 23 641 11 23 641 11 23 641 11 23 641 11 23 3,098 55 115 Department of Commerce National Oceanic and Atmospheric Administration, Navigational assistance fees .................................................... Fisheries management fees ........................................................................................................................................ 14 20 14 20 14 20 14 20 14 20 70 100 Department of Health and Human Services Food and Drug Administration fees ............................................................................................................................ Health Care Financing Administration fee proposals: Managed care application and renewal fees ......................................................................................................... Provider initial certification fees .............................................................................................................................. Provider recertification fees ..................................................................................................................................... Paper claims submission fees ................................................................................................................................ Duplicate and unprocessable claims fees .............................................................................................................. Increase Medicare+Choice fees .............................................................................................................................. Nursing home criminal abuse registry fee .............................................................................................................. 19 19 19 19 19 95 21 13 50 83 53 131 4 21 13 50 83 53 130 4 21 13 50 83 53 129 4 21 13 50 83 53 128 4 21 13 50 83 53 128 4 105 65 250 415 265 646 20 Department of the Interior User fees on Outer Continental Shelf lands .............................................................................................................. 10 10 10 10 10 50 Department of Justice Hart-Scott Rodino pre-merger filing fees .................................................................................................................... 38 38 38 38 38 190 Department of Transportation Coast Guard, navigational services fees .................................................................................................................... Federal Railroad Administration, rail safety inspection fees ...................................................................................... Hazardous materials transportation safety fees ......................................................................................................... Surface Transportation Board fees ............................................................................................................................. 212 103 19 17 636 103 19 17 644 103 19 17 660 103 19 17 674 103 19 17 2,826 515 95 85 Department of the Treasury Customs, automation modernization fee ..................................................................................................................... 210 210 210 210 210 1,050 Federal Trade Commission Hart-Scott Rodino pre-merger filing fees .................................................................................................................... 38 38 38 38 38 190 National Transportation Safety Board Commercial accident investigation fees ...................................................................................................................... 10 10 10 10 10 50 Department of Justice Immigration premium processing fee .......................................................................................................................... Increase inspection user fees ..................................................................................................................................... 17 167 17 167 17 167 17 167 17 167 85 835 Department of Transportation Pipeline safety fees ..................................................................................................................................................... 11 12 12 12 12 59 Environmental Protection Agency Pesticide registration fees ........................................................................................................................................... Pre-manufacture notice (PMN) fees ............................................................................................................................ 16 4 ............ 8 ............ 8 ............ 8 ............ 8 16 36 Nuclear Regulatory Commission Extend Nuclear Regulatory Commission user fees .................................................................................................... 295 295 295 295 295 1,475 Subtotal, proposals for discretionary user fees ...................................................................................................... 2,143 2,662 2,669 2,684 2,698 12,856 92 96 102 106 111 507 417 361 313 315 296 1,702 Department of Transportation Federal Aviation Administration cost-based user fees (governmental receipt) 2 ....................................................... 965 1,866 1,999 2,030 2,030 8,890 Subtotal, proposals for mandatory user fees to offset discretionary spending ..................................................... 1,474 2,323 2,414 2,451 2,437 11,099 Subtotal, user fee proposals to offset discretionary spending .............................................................................. 3,617 4,985 5,083 5,135 5,135 23,955 b. Offsetting collections deposited in receipt accounts 2. Proposals for Mandatory User Fees to Offset Discretionary Spending a. Offsetting collections deposited in appropriation accounts Federal Deposit Insurance Corporation State bank exam fees ................................................................................................................................................. b. Offsetting collections deposited in receipt accounts Corps of Engineers Harbor services user fee, replaces harbor maintenance tax 1 ................................................................................... c. Receipts 99 4. USER FEES AND OTHER COLLECTIONS Table 4–3. USER FEE PROPOSALS—Continued (estimated collections in millions of dollars) 2001 2002 2003 2004 2005 69 ............ ............ ............ ............ 69 138 122 122 122 122 626 104 107 109 112 114 546 ............ 6 28 7 36 13 48 13 50 13 162 52 –180 226 392 418 590 1,446 ............ 3 ............ 73 3 8 74 4 26 76 4 26 74 5 26 297 19 86 ............ ............ ............ ............ ............ ............ 424 1,036 465 1,059 889 2,095 Subtotal user fee proposals to offset mandatory spending .................................................................................... 140 574 776 2,279 2,518 6,287 Total user fee proposals ................................................................................................................................................ 3,757 5,559 5,859 7,414 7,653 30,242 B. USER FEE PROPOSALS TO OFFSET MANDATORY SPENDING a. Offsetting collections deposited in appropriation accounts Department of Agriculture Federal crop insurance ................................................................................................................................................ Department of Labor Implement alien labor certification fees ...................................................................................................................... Federal Emergency Management Agency Flood map license fee for flood map modernization .................................................................................................. b. Offsetting collections deposited in receipt accounts Department of Agriculture Recreation and entrance fees ...................................................................................................................................... Concession, land use, right of way, and filming permits ............................................................................................ Department of Health and Human Services Medicare premiums ...................................................................................................................................................... Department of the Interior Recreation and entrance fees ..................................................................................................................................... Filming and special use permits fees ......................................................................................................................... Hardrock mining production fees ................................................................................................................................ Department of the Treasury Customs, extend conveyance/passenger fee ............................................................................................................. Customs, extend merchandise processing fee ........................................................................................................... 2001–2005 1 The amounts shown here are the amounts available to offset discretionary spending. This is the total amount from the proposed harbor services user fee, less three-fourths (to account for the income tax offset) of the tax revenues that would be lost from repealing the existing harbor maintenance tax. 2 Gross revenue increase from proposed fees. Current aviation excise taxes, which are not user fees, will gradually be converted to cost-based user fees. While considered governmental receipts, the following proceeds from the fees, net of income tax offsets, would be made to offset discretionary spending: 2001 FAA collections available for spending ............................................................................................................................................................................................... Provider recertification fees.—The Administration proposes to levy a fee on providers who are recertified for the Medicare program. By statute, skilled nursing facilities must be surveyed every year, home health agencies 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 funding. Paper claims submission fees.—The Administration proposes to charge providers $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 to offset Contractor funding related to claims processing. Duplicate and unprocessable claims fees.—The Administration 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 to offset Contractor funding related to claims processing. Increase in the Medicare+Choice fees.—The Administration proposes to increase the fee on Medicare+Choice plans by approximately $131 million 724 2002 2003 2004 2005 1,399 1,499 1,522 1,522 2001–05 6,667 in 2001. The fee was authorized at $100 million in the Balanced Budget Act of 1997 but reduced to approximately $19 million (for 2001) by the Balanced Budget Refinement Act of 1999. This increase would be used to maintain the current level of effort in providing information to Medicare beneficiaries regarding the Medicare+Choice program. Nursing home criminal abuse registry fee.—The Administration proposes to charge nursing facilities a fee to query a nursing home criminal abuse registry. Proceeds from the fee would be used to fund the operation and maintenance of the registry. Department of the Interior User fees on Outer Continental Shelf lands.—The Administration proposes new and modifications to existing user fees on the Minerals Management Service program that supports energy and mineral exploration, development and production on the Outer Continental lands such as increasing rental rates, implementing a bidding fee, and charging for violation re-inspections. Collections would be available upon appropriation to fund royalty and offshore minerals management activities. Department of Justice Hart-Scott-Rodino pre-merger filing fees.—The Administration proposes to restructure the Hart- Scott- 100 Rodino fee, which is charged to acquiring firms in mergers. Fees are collected by the Federal Trade Commission (FTC) and divided evenly between the FTC and the Antitrust Division in the Department of Justice. Department of Transportation Coast Guard, navigational services fees.—The Administration proposes to levy a fee on U.S. and foreign commercial cargo and cruise vessels 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, ice breaking, and vessel traffic services. Fishing and recreational vessels would be exempt. Federal Railroad Administration, rail safety inspection fees.—This proposed fee would offset the costs of the Federal Railroad Administration’s safety inspection program. An estimated $103 million in fees would be collected from railroad carriers based upon a calculation of their rail usage. Hazardous materials transportation safety fees.—Beginning late in 2001, hazardous materials transportation safety activities previously financed by general fund appropriations to the Research and Special Programs Administration are proposed to be financed instead by an increase in hazardous materials registration fees. Authorizing legislation will be proposed to increase the fees paid by shippers and carriers of hazardous materials by an estimated $19 million in 2001 to fund these safety activities. 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, i.e. railroads and shippers. Department of the Treasury Customs, automation modernization fee.—The Administration proposes to establish a fee to offset the costs of modernizing automated commercial operations of the U. S. Customs Service. Fees would finance the development of the Automated Commercial Environment (ACE), which is critical to maintain the ability of the U. S. Customs Service to process the increasing volume of trade. Subsequent to the budget, authorization legislation will be transmitted to allow the Secretary to establish the fee. Federal Trade Commission (FTC) Hart-Scott-Rodino pre-merger filing fees.—The Administration proposes to restructure the Hart- ScottRodino fee, which is charged to acquiring firms in mergers. Fees are collected by the Federal FTC and divided evenly between the FTC and the Antitrust Division in the Department of Justice. National Transportation Safety Board (NTSB) ANALYTICAL PERSPECTIVES Commercial accident investigation fees.—To offset a portion of the growing cost of commercial accident investigations by the NTSB, a new aviation accident recovery and investigation fee is proposed. This fee, which would be paid by commercial air, motor, ocean, rail, and pipeline carriers based on an approximation of risk, would collect an estimated $10 million in 2001. b. Offsetting collections deposited in receipt accounts Department of Justice Immigration premium processing fee.—This is a voluntary fee paid in addition to existing user fees charged for business visa processing that will guarantee expedited processing and direct liaison with the Immigration and Naturalization Service (INS). The INS estimates that $17 million of the projected $80 million in annual receipts will be used for expedited processing. The remainder will be earmarked for fraud investigations ($8 million), reduction of backlog, and infrastructure improvements ($55 million). Increase inspection user fees.—Congress established the user fee account to cover the full cost of air and sea passenger inspections. The Administration is proposing to increase the per passenger inspection fee from $6 to $8 and eliminate an exemption from the inspection fee for cruise ship passengers. The increase will be used solely to defray inspection expenses. Department of Transportation Pipeline safety fees.—The Administration proposes to increase offsetting collections from the pipeline safety fund by an estimated $11 million in user fees in 2001. These fees would fund grants to States to inspect intrastate pipelines, damage prevention grants to implement best practices of damage prevention, and additional research, training and risk assessment. 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. 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 user fees.— Under current law, the NRC must recover approximately 100 percent of its budget (less appropriations from the Nuclear Waste Fund) from licensing, inspection, and annual fees charged to its applicants and licensees through 2000. Unless the law is extended, this requirement will revert to 33 percent of NRC’s budget. Because of fairness and equity concerns related to charging NRC licensees for expenses that do not 101 4. USER FEES AND OTHER COLLECTIONS provide a direct benefit to them, the Administration proposes to extend the requirement to collect fees at approximately 98 percent of the NRC’s budget in 2001, 96 percent in 2002, 94 percent in 2003, 92 percent in 2004, and 90 percent in 2005. 2. Proposals for Mandatory User Fees to Offset Discretionary Spending a. Offsetting collections deposited in appropriation accounts Federal Deposit Insurance Corporation (FDIC) Recovery of supervision and regulation expenses.—The Administration proposes to require the FDIC and the Federal Reserve to recover their respective costs for supervision and regulation of state-chartered banks and bank holding companies. Currently, supervision and regulation expenses are funded from deposit insurance premiums (FDIC) and interest earnings on Treasury securities (Federal Reserve). The FDIC’s collections would finance its state bank supervision and regulation operations. b. Offsetting collections deposited in receipt accounts Corps of Engineers Harbor services fee.—The Administration proposes to replace collection of the ad valorem harbor maintenance tax with a cost-based user fee, the harbor services user fee. The user fee will finance construction, operation, and maintenance of harbor activities performed by the Corps of Engineers, the costs of operating and maintaining the Saint Lawrence Seaway, and the costs of administering the fee. Through appropriations acts, the fee will raise an average of $980 million annually through 2005, which is less than would have been raised by the harbor maintenance tax before the Supreme Court decision that the ad valorem tax on exports was unconstitutional. While the collections from the harbor services fee would be mandatory, collections would be available to offset discretionary spending. c. Receipts Federal Aviation Administration (FAA), cost-based user fees.—The Budget proposes to reduce the existing aviation excise taxes over time as more efficient, costbased user fees for air traffic services are phased in beginning in 2001. Under this proposal, the collections each year from the new cost-based user fees and the existing excise taxes combined would be equal to the total budget resources requested for the FAA in each succeeding year. In 2001, this proposal would result in the collection of $1.0 billion in additional aviation user charges. These charges will be deposited into a governmental receipt account and be made available for FAA discretionary spending. Proposals to Department of Agriculture Federal crop insurance.—The President’s Budget contains a proposal to strengthen the farm safety net that includes nearly $1 billion in crop insurance reforms. These reforms include a crop insurance premium discount which is expected to attract new participants to the crop insurance program and induce current participants to purchase higher coverage levels. Both of these expected outcomes will result in an increase in gross premiums, a portion of which are paid by producers. The estimated increase in producer-paid premiums as a result of the safety net proposal is $69 million, as shown in Table 4–3. Department of Labor Implement alien labor certification fees.—The proposal would establish a new fee, charged to businesses, for processing of alien labor certification applications by the Department of Labor. The fee proceeds would offset the costs of administering and enforcing the alien labor program, and provide reemployment and training assistance to U.S. workers who have been dislocated from their jobs. Federal Emergency Management Agency (FEMA) Flood map license fee.—The Administration proposes to establish a $12 license fee on the use of FEMA’s flood hazard maps to support a multi-year program to update and modernize FEMA’s inventory of flood-plain maps (100,000 maps). Accurate and easy to use flood hazard maps are essential in determining if a property is located in a flood plain. The maps allow lenders to meet their statutory obligation of requiring the riskprone homes they insure to carry flood insurance, and allow homeowners to assess their risk of flood damage. The maps are the basis for developing appropriate riskbased flood insurance premium charges, and improved maps will result in a more actuarially sound insurance program. b. Offsetting collections deposited in receipt accounts Department of Transportation B. User Fee Spending a. Offsetting collections deposited in appropriation accounts Offset Mandatory Department of Agriculture Recreation and entrance fees.—The Administration proposes to permanently extend the current pilot program which expires in 2001. The United States Forest Service would be allowed to collect increased recreation and entrance fees and use the receipts without further appropriation for facility improvements and new services. The Forest Service would also be authorized to use collections from existing fees for similar improvements and services. Concession, land use, right of way, and filming permits. This budget proposes to collect fair market value from a variety of forest uses, including special use permits for rights-of-way on Forest Service lands (e.g., for oil and gas pipelines, phone lines, and optic cables), recreational concessions, marinas, and film, motion pic- 102 ANALYTICAL PERSPECTIVES ture, and other similar uses. Funds would be available for spending one year after these collections. Department of Health and Human Services Medicare premiums for retirees under the age of 65 and displaced workers.—The Administration proposes, in the context of the President’s Medicare Reform Plan, 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 offset by the reduction in premium collections due to the Medicare savings proposals. Medicare premiums for prescription drug benefit.— The President’s Medicare reform plan includes a prescription drug benefit which is financed through a 50 percent premium. After paying the premium, Medicare beneficiaries receive first-dollar coverage of prescription drugs up to a $5,000 limit once the benefit is fully implemented. Department of the Interior Recreation and entrance fees.—The Administration proposes to permanently extend the current pilot program which expires in 2001. The National Park Service, Fish and Wildlife Service, and the Bureau of Land Management would be allowed to collect increased recreation and entrance fees and use the receipts without further appropriation for facility improvements and new services. Filming and special use permits fees.—The Administration proposes to authorize the National Park Service and other land management agencies, including the Department of Agriculture’s Forest Service, to increase fees for permits to use land and facilities for the making of motion pictures, television productions, still photos, sound tracks and other similar purposes. Collections would be available without further appropriations to cover related Government costs (as currently authorized) and provide a fair return to the Government. Hardrock mining production fees.—The Administration proposes to charge mining companies a 5% fee on net smelter production from hard rock mining on public domain or reserved public domain Federal lands. Department of the Treasury Extend Customs conveyance and passenger and merchandise processing fees.—Under existing legislation, the Customs Conveyance/Passenger Fee and the Merchandise Processing Fee will expire on September 30, 2003. The Administration proposes to extend both of these fees starting on October 1, 2003. OTHER OFFSETTING COLLECTIONS AND RECEIPTS Table 4–4 shows that total offsetting collections and receipts from the public are estimated to be $214.8 billion in 2001. Of these, an estimated $141.4 billion are offsetting collections credited to appropriation accounts and an estimated $73.4 billion are deposited in offsetting receipt accounts. The user fees in Table 4–4 were discussed in the previous section. Major offsetting collections deposited in expenditure accounts that are not user fees are precredit reform loan repayments, collections from States to supplement payments in the supplemental security income program, and collections for the Federal Savings and Loan resolution fund. Major offsetting receipts that are not user fees include spectrum auction receipts, rents and royalties for oil and gas on the Outer Continental Shelf, and interest income. Table 4–5 includes all offsetting receipts deposited in receipt accounts. These include payments from one part of the Government to another, called intragovernmental transactions, and collections from the public. These receipts are offset (deducted) from outlays in the Federal budget. In total, offsetting receipts are estimated to be $413.2 billion in 2001— $339.9 billion are intragovernmental transactions, and $73.4 billion are from the public, shown in the table as proprietary receipts and offsetting governmental receipts. As noted above, offsetting collections and receipts by agency are also displayed in Table 20–1, ‘‘Outlays to the Public, Net and Gross,’’ which appears in Chapter 20 of this volume. 103 4. USER FEES AND OTHER COLLECTIONS Table 4–4. OFFSETTING COLLECTIONS AND RECEIPTS FROM THE PUBLIC (In millions of dollars) 1999 Actual Estimate 2000 2001 Offsetting collections credited to expenditure accounts: User fees: Postal service stamps and other postal fees .................................................................................................................................................... Defense Commissary Agency ............................................................................................................................................................................ Employee contributions for employees and retired employees health benefits funds .................................................................................... Sale of energy: Tennessee Valley Authority ........................................................................................................................................................................... Bonneville Power Administration ................................................................................................................................................................... All other user fees .............................................................................................................................................................................................. 61,957 4,967 4,853 63,998 4,999 5,249 67,421 4,999 5,622 6,818 2,539 17,904 6,590 2,309 17,290 6,718 2,345 19,929 Subtotal, user fees ......................................................................................................................................................................................... 99,038 100,435 107,034 Other collections credited to expenditure accounts: Pre-credit reform loan repayments .................................................................................................................................................................... Supplemental security income (collections from the States) ............................................................................................................................ Federal Savings and Loan Insurance Corporation resolution fund .................................................................................................................. All other collections ............................................................................................................................................................................................ 14,919 3,219 3,784 15,417 14,977 3,310 2,188 16,524 14,787 3,410 624 15,564 Subtotal, other collections ....................................................................................................................................................................................... 37,339 36,999 34,385 Subtotal, collections credited to expenditure accounts .............................................................................................................................................. 136,377 137,434 141,419 User fees: Medicare premiums ............................................................................................................................................................................................ Foreign military sales program ........................................................................................................................................................................... Immigration fees ................................................................................................................................................................................................. Customs fees ...................................................................................................................................................................................................... All other user fees .............................................................................................................................................................................................. 21,561 11,624 1,053 1,210 2,498 21,735 10,560 1,219 1,255 2,396 23,160 10,760 1,389 1,294 3,521 Offsetting receipts: Subtotal, user fees deposited in receipt accounts ........................................................................................................................................ 37,946 37,165 40,124 Other collections deposited in receipt accounts: Spectrum auction receipts .................................................................................................................................................................................. OCS rents, bonuses, and royalties .................................................................................................................................................................... Interest income ................................................................................................................................................................................................... All other collections deposited in receipt accounts ........................................................................................................................................... 1,505 3,098 9,441 18,941 2,076 3,550 10,971 20,794 3,559 3,691 13,564 12,426 Subtotal, other collections deposited in receipt accounts ............................................................................................................................ 32,985 37,391 33,240 Subtotal, collections deposited in receipt accounts ............................................................................................................................................... 70,931 74,556 73,364 Total, offsetting collections and receipts from the public ................................................................................................................................... 207,308 211,990 214,783 Total, offsetting collections and receipts excluding off-budget ................................................................................................................................... 145,331 147,976 147,346 ADDENDUM: User fees that are offsetting collections and receipts 1 ......................................................................................................................................... Other offsetting collections and receipts from the public ...................................................................................................................................... 136,984 70,324 137,600 74,390 147,158 67,625 207,308 211,990 214,783 Total, offsetting collections and receipts from the public ............................................................................................................................... 1 Excludes user fees that are classified on the receipts side of the budget. For total user fees, see Table 4.1 or Table 4.2. 104 ANALYTICAL PERSPECTIVES Table 4–5. OFFSETTING RECEIPTS BY TYPE (In millions of dollars) Source 1999 Actual Estimate 2000 INTRAGOVERNMENTAL TRANSACTIONS On-budget receipts: Federal intrafund transactions: Distributed by agency: Interest from the Federal Financing Bank ................................................................... 2,503 2,412 Interest on Government capital in enterprises ............................................................ 1,473 1,634 Other ............................................................................................................................. 1,119 1,721 Proposed Legislation (non-PAYGO) ............................................................................. .................. .................. Total Federal intrafunds ................................................................................................ 2001 2002 2003 2004 2005 2,159 1,633 2,084 65 1,988 1,400 2,190 79 1,853 1,269 2,298 82 2,205 1,138 2,361 85 2,472 1,059 2,354 96 5,095 5,767 5,941 5,657 5,502 5,789 5,981 Trust intrafund transactions: Distributed by agency: Payments to railroad retirement ................................................................................... 3,816 Other ............................................................................................................................. .................. 3,760 1 3,637 1 3,749 1 3,763 1 3,786 1 3,810 1 Total trust intrafunds ..................................................................................................... 3,816 3,761 3,638 3,750 3,764 3,787 3,811 Total intrafund transactions .............................................................................................. 8,911 9,528 9,579 9,407 9,266 9,576 9,792 Interfund transactions: Distributed by agency: Federal fund payments to trust funds: Contributions to insurance programs: Military retirement fund ........................................................................................ Supplementary medical insurance ....................................................................... Proposed Legislation (non-PAYGO) .................................................................... Hospital insurance ................................................................................................ Proposed Legislation (non-PAYGO) .................................................................... Railroad social security equivalent fund ............................................................. Rail industry pension fund ................................................................................... Civilian supplementary retirement contributions .................................................. Proposed Legislation (non-PAYGO) .................................................................... Unemployment insurance .................................................................................... Other contributions ............................................................................................... Proposed Legislation (non-PAYGO) .................................................................... Miscellaneous payments ...................................................................................... Proposed Legislation (non-PAYGO) .................................................................... 15,250 62,185 .................. 7,367 .................. 98 394 21,706 .................. 403 438 .................. 597 .................. 15,302 65,063 .................. 7,865 .................. 105 265 21,496 .................. 399 541 .................. 960 .................. 15,914 69,777 –280 7,571 15,400 88 238 21,760 1 454 441 38 569 1,467 Subtotal ..................................................................................................................... 108,438 111,996 133,438 Trust fund payments to Federal funds: Quinquennial adjustment for military service credits .............................................. .................. .................. Other ......................................................................................................................... 1,082 1,051 Proposed Legislation (non-PAYGO) ........................................................................ .................. .................. 16,551 17,213 17,901 18,618 75,983 83,259 89,121 96,212 –780 3,636 9,668 11,404 7,855 8,409 8,952 9,476 12,600 .................. .................. .................. 88 89 91 94 243 248 255 262 22,074 22,491 22,860 23,250 1 1 2 3 474 500 543 574 492 488 485 482 37 36 36 34 577 566 570 580 –1 –1 –1 –1 136,194 136,935 150,483 160,988 1,152 .................. .................. .................. .................. 1,076 1,103 1,130 1,160 1,188 3,226 .................. .................. .................. .................. Subtotal ..................................................................................................................... 1,082 1,051 5,454 1,103 1,130 1,160 1,188 Total interfunds distributed by agency ......................................................................... 109,520 113,047 138,892 137,297 138,065 151,643 162,176 Undistributed by agency: Employer share, employee retirement (on-budget): Civil service retirement and disability insurance (CSRDI) ...................................... 9,094 8,879 Proposed Legislation (non-PAYGO) ........................................................................ .................. .................. CSRDI from Postal Service ..................................................................................... 6,001 6,437 Hospital insurance (contribution as employer) 1 ..................................................... 1,965 2,043 Postal employer contributions to FHI ...................................................................... 611 633 Military retirement fund ............................................................................................. 10,417 11,454 Other Federal employees retirement ....................................................................... 121 129 9,335 –34 6,624 2,093 659 11,413 135 9,729 22 6,799 2,211 687 11,781 141 9,839 –17 6,919 2,292 717 12,114 144 10,344 –24 7,041 2,384 749 12,459 150 10,895 –26 7,166 2,499 781 12,825 157 Total employer share, employee retirement (on-budget) ........................................ 28,209 29,575 30,225 31,370 32,008 33,103 34,297 Interest received by on-budget trust funds ............................................................. 66,561 Proposed Legislation (non-PAYGO) ........................................................................ .................. 71,291 65 73,735 377 76,779 1,413 79,629 2,297 82,210 2,556 84,782 2,804 100,931 104,337 109,562 113,934 117,869 121,883 Total interfund transactions undistributed by agency .................................................. 94,770 105 4. USER FEES AND OTHER COLLECTIONS Table 4–5. OFFSETTING RECEIPTS BY TYPE—Continued (In millions of dollars) Estimate 1999 Actual 2000 2001 2002 2003 2004 2005 Total interfund transactions .............................................................................................. 204,290 213,978 243,229 246,859 251,999 269,512 284,059 Total on-budget receipts ....................................................................................................... 213,201 223,506 252,808 256,266 261,265 279,088 293,851 Off-budget receipts: Interfund transactions: Distributed by agency: Federal fund payments to trust funds: Old-age, survivors, and disability insurance ............................................................ 10,824 11,663 Undistributed by agency: Employer share, employee retirement (off-budget) ................................................. 7,385 7,860 Proposed Legislation (non-PAYGO) ........................................................................ .................. .................. Interest received by off-budget trust funds ............................................................. 52,070 59,656 10,985 11,494 12,048 12,813 13,725 8,212 –271 68,138 8,919 –321 77,622 9,493 –285 87,895 10,144 –289 98,812 10,905 –291 110,493 Source Total off-budget receipts: ...................................................................................................... 70,279 79,179 87,064 97,714 109,151 121,480 134,832 Total intragovernmental transactions ................................................................................... 283,480 302,685 339,872 353,980 370,416 400,568 428,683 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 ...................................................................................... 888 935 7,617 753 1,152 9,066 749 1,104 10,369 758 1,052 11,372 823 1,052 12,368 812 1,052 13,324 806 1,052 14,216 Total interest ...................................................................................................................... 9,440 10,971 12,222 13,182 14,243 15,188 16,074 Royalties and rents ............................................................................................................... 1,097 1,510 1,318 Proposed Legislation (PAYGO) ........................................................................................ .................. .................. .................. 1,355 9 1,339 33 1,354 33 1,401 33 453 –1 219 21 776 59 438 –1 262 21 758 64 423 –1 288 14 753 64 446 –1 286 20 750 65 425 –1 293 17 690 66 Sale of products: Sale of timber and other natural land products ............................................................... 366 618 Proposed Legislation (non-PAYGO) ................................................................................. .................. .................. Proposed Legislation (PAYGO) ........................................................................................ .................. .................. Sale of minerals and mineral products ............................................................................ 38 27 Sale of power and other utilities ...................................................................................... 731 737 Other .................................................................................................................................. 65 61 Total sale of products ....................................................................................................... 1,200 1,443 1,527 1,542 1,541 1,566 1,490 Fees and other charges for services and special benefits: Medicare premiums and other charges (trust funds) ...................................................... Proposed Legislation (PAYGO) ........................................................................................ Nuclear waste disposal revenues ..................................................................................... Veterans life insurance (trust funds) ................................................................................ Other 2 ............................................................................................................................... Proposed Legislation (non-PAYGO) ................................................................................. Proposed Legislation (PAYGO) ........................................................................................ Legislative proposal, discretionary offset ......................................................................... 21,561 .................. 662 204 1,860 .................. .................. .................. 21,735 .................. 663 189 1,892 .................. .................. .................. 23,340 –180 550 179 2,565 –3 –157 966 25,396 226 550 168 2,520 –3 –66 963 27,813 8,052 550 157 2,543 –3 –56 960 30,427 10,921 545 145 2,578 –3 –42 996 33,095 13,703 535 133 2,619 –3 –41 1,015 Total fees and other charges ........................................................................................... 24,287 24,479 27,260 29,754 40,016 45,567 51,056 Sale of Government property: Sale of land and other real property ................................................................................ 58 59 Proposed Legislation (PAYGO) ........................................................................................ .................. .................. Military assistance program sales (trust funds) ............................................................... 11,624 10,560 Other .................................................................................................................................. 172 170 114 3 10,760 220 419 5 10,890 224 79 13 10,920 188 77 14 11,020 73 77 14 11,150 88 11,097 11,538 11,200 11,184 11,329 Total sale of Government property .................................................................................. Realization upon loans and investments: Foreign military credit sales .............................................................................................. Negative subsidies and downward reestimates ............................................................... Repayment of loans to foreign nations ............................................................................ Other .................................................................................................................................. Total realization upon loans and investments ................................................................. 11,854 10,789 367 .................. .................. .................. .................. .................. .................. 5,914 10,606 894 5,176 5,424 5,690 6,323 175 253 254 67 80 81 87 96 84 88 136 116 113 111 6,552 10,943 1,236 5,379 5,620 5,884 6,521 106 ANALYTICAL PERSPECTIVES Table 4–5. OFFSETTING RECEIPTS BY TYPE—Continued (In millions of dollars) 1999 Actual Source Estimate 2000 2001 Recoveries and refunds 2 ..................................................................................................... 3,831 4,028 Proposed Legislation (PAYGO) ............................................................................................ .................. .................. Legislative proposal, discretionary offset .............................................................................. .................. .................. Miscellaneous receipt accounts 2 ......................................................................................... 4,724 1,426 Total proprietary receipts from the public distributed by agency ........................................ 62,985 2002 2003 2004 2005 3,406 4,440 3,436 3,514 3,688 22 –180 –16 –24 –21 1,309 .................. .................. .................. .................. 1,436 1,437 1,442 1,449 1,452 65,589 60,833 68,456 78,854 85,715 93,023 Undistributed by agency: Other interest: Interest received from Outer Continental Shelf escrow account ................ 1 .................. 1,342 .................. .................. .................. .................. Rents and royalties on the Outer Continental Shelf: Rents and bonuses ........................................................................................................... 791 365 809 401 277 249 236 Royalties ............................................................................................................................ 2,307 3,185 2,882 2,881 2,705 2,604 2,469 Sale of major assets ............................................................................................................. .................. .................. .................. .................. 323 .................. .................. Total proprietary receipts from the public undistributed by agency .................................... 3,099 3,550 5,033 3,282 3,305 2,853 2,705 Total proprietary receipts from the public 3 ........................................................................ 66,084 69,139 65,866 71,738 82,159 88,568 95,728 2,318 8 1,460 6 2,342 8 1,524 6 770 200 675 200 OFFSETTING GOVERNMENTAL RECEIPTS Distributed by agency: Regulatory fees ...................................................................................................................... 3,020 3,264 3,640 3,603 3,692 Proposed Legislation (non-PAYGO) ..................................................................................... .................. .................. 20 8 8 Proposed Legislation (PAYGO) ............................................................................................ .................. .................. .................. .................. .................. Other ...................................................................................................................................... 74 77 79 81 6 Undistributed by agency: Spectrum auction proceeds .................................................................................................. 1,753 2,076 3,559 5,535 2,480 Proposed Legislation (non-PAYGO) ..................................................................................... .................. .................. 200 200 200 Total offsetting governmental receipts ............................................................................ 4,847 5,417 7,498 9,427 6,386 4,762 4,755 Total offsetting receipts .......................................................................................................... 354,411 377,241 413,236 435,145 458,961 493,898 529,166 1 Includes 2 Includes 3 Consists provision for covered Federal civilian employees and military personnel. both Federal funds and trust funds. of: 1999 Actual Federal funds ...................................... Trust funds .......................................... Off-budget ............................................ 27,796 38,267 21 Estimate 2000 2001 2002 2003 2004 2005 35,402 33,708 29 30,725 35,099 42 34,052 37,644 42 34,218 47,899 42 35,065 53,461 42 36,661 59,025 42 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: 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, sizeable tax preferences are provided for pension contributions and earnings, employer contributions for medical insurance, mortgage interest payments on owner-occupied homes, capital gains, and payments of State and local individual income and property 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 for the revenue loss estimated from 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 1999–2005 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 of the chapter on performance measures and economic effects presents information related to assessment of the effect of tax expenditures on the achievement of program performance goals. This section is a complement to the government-wide performance plan required by the Government Performance and Results Act of 1993. Tax expenditures are also discussed in Section V 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, 1999. Expired or repealed provisions are not listed if their revenue effects result only from taxpayer activity occurring before fiscal year 1999. 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 1999–2005 are displayed according to 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 tables. 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 breakdowns show the specific tax accounts through which the various provisions are cleared. The ultimate beneficiaries of corporate tax expenditures could be stock- 107 108 ANALYTICAL PERSPECTIVES holders, employees, customers, or others, depending on economic forces. Table 5–3 ranks the major tax expenditures by fiscal year 2001 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 The revenue loss estimates shown for individual tax expenditures in Tables 5–1, 5–2, and 5–3 do not necessarily equal the increase in Federal revenues (or the change in the budget balance) that would result from repealing these special provisions, for the following reasons: Eliminating a tax expenditure may have incentive effects that alter economic behavior. These incentives can affect the resulting magnitudes of the 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, because 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 estimates 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 could yield their full potential revenue gains relatively quickly, whereas changes to other provisions would only gradually yield their full revenue potential, especially if certain deductions or exemptions were 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. Although such estimates are useful as a measure of cash flows into the Government, they do not accurately reflect the true economic cost of these provisions. For example, for a provision where activity levels have changed, so that incoming tax receipts from past deferrals are greater than deferred receipts from new activity, the cash-basis tax expenditure estimate can be negative, despite the fact that in present-value terms current deferrals do have a real cost to the Government. Alternatively, in the case of a newly enacted deferral provision, a cash-based estimate can overstate the real cost to the Government because the newly deferred taxes will ultimately be received. Presentvalue estimates, which are a useful supplement to the cash-basis estimates for provisions involving deferrals, are discussed below. Repeal on major tax provisions may have some impact on overall levels of income and rates of economic growth and, thus, on the budget economic assumptions. In practice, 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 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 1999 which cause the deferrals or other long-term revenue effects. For instance, a pension contribution in 1999 would cause a deferral of tax payments on wages in 1999 and on pension earnings on this contribution (e.g., interest) in later years. In some future year, however, the 1999 pension contribution and accrued earnings would be paid out and taxes would 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. 109 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 1999 2000 2001 2002 2003 2004 2005 2001–2005 1 National Defense Exclusion of benefits and allowances to armed forces personnel ....................................................... 2,120 2,140 2,160 2,180 2,200 2,220 2,240 11,000 2 3 4 5 6 7 International affairs: Exclusion of income earned abroad by U.S. citizens ........................................................................... Exclusion of certain allowances for Federal employees abroad .......................................................... Exclusion of income of foreign sales corporations ................................................................................ Inventory property sales source rules exception ................................................................................... Deferral of income from controlled foreign corporations (normal tax method) .................................... Deferred taxes for financial firms on certain income earned overseas ................................................ 2,330 635 3,640 1,050 5,800 960 2,550 665 3,890 1,100 6,200 1,190 2,790 695 4,160 1,150 6,600 1,290 3,040 725 4,460 1,250 7,000 540 3,285 760 4,770 1,350 7,450 0 3,545 795 5,100 1,450 7,900 0 3,825 830 5,460 1,550 8,400 0 16,485 3,805 23,950 6,750 37,350 1,830 8 9 General science, space, and technology: Expensing of research and experimentation expenditures (normal tax method) ................................. Credit for increasing research activities ................................................................................................. 1,890 1,705 1,865 1,010 1,885 3,360 1,965 3,710 2,090 2,970 2,245 2,605 2,410 1,505 10,595 14,150 10 11 12 13 14 15 16 17 18 19 20 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 credits 1 ............................................................................................................................... Tax credit and deduction for clean-fuel burning vehicles ..................................................................... Exclusion from income of conservation subsidies provided by public utilities ..................................... –80 265 1,025 30 65 115 225 50 15 85 85 –15 275 960 25 65 115 260 60 15 90 80 –30 280 905 25 70 115 295 80 15 105 80 –10 280 845 25 70 120 340 90 15 100 80 15 285 125 25 75 120 390 90 15 80 85 15 290 125 25 80 120 450 90 15 55 85 15 290 125 25 85 120 515 85 15 20 85 5 1,425 2,125 125 380 595 1,990 435 75 360 415 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 ............................................................... 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 ............................................................................ 15 225 460 65 495 10 210 15 230 460 65 500 10 220 20 245 470 70 530 10 240 20 250 475 70 565 15 250 20 265 480 75 590 15 265 20 275 480 80 605 15 280 20 285 490 85 630 15 295 100 1,320 2,395 380 2,920 70 1,330 28 29 30 31 32 33 Agriculture: Expensing of certain capital outlays ...................................................................................................... Expensing of certain multiperiod production costs ................................................................................ Treatment of loans forgiven for solvent farmers ................................................................................... Capital gains treatment of certain income ............................................................................................. Income averaging for farmers ................................................................................................................ Deferral of gain on sale of farm refiners ............................................................................................... 70 85 10 635 75 10 70 85 10 665 75 10 75 90 10 695 80 10 75 95 10 725 80 10 80 105 10 760 80 15 85 110 10 795 85 15 90 110 10 830 85 15 405 510 50 3,805 410 65 1,470 60 13,920 5 220 100 1,550 65 14,985 5 225 100 1,650 55 16,130 5 235 100 1,765 45 17,365 5 240 100 1,890 35 18,870 5 250 100 2,020 20 20,130 5 255 105 2,155 5 21,680 5 265 105 9,480 160 94,175 25 1,245 510 905 155 56,920 21,215 995 18,000 5,315 2,820 3,710 915 155 58,815 22,185 1,015 18,540 5,035 3,055 3,985 920 160 60,925 23,075 1,035 19,095 4,790 3,195 4,225 930 160 63,240 24,000 1,055 19,670 4,555 3,300 4,500 940 160 65,955 24,980 1,075 20,260 4,330 3,405 4,765 950 160 68,965 25,915 1,095 20,870 4,100 3,485 4,975 955 160 72,160 26,840 1,115 21,495 3,885 3,540 5,145 4,695 800 331,245 124,810 5,375 101,390 21,660 16,925 23,610 40 160 39,405 5 25,800 175 35 25 160 40,575 5 27,090 185 35 15 160 41,780 5 28,240 195 40 15 165 43,025 5 29,370 205 40 20 165 44,300 5 30,545 210 40 20 165 45,615 5 31,765 220 40 25 165 46,965 5 33,035 230 40 95 820 221,685 25 152,955 1,060 200 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 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 certain 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 ....................................................................... Capital gains exclusion on home sales ............................................................................................. Exception from passive loss rules for $25,000 of rental loss .......................................................... Credit for low-income housing investments ....................................................................................... Accelerated depreciation on rental housing (normal tax method) .................................................... Commerce: Cancellation of indebtedness ............................................................................................................. Exceptions from imputed interest rules ............................................................................................. Capital gains (except 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 ............................. 110 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 1999 2000 2001 2002 2003 2004 2005 2001–2005 56 57 58 59 60 61 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 ....................................................................................... 1,660 26,445 1,465 200 6,360 310 710 27,740 1,590 205 6,300 315 –435 32,830 1,925 205 6,275 315 –755 33,345 1,965 215 6,460 320 –1,115 34,265 1,920 215 6,490 320 –1,695 36,390 1,895 220 6,710 325 –2,145 37,330 1,905 225 6,815 330 –6,145 174,160 9,610 1,080 32,750 1,610 62 63 64 Transportation: Deferral of tax on shipping companies .................................................................................................. Exclusion of reimbursed employee parking expenses .......................................................................... Exclusion for employer-provided transit passes .................................................................................... 15 1,725 130 15 1,805 150 15 1,895 170 15 1,995 190 15 2,100 215 15 2,210 235 15 2,330 260 75 10,530 1,070 65 66 67 68 69 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 ..................................................................................... 25 730 60 330 115 25 735 60 445 150 30 740 60 500 175 30 750 65 465 60 30 755 65 330 –30 30 765 65 300 –35 30 770 70 260 –30 150 3,780 325 1,855 140 1,085 4,595 2,170 0 240 120 245 590 5 10 915 19,435 2,525 220 1,110 4,925 2,375 10 265 175 250 595 10 15 965 19,575 2,650 235 1,120 5,125 2,420 25 310 225 255 600 20 15 1,015 19,480 2,765 250 1,130 5,145 2,465 40 350 275 255 600 35 15 1,055 18,970 2,910 175 1,140 4,745 4,405 60 375 320 255 610 50 15 1,105 18,155 3,035 0 1,150 4,615 4,430 80 395 350 260 615 65 20 1,155 17,535 3,140 0 1,165 5,335 4,630 105 430 385 260 620 70 20 1,185 16,855 3,300 0 5,705 24,965 18,350 310 1,860 1,555 1,285 3,045 240 85 5,515 90,995 15,150 425 84 85 86 87 88 89 90 91 92 93 94 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 for 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 redeemed to finance educational expenses ..................... 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 ................................................................................................... 270 35 645 125 650 2,420 50 0 19,220 35 320 455 60 670 140 680 2,390 50 0 20,015 40 340 465 80 700 140 710 2,360 55 5 20,860 40 365 350 80 725 125 740 2,330 55 5 21,780 45 390 215 60 765 40 775 2,305 55 5 22,750 45 415 95 25 805 15 810 2,275 60 5 23,765 50 445 35 10 850 10 845 2,250 60 5 24,895 50 475 1,160 255 3,845 330 3,880 11,520 285 25 114,050 230 2,090 95 96 97 98 99 100 101 102 103 Health: Exclusion of employer contributions for medical insurance premiums and medical care ................... Self-employed medical insurance premiums ......................................................................................... Workers’ compensation insurance premiums ........................................................................................ 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 ............................................................................................. 69,610 935 4,420 20 3,695 1,210 2,675 70 245 75,095 1,250 4,585 30 3,910 1,225 2,800 80 315 80,570 1,380 4,555 30 4,160 1,235 2,930 90 200 86,175 1,545 4,935 30 4,440 1,250 3,080 100 135 90,655 2,070 5,120 30 4,720 1,265 3,210 115 180 95,960 2,905 5,315 30 5,005 1,275 3,315 130 245 102,725 3,210 5,515 25 5,305 1,290 3,490 140 315 456,085 11,110 25,440 145 23,630 6,315 16,025 575 1,075 395 5,185 345 75 130 405 5,330 360 75 130 410 5,785 375 70 135 415 6,040 390 70 140 420 6,310 405 65 140 430 6,575 420 60 145 430 6,865 435 55 150 2,105 31,575 2,025 320 710 83,780 13,350 5,230 88,830 15,050 5,550 92,390 15,975 5,895 97,085 17,030 6,255 102,575 17,630 6,635 108,020 18,250 7,040 113,705 18,750 7,465 513,775 87,635 33,290 70 71 72 73 74 75 76 77 78 79 80 81 82 83 104 105 106 107 108 109 110 111 Income security: Exclusion of railroad retirement system benefits ................................................................................... Exclusion of workers’ 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 other employee benefits: 111 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 1999 2000 2001 2002 2003 2004 2005 2001–2005 112 13 114 115 116 117 118 119 120 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 ..................................................................................................................... 1,700 185 0 1,130 30 1,785 35 255 4,825 1,740 195 0 1,175 30 1,830 35 265 4,700 1,780 205 0 1,205 30 1,890 35 275 4,790 1,820 215 5 1,250 30 1,955 35 285 4,985 1,860 225 5 1,300 35 1,985 35 295 5,205 1,915 235 5 1,360 35 2,030 35 310 5,440 1,970 245 5 1,425 35 2,110 35 325 5,740 9,345 1,125 20 6,540 165 9,970 175 1,490 26,160 121 122 123 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 ..................................................................... 17,135 2,390 3,775 18,010 2,595 3,900 18,885 2,830 4,050 19,995 3,090 4,210 21,230 3,375 4,385 22,505 3,700 4,555 16,515 3,150 3,625 99,130 16,145 20,825 124 125 126 127 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 ................................................................................. 2,940 65 75 40 3,070 70 85 40 3,200 75 90 40 3,335 80 90 40 3,490 85 95 40 3,655 85 100 40 3,830 90 105 40 17,510 415 480 200 128 129 130 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 .................... 22,750 37,740 2,515 22,975 40,240 2,590 23,205 42,390 2,670 23,440 44,735 2,600 23,670 47,610 2,550 23,905 50,530 2,600 24,145 53,480 2,650 118,365 238,745 13,070 131 Interest: Deferral of interest on U.S. savings bonds ........................................................................................... 1,015 1,065 1,115 1,175 1,235 1,295 1,355 6,175 21,215 37,740 22,185 40,240 23,075 42,390 24,000 44,735 24,980 47,610 25,915 50,530 26,840 53,480 124,810 238,745 22,750 115 460 310 905 155 730 245 590 1,210 40 5 22,975 115 460 315 915 155 735 250 595 1,225 40 10 23,205 115 470 315 920 160 740 255 600 1,235 40 20 23,440 120 475 320 930 160 750 255 600 1,250 40 35 23,670 120 480 320 940 160 755 255 610 1,265 40 50 23,905 120 480 325 950 160 765 260 615 1,275 40 65 24,145 120 490 330 955 160 770 260 620 1,290 40 70 118,365 595 2,395 1,610 4,695 800 3,780 1,285 3,045 6,315 200 240 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 State and local bonds for: Public purposes .................................................................................................................................. Energy facilities ................................................................................................................................... Water, sewage, and hazardous waste disposal facilities ................................................................. Small-issues ........................................................................................................................................ Owner-occupied mortgage subsidies ................................................................................................. Rental housing .................................................................................................................................... Airports, docks, and similar facilities ................................................................................................. Student loans ...................................................................................................................................... Private nonprofit educational facilities ............................................................................................... Hospital construction .......................................................................................................................... Veterans’ housing ............................................................................................................................... Credit for holders of zone academy bonds ........................................................................................... 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: 1999 $760; 2000 $800; 2001 $805; 2002 $810; 2003 $815; 2004 $825; and 2005 $830. 2 The figures in the table indicate the effect of the child tax credit on receipts. The effect on outlays (in millions of dollars) is as follows: 1999 $445; 2000 $550; 2001 $520; 2002 $505; 2003 $460; 2004 $450; and 2005 $420. 3 The figures in the table indicate the effect of the earned income tax credit on receipts. The effect on outlays (in millions of dollars) is as follows: 1999 $25,632; 2000 $25,676; 2001 $25,799; 2002 $26,876; 2003 $27,638; 2004 $28,701; and 2005 $29,722. 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. Provisions with estimates that rounded to zero in each year are not included in the table. 112 ANALYTICAL PERSPECTIVES Table 5–2. CORPORATE AND INDIVIDUAL INCOME TAX REVENUE LOSS ESTIMATES FOR TAX EXPENDITURES (In millions of dollars) Revenue Loss Corporations 1999 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 2000 2001 2002 2003 Individuals 2004 2001– 2005 2005 National Defense Exclusion of benefits and allowances to armed forces personnel ....................... ............ ............ ............ ............ ............ ............ ............ .............. 1999 2000 2001 2002 2003 2,120 2,140 2,160 2,180 International affairs: Exclusion of income earned abroad by U.S. citizens ......................................... ............ ............ ............ ............ ............ ............ ............ .............. 2,330 2,550 2,790 3,040 Exclusion of certain allowances for Federal employees abroad ........................ ............ ............ ............ ............ ............ ............ ............ .............. 635 665 695 725 Exclusion of income of foreign sales corporations ............................................... 3,640 3,890 4,160 4,460 4,770 5,100 5,460 23,950 ............ ............ ............ ............ Inventory property sales source rules exception .................................................. 1,050 1,100 1,150 1,250 1,350 1,450 1,550 6,750 ............ ............ ............ ............ Deferral of income from controlled foreign corporations (normal tax method) 5,800 6,200 6,600 7,000 7,450 7,900 8,400 37,350 ............ ............ ............ ............ Deferred taxes for financial firms on certain income earned overseas .............. 960 1,190 1,290 540 0 0 0 1,830 ............ ............ ............ ............ General science, space, and technology: Expensing of research and experimentation expenditures (normal tax method) ........................................................ Credit for increasing research activities .. 1,855 1,675 1,830 995 1,850 3,300 1,925 3,650 2,050 2,925 2,200 2,565 2,365 1,490 10,390 13,930 Energy: Expensing of exploration and development costs, fuels .................................. –70 –15 –30 –10 15 15 15 5 Excess of percentage over cost depletion, fuels .............................................. 220 225 230 230 235 240 240 1,175 Alternative fuel production credit ............. 975 915 860 805 125 125 125 2,040 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 .................................................... 30 30 30 30 30 30 30 150 Enhanced oil recovery credit ................... 205 235 270 310 355 410 470 1,815 New technology credit .............................. 45 50 60 70 70 70 65 335 Alcohol fuel credits 1 ................................. 10 10 10 10 10 10 10 50 Tax credit and deduction for clean-fuel burning vehicles ................................... 70 75 85 80 65 45 15 290 Exclusion from income of conservation subsidies provided by public utilities ... –5 –5 –5 –5 0 0 0 –10 Natural resources and environment: Expensing of exploration and development costs, nonfuel minerals .............. 10 10 15 15 15 15 15 75 Excess of percentage over cost depletion, nonfuel minerals ........................... 180 185 195 200 210 220 230 1,055 Exclusion of interest on bonds for water, sewage, and hazardous waste facilities ........................................................ 115 115 120 120 120 120 125 605 Capital gains treatment of certain timber income .................................................. ............ ............ ............ ............ ............ ............ ............ .............. Expensing of multiperiod timber growing costs ..................................................... 305 310 330 350 365 375 390 1,810 Investment credit and seven-year amortization for reforestation expenditures ... ............ ............ ............ ............ ............ ............ ............ .............. Tax incentives for preservation of historic structures .............................................. 170 180 195 205 215 230 240 1,085 Agriculture: Expensing of certain capital outlays ........ 10 10 10 10 10 10 10 50 Expensing of certain multiperiod production costs .............................................. 10 10 10 10 15 15 15 65 Treatment of loans forgiven for solvent farmers ................................................. ............ ............ ............ ............ ............ ............ ............ .............. Capital gains treatment of certain income ............ ............ ............ ............ ............ ............ ............ .............. Income averaging for farmers .................. ............ ............ ............ ............ ............ ............ ............ .............. Deferral of gain on sale of farm refiners 10 10 10 10 15 15 15 65 Commerce and housing: Financial institutions and insurance: Exemption of credit union income ....... Excess bad debt reserves of financial institutions ........................................ 2004 2001– 2005 2005 2,200 2,220 2,240 11,000 3,285 3,545 3,825 16,485 760 795 830 3,805 .............. .............. .............. .............. .............. .............. .............. .............. .............. .............. .............. .............. .............. .............. .............. .............. 35 30 35 15 35 60 40 60 40 45 45 40 45 15 205 220 –10 0 0 0 0 0 0 0 45 50 50 45 50 45 50 40 50 0 50 0 50 0 250 85 30 25 25 25 25 25 25 125 65 65 70 70 75 80 85 380 85 20 5 5 85 25 10 5 85 25 20 5 90 30 20 5 90 35 20 5 90 40 20 5 90 45 20 5 445 175 100 25 15 15 20 20 15 10 5 70 90 85 85 85 85 85 85 425 5 5 5 5 5 5 5 25 45 45 50 50 55 55 55 265 345 345 350 355 360 360 365 1,790 65 65 70 70 75 80 85 380 190 190 200 215 225 230 240 1,110 10 10 10 15 15 15 15 70 40 40 45 45 50 50 55 245 60 60 65 65 70 75 80 355 75 75 80 85 90 95 95 445 10 635 75 10 665 75 10 695 80 10 725 80 10 760 80 10 795 85 10 830 85 50 3,805 410 1,470 1,550 1,650 1,765 1,890 2,020 2,155 9,480 ............ ............ ............ ............ .............. .............. .............. .............. 60 65 55 45 35 20 5 160 ............ ............ ............ ............ .............. .............. .............. .............. 113 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 1999 36 37 38 39 40 41 42 43 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 Exclusion of interest on life insurance savings ............................................. Special alternative tax on small property and casualty insurance companies ................................................... Tax exemption of certain 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 ................................. Capital gains exclusion on home sales Exception from passive loss rules for $25,000 of rental loss ..................... Credit for low-income housing investments ............................................... Accelerated depreciation on rental housing (normal tax method) .......... Commerce: Cancellation of indebtedness ............... Exceptions from imputed interest rules Capital gains (except 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 ............................................... 2000 2001 2002 Individuals 2003 2004 2001– 2005 2005 1999 2000 2001 2002 2,825 13,500 14,535 15,645 16,845 2003 2004 2005 2001– 2005 18,305 19,525 21,030 91,350 420 450 485 520 565 605 650 5 5 5 5 5 5 5 25 ............ ............ ............ ............ .............. .............. .............. .............. 220 225 235 240 250 255 265 1,245 ............ ............ ............ ............ .............. .............. .............. .............. 100 100 100 100 100 105 105 510 ............ ............ ............ ............ .............. .............. .............. .............. 230 230 230 235 235 240 240 1,180 675 685 690 695 705 710 715 3,515 40 40 40 40 40 40 40 200 115 115 120 120 120 120 120 600 ............ ............ ............ ............ ............ ............ ............ .............. 56,920 58,815 60,925 63,240 65,955 68,965 72,160 331,245 ............ ............ ............ ............ ............ ............ ............ .............. 21,215 22,185 23,075 24,000 24,980 25,915 26,840 124,810 260 265 270 275 280 285 290 1,400 735 750 765 780 ............ ............ ............ ............ ............ ............ ............ .............. 18,000 18,540 19,095 19,670 795 20,260 810 20,870 825 3,975 21,495 101,390 ............ ............ ............ ............ ............ ............ ............ .............. 5,315 5,035 4,790 4,555 4,330 4,100 3,885 21,660 2,115 2,290 2,395 2,475 2,555 2,615 2,655 12,695 705 765 800 825 850 870 885 4,230 110 120 135 160 180 200 230 905 3,600 3,865 4,090 4,340 4,585 4,775 4,915 22,705 ............ ............ ............ ............ ............ ............ ............ .............. ............ ............ ............ ............ ............ ............ ............ .............. 40 160 25 160 15 160 15 165 20 165 20 165 25 165 95 820 ............ ............ ............ ............ ............ ............ ............ .............. 39,405 40,575 41,780 43,025 44,300 45,615 5 5 5 ............ ............ ............ ............ ............ ............ ............ .............. 25,800 27,090 28,240 29,370 30,545 31,765 ............ ............ ............ ............ ............ ............ ............ .............. 5 5 5 46,965 221,685 5 25 33,035 152,955 ............ ............ ............ ............ ............ ............ ............ .............. 175 185 195 205 210 220 230 1,060 ............ ............ ............ ............ ............ ............ ............ .............. 35 35 40 40 40 40 40 200 –1,545 465 55 –665 –770 –855 –1,070 –1,240 –4,600 21,100 22,085 26,970 27,265 27,965 29,825 30,465 142,490 5,345 5,655 5,860 6,080 6,300 6,565 6,865 31,670 3,195 1,070 1,100 1,295 1,300 1,290 1,270 1,260 6,415 655 80 80 80 85 85 85 90 425 1,195 395 655 490 230 630 15 665 –260 630 –625 625 –905 645 120 125 125 130 130 135 135 6,360 6,300 6,275 6,460 6,490 6,710 6,815 80 80 80 80 80 80 85 32,750 ............ ............ ............ ............ .............. .............. .............. .............. 405 230 235 235 240 240 245 245 1,205 Transportation: Deferral of tax on shipping companies ... 15 15 15 15 15 15 15 75 ............ ............ ............ ............ .............. .............. .............. .............. Exclusion of reimbursed employee parking expenses ........................................ ............ ............ ............ ............ ............ ............ ............ .............. 1,725 1,805 1,895 1,995 2,100 2,210 2,330 10,530 Exclusion for employer-provided transit passes .................................................. ............ ............ ............ ............ ............ ............ ............ .............. 130 150 170 190 215 235 260 1,070 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 ..................................................... 15 15 15 15 15 15 15 75 10 10 15 15 15 15 15 75 185 185 185 190 190 195 195 955 545 550 555 560 565 570 575 2,825 60 60 60 65 65 65 70 325 ............ ............ ............ ............ .............. .............. .............. .............. 150 205 220 185 130 110 90 735 180 240 280 280 200 190 170 1,120 95 125 145 50 –25 –30 –25 115 20 25 30 10 –5 –5 –5 25 114 ANALYTICAL PERSPECTIVES Table 5–2. CORPORATE AND INDIVIDUAL INCOME TAX REVENUE LOSS ESTIMATES FOR TAX EXPENDITURES—Continued (In millions of dollars) Revenue Loss Corporations 1999 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 101 102 103 104 105 106 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 for 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 redeemed to finance educational expenses .......................................... 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 .... Health: Exclusion of employer contributions for medical insurance premiums and medical care ......................................... Self-employed medical insurance premiums ................................................... Workers’ compensation insurance premiums ................................................... 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 2000 2001 2002 Individuals 2003 2004 2001– 2005 2005 2003 2004 2001– 2005 1999 2000 2001 2002 2005 ............ ............ ............ ............ ............ ............ ............ .............. ............ ............ ............ ............ ............ ............ ............ .............. ............ ............ ............ ............ ............ ............ ............ .............. 1,085 4,595 2,170 1,110 4,925 2,375 1,120 5,125 2,420 1,130 5,145 2,465 1,140 4,745 4,405 1,150 4,615 4,430 1,165 5,335 4,630 5,705 24,965 18,350 ............ ............ ............ ............ ............ ............ ............ .............. ............ ............ ............ ............ ............ ............ ............ .............. ............ ............ ............ ............ ............ ............ ............ .............. 0 240 120 10 265 175 25 310 225 40 350 275 60 375 320 80 395 350 105 430 385 310 1,860 1,555 60 65 65 65 65 65 65 325 185 185 190 190 190 195 195 960 150 150 150 150 155 155 155 765 440 445 450 450 455 460 465 2,280 5 10 20 35 50 65 70 240 ............ ............ ............ ............ .............. .............. .............. .............. ............ ............ ............ ............ ............ ............ ............ .............. 15 15 20 20 85 ............ ............ ............ ............ ............ ............ ............ .............. 915 965 1,015 1,055 ............ ............ ............ ............ ............ ............ ............ .............. 19,435 19,575 19,480 18,970 1,105 18,155 1,155 17,535 1,185 16,855 5,515 90,995 485 2,135 2,220 2,315 2,420 2,530 2,650 12,135 ............ ............ ............ ............ ............ ............ ............ .............. 220 235 250 175 0 0 0 425 990 215 40 5 70 10 70 15 50 10 30 10 15 5 5 0 170 40 ............ ............ ............ ............ ............ ............ ............ .............. ............ ............ ............ ............ ............ ............ ............ .............. 645 125 670 140 700 140 725 125 765 40 805 15 850 10 3,845 330 ............ ............ ............ ............ ............ ............ ............ .............. 650 680 710 740 775 810 845 3,880 ............ ............ ............ ............ ............ ............ ............ .............. 2,420 2,390 2,360 2,330 2,305 2,275 2,250 11,520 35 35 40 40 40 45 45 210 3,740 18,620 19,380 20,180 21,040 21,990 23,010 45 390 45 415 50 445 ............ ............ ............ ............ ............ ............ ............ .............. 69,610 75,095 80,570 86,175 90,655 395 65 595 300 70 615 185 50 610 80 20 650 15 2,040 385 50 545 15 3,015 230 30 515 10 30 10 15 15 15 15 15 15 15 75 0 0 5 5 5 5 5 25 600 635 680 740 760 755 805 ............ ............ ............ ............ ............ ............ ............ .............. ............ ............ ............ ............ ............ ............ ............ .............. 35 320 40 340 40 365 24,090 110,310 50 475 230 2,090 95,960 102,725 456,085 ............ ............ ............ ............ ............ ............ ............ .............. 935 1,250 1,380 1,545 2,070 2,905 3,210 11,110 ............ ............ ............ ............ ............ ............ ............ .............. ............ ............ ............ ............ ............ ............ ............ .............. ............ ............ ............ ............ ............ ............ ............ .............. 4,420 20 3,695 4,585 30 3,910 4,555 30 4,160 4,935 30 4,440 5,120 30 4,720 5,315 30 5,005 5,515 25 5,305 25,440 145 23,630 905 915 925 935 945 955 965 4,725 305 310 310 315 320 320 325 1,590 585 70 245 620 80 315 660 90 200 720 100 135 740 115 180 735 130 245 780 140 315 3,635 2,090 2,180 2,270 2,360 2,470 2,580 2,710 12,390 575 ............ ............ ............ ............ .............. .............. .............. .............. 1,075 ............ ............ ............ ............ .............. .............. .............. .............. Income security: Exclusion of railroad retirement system benefits ................................................. ............ ............ ............ ............ ............ ............ ............ .............. Exclusion of workers’ compensation benefits ....................................................... ............ ............ ............ ............ ............ ............ ............ .............. Exclusion of public assistance benefits (normal tax method) ............................. ............ ............ ............ ............ ............ ............ ............ .............. 395 405 410 415 420 430 430 2,105 5,185 5,330 5,785 6,040 6,310 6,575 6,865 31,575 345 360 375 390 405 420 435 2,025 115 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 1999 107 108 109 110 111 112 113 114 115 116 117 118 119 120 121 122 123 124 125 126 127 128 129 130 131 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 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 .................. 2000 2001 2002 2003 Individuals 2004 2005 2001– 2005 ............ ............ ............ ............ ............ ............ ............ .............. ............ ............ ............ ............ ............ ............ ............ .............. 1999 75 130 2000 75 130 2001 70 135 2002 70 140 2003 65 140 2004 60 145 2005 55 150 2001– 2005 320 710 ............ ............ ............ ............ ............ ............ ............ .............. 83,780 88,830 92,390 97,085 102,575 108,020 113,705 513,775 ............ ............ ............ ............ ............ ............ ............ .............. 13,350 15,050 15,975 17,030 17,630 18,250 18,750 87,635 ............ ............ ............ ............ ............ ............ ............ .............. 5,230 5,550 5,895 6,255 6,635 7,040 7,465 33,290 ............ ............ ............ ............ ............ ............ ............ .............. 1,700 1,740 1,780 1,820 1,860 1,915 1,970 9,345 ............ ............ ............ ............ ............ ............ ............ .............. 185 195 205 215 225 235 245 1,125 0 860 ............ ............ ............ ............ ............ 0 890 ............ ............ ............ ............ ............ 0 915 ............ ............ ............ ............ ............ 5 950 ............ ............ ............ ............ ............ 5 990 ............ ............ ............ ............ ............ 5 1,040 ............ ............ ............ ............ ............ 5 1,090 ............ ............ ............ ............ ............ 20 ............ ............ ............ ............ .............. .............. .............. .............. 4,985 270 285 290 300 310 320 335 1,555 .............. 30 30 30 30 35 35 35 165 .............. 1,785 1,830 1,890 1,955 1,985 2,030 2,110 9,970 .............. 35 35 35 35 35 35 35 175 .............. 255 265 275 285 295 310 325 1,490 .............. 4,825 4,700 4,790 4,985 5,205 5,440 5,740 26,160 Social Security: Exclusion of social security benefits: Social Security benefits for retired workers ............................................. ............ ............ ............ ............ ............ ............ ............ .............. 17,135 18,010 18,885 19,995 Social Security benefits for disabled ... ............ ............ ............ ............ ............ ............ ............ .............. 2,390 2,595 2,830 3,090 Social Security benefits for dependents and survivors ........................... ............ ............ ............ ............ ............ ............ ............ .............. 3,775 3,900 4,050 4,210 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 .................................................... 10 10 10 10 10 10 10 50 21,230 3,375 22,505 3,700 16,515 3,150 99,130 16,145 4,385 4,555 3,625 20,825 2,940 65 75 3,070 70 85 3,200 75 90 3,335 80 90 3,490 85 95 3,655 85 100 3,830 90 105 17,510 415 480 30 30 30 30 30 30 30 150 General purpose fiscal assistance: Exclusion of interest on public purpose bonds .................................................... 5,735 5,790 5,850 5,910 5,965 6,025 6,085 29,835 17,015 17,185 17,355 17,530 17,705 17,880 18,060 88,530 Deductibility of nonbusiness State and local taxes other than on owner-occupied homes ........................................... ............ ............ ............ ............ ............ ............ ............ .............. 37,740 40,240 42,390 44,735 47,610 50,530 53,480 238,745 Tax credit for corporations receiving income from doing business in U.S. possessions .......................................... 2,515 2,590 2,670 2,600 2,550 2,600 2,650 13,070 ............ ............ ............ ............ .............. .............. .............. .............. Interest: Deferral of interest on U.S. savings bonds .................................................... ............ ............ ............ ............ ............ ............ ............ .............. 1,015 1,065 1,115 1,175 Addendum: Aid to State and local governments: Deductibility of: Property taxes on owner-occupied homes .............................................. ............ ............ ............ ............ ............ ............ ............ .............. 21,215 22,185 23,075 24,000 Nonbusiness State and local taxes other than on owner-occupied homes .............................................. ............ ............ ............ ............ ............ ............ ............ .............. 37,740 40,240 42,390 44,735 Exclusion of interest on State and local bonds for: Public purposes .................................... 5,735 5,790 5,850 5,910 5,965 6,025 6,085 29,835 17,015 17,185 17,355 17,530 Energy facilities .................................... 30 30 30 30 30 30 30 150 85 85 85 90 Water, sewage, and hazardous waste disposal facilities .............................. 115 115 120 120 120 120 125 605 345 345 350 355 Small-issues ......................................... 80 80 80 80 80 80 85 405 230 235 235 240 Owner-occupied mortgage subsidies .. 230 230 230 235 235 240 240 1,180 675 685 690 695 Rental housing ..................................... 40 40 40 40 40 40 40 200 115 115 120 120 Airports, docks, and similar facilities ... 185 185 185 190 190 195 195 955 545 550 555 560 Student loans ....................................... 60 65 65 65 65 65 65 325 185 185 190 190 Private nonprofit educational facilities 150 150 150 150 155 155 155 765 440 445 450 450 Hospital construction ............................ 305 310 310 315 320 320 325 1,590 905 915 925 935 Veterans’ housing ................................ 10 10 10 10 10 10 10 50 30 30 30 30 1,235 1,295 1,355 6,175 24,980 25,915 26,840 124,810 47,610 50,530 53,480 238,745 17,705 90 17,880 90 18,060 90 88,530 445 360 240 705 120 565 190 455 945 30 360 245 710 120 570 195 460 955 30 365 245 715 120 575 195 465 965 30 1,790 1,205 3,515 600 2,825 960 2,280 4,725 150 116 ANALYTICAL PERSPECTIVES Table 5–2. CORPORATE AND INDIVIDUAL INCOME TAX REVENUE LOSS ESTIMATES FOR TAX EXPENDITURES—Continued (In millions of dollars) Revenue Loss Corporations 1999 Credit for holders of zone academy bonds .................................................... 1 In 2000 5 10 2001 20 2002 35 2003 50 Individuals 2004 65 2005 70 2001– 2005 1999 2000 2001 2002 2003 2004 2005 2001– 2005 240 ............ ............ ............ ............ .............. .............. .............. .............. 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: 1999 $760; 2000 $800; 2001 $805; 2002 $810; 2003 $815; 2004 $825; and 2005 $830. 2 The figures in the table indicate the effect of the child tax credit on receipts. The effect on outlays (in millions of dollars) is as follows: 1999 $445; 2000 $550; 2001 $520; 2002 $505; 2003 $460; 2004 $450; and 2005 $420. 3 The figures in the table indicate the effect of the earned income tax credit on receipts. The effect on outlays (in millions of dollars) is as follows: 1999 $25,632; 2000 $25,676; 2001 $25,799; 2002 $26,876; 2003 $27,638; 2004 $28,701; and 2005 $29,722. 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. Provisions with estimates that rounded to zero in each year are not included in the table. 117 5. TAX EXPENDITURES Table 5–3. MAJOR TAX EXPENDITURES IN THE INCOME TAX, RANKED BY TOTAL 2001 REVENUE LOSS (In millions of dollars) Provision Net exclusion of pension contributions and earnings: Employer plans ............................................................................. Exclusion of employer contributions for medical insurance premiums and medical care ................................................. Deductibility of mortgage interest on owner-occupied homes ............................................................................................ Deductibility of nonbusiness State and local taxes other than on owner-occupied homes .............................................. Capital gains (except agriculture, timber, iron ore, and coal) (normal tax method) .......................................................... Accelerated depreciation of machinery and equipment (normal tax method) ................................................................... Step-up basis of capital gains at death .............................................................................................................................. Deductibility of charitable contributions, total ...................................................................................................................... Exclusion of interest on public purpose bonds ................................................................................................................... Deductibility of State and local property tax on owner-occupied homes ........................................................................... Child credit 2 ......................................................................................................................................................................... Capital gains exclusion on home sales ............................................................................................................................... Exclusion of Social Security benefits for retired workers ................................................................................................... Exclusion of interest on life insurance savings ................................................................................................................... Net exclusion of pension contributions and earnings: Individual Retirement Accounts .................................................... Deferral of income from controlled foreign corporations (normal tax method) .................................................................. Graduated corporation income tax rate (normal tax method) ............................................................................................ Net exclusion of pension contributions and earnings: Keogh plans .................................................................................. Exclusion of workers’ compensation benefits ...................................................................................................................... HOPE tax credit ................................................................................................................................................................... Exclusion of interest on non-public purpose State and local debt .................................................................................... Earned income tax credit 3 ................................................................................................................................................... Exception from passive loss rules for $25,000 of rental loss ............................................................................................ Workers’ compensation insurance premiums ...................................................................................................................... Accelerated depreciation on rental housing (normal tax method) ...................................................................................... Exclusion of income of foreign sales corporations ............................................................................................................. Deductibility of medical expenses ........................................................................................................................................ Exclusion of Social Security benefits for dependents and survivors ................................................................................. Credit for increasing research activities .............................................................................................................................. Exclusion of veterans death benefits and disability compensation .................................................................................... Credit for low-income housing investments ......................................................................................................................... Exclusion of Social Security benefits for disabled .............................................................................................................. Exclusion of income earned abroad by U.S. citizens ......................................................................................................... Tax credit for corporations receiving income from doing business in U.S. possessions .................................................. Lifetime Learning tax credit .................................................................................................................................................. Credit for child and dependent care expenses ................................................................................................................... Exclusion of benefits and allowances to armed forces personnel ..................................................................................... Expensing of certain small investments (normal tax method) ............................................................................................ Exclusion of reimbursed employee parking expenses ........................................................................................................ Additional deduction for the elderly ..................................................................................................................................... Expensing of research and experimentation expenditures (normal tax method) .............................................................. Exclusion of other employee benefits: Premiums on group term life insurance ............................................................... Exemption of credit union income ....................................................................................................................................... Self-employed medical insurance premiums ....................................................................................................................... Deferred taxes for financial firms on certain income earned overseas ............................................................................. Special ESOP rules .............................................................................................................................................................. Inventory property sales source rules exception ................................................................................................................. Exclusion of scholarship and fellowship income (normal tax method) .............................................................................. Deferral of interest on U.S. savings bonds ......................................................................................................................... Deferral of income from post-1987 installment sales ......................................................................................................... Parental personal exemption for students age 19 or over ................................................................................................. Alternative fuel production credit ......................................................................................................................................... Exclusion of employee meals and lodging (other than military) ........................................................................................ Exclusion of employer-provided child care .......................................................................................................................... Capital gains treatment of certain income from agriculture ................................................................................................ Exclusion of certain allowances for Federal employees abroad ........................................................................................ Expensing of multiperiod timber growing costs ................................................................................................................... Excess of percentage over cost depletion, fuels and nonfuel minerals ............................................................................ Empowerment zones and enterprise communities ............................................................................................................. Work opportunity tax credit .................................................................................................................................................. Exclusion of railroad retirement system benefits ................................................................................................................ Exclusion of public assistance benefits (normal tax method) ............................................................................................ Exclusion of parsonage allowances ..................................................................................................................................... Deductibility of student-loan interest .................................................................................................................................... Enhanced oil recovery credit ............................................................................................................................................... Deductibility of casualty losses ............................................................................................................................................ Exclusion of employer-provided educational assistance ..................................................................................................... Tax incentives for preservation of historic structures ......................................................................................................... Tax exemption of certain insurance companies owned by tax-exempt organizations ...................................................... 2001 92,390 80,570 60,925 42,390 41,780 32,830 28,240 26,555 23,205 23,075 19,480 19,095 18,885 16,130 15,975 6,600 6,275 5,895 5,785 5,125 4,850 4,790 4,790 4,555 4,225 4,160 4,160 4,050 3,360 3,200 3,195 2,830 2,790 2,670 2,420 2,360 2,160 1,925 1,895 1,890 1,885 1,780 1,650 1,380 1,290 1,205 1,150 1,120 1,115 1,035 1,015 905 710 700 695 695 530 525 500 465 410 375 365 310 295 275 250 240 235 2001–2005 513,775 456,085 331,245 238,745 221,685 174,160 152,955 145,225 118,365 124,810 90,995 101,390 99,130 94,175 87,635 37,350 32,750 33,290 31,575 24,965 24,720 26,160 21,660 25,440 23,610 23,950 23,630 20,825 14,150 17,510 16,925 16,145 16,485 13,070 18,350 11,520 11,000 9,610 10,530 9,970 10,595 9,345 9,480 11,110 1,830 6,540 6,750 5,705 6,175 5,375 5,515 2,125 3,880 3,845 3,805 3,805 2,920 2,745 1,855 1,160 2,105 2,025 2,090 1,860 1,990 1,490 425 1,330 1,245 118 ANALYTICAL PERSPECTIVES Table 5–3. MAJOR TAX EXPENDITURES IN THE INCOME TAX, RANKED BY TOTAL 2001 REVENUE LOSS— Continued (In millions of dollars) Provision Deferral for State prepaid tuition plans ............................................................................................................................... Amortization of start-up costs (normal tax method) ............................................................................................................ Exclusion of other employee benefits: Premiums on accident and disability insurance ................................................... Special Blue Cross/Blue Shield deduction .......................................................................................................................... Carryover basis of capital gains on gifts ............................................................................................................................. Expensing of environmental remediation costs ................................................................................................................... Exclusion for employer-provided transit passes .................................................................................................................. Exceptions from imputed interest rules ............................................................................................................................... Adoption assistance .............................................................................................................................................................. Exclusion of military disability pensions .............................................................................................................................. Tax credit and deduction for clean-fuel burning vehicles ................................................................................................... Small life insurance company deduction ............................................................................................................................. Expensing of certain multiperiod production costs .............................................................................................................. Exclusion of GI bill benefits ................................................................................................................................................. Tax credit for orphan drug research .................................................................................................................................... Welfare-to-work tax credit .................................................................................................................................................... Income averaging for farmers .............................................................................................................................................. New technology credit .......................................................................................................................................................... Exclusion from income of conservation subsidies provided by public utilities ................................................................... Exclusion of veterans pensions ........................................................................................................................................... Expensing of certain capital outlays .................................................................................................................................... Capital gains treatment of royalties on coal ....................................................................................................................... Exclusion of special benefits for disabled coal miners ....................................................................................................... Capital gains treatment of certain timber income ............................................................................................................... Exemption of certain mutuals’ and cooperatives’ income .................................................................................................. Credit for disabled access expenditures ............................................................................................................................. Excess bad debt reserves of financial institutions .............................................................................................................. Ordinary income treatment of loss from small business corporation stock sale ............................................................... Exclusion of certain foster care payments .......................................................................................................................... Tax credit for the elderly and disabled ............................................................................................................................... Medical Savings Accounts ................................................................................................................................................... Additional deduction for the blind ........................................................................................................................................ Investment credit for rehabilitation of structures (other than historic) ................................................................................ Education Individual Retirement Accounts .......................................................................................................................... Exception from passive loss limitation for working interests in oil and gas properties ..................................................... Credit for holders of zone academy bonds ......................................................................................................................... Expensing of exploration and development costs, nonfuel minerals ................................................................................. Cancellation of indebtedness ............................................................................................................................................... Alcohol fuel credits 1 ............................................................................................................................................................. Exclusion of interest on savings bonds redeemed to finance educational expenses ....................................................... Deferral of tax on shipping companies ............................................................................................................................... Deferral of gain on sale of farm refiners ............................................................................................................................. Investment credit and seven-year amortization for reforestation expenditures ................................................................. Treatment of loans forgiven for solvent farmers ................................................................................................................. Capital gains exclusion of small corporation stock ............................................................................................................. Special alternative tax on small property and casualty insurance companies .................................................................. Expensing of costs of removing certain architectural barriers to the handicapped .......................................................... Income of trusts to finance supplementary unemployment benefits .................................................................................. Expensing of exploration and development costs, fuels .................................................................................................... Accelerated depreciation of buildings other than rental housing (normal tax method) ..................................................... 2001 2001–2005 225 205 205 200 195 175 170 160 140 135 105 100 90 90 90 80 80 80 80 75 75 70 70 70 60 55 55 40 40 35 30 30 30 25 25 20 20 15 15 15 15 10 10 10 5 5 5 0 –30 –435 1,555 1,080 1,125 1,075 1,060 140 1,070 820 330 710 360 510 510 480 575 255 410 435 415 415 405 380 320 380 325 285 160 200 230 175 145 165 150 310 125 240 100 95 75 85 75 65 70 50 25 25 25 20 5 –6,145 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: 1999 $760; 2000 $800; 2001 $805; 2002 $810; 2003 $815; 2004 $825; and 2005 $830. 2 The figures in the table indicate the effect of the child tax credit on receipts. The effect on outlays (in millions of dollars) is as follows: 1999 $445; 2000 $550; 2001 $520; 2002 $505; 2003 $460; 2004 $450; and 2005 $420. 3 The figures in the table indicate the effect of the earned income tax credit on receipts. The effect on outlays (in millions of dollars) is as follows: 1999 $25,630; 2000 $25,675; 2001 $25,800; 2002 $26,875; 2003 $27,640; 2004 $28,700; and 2005 $29,720. 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. Provisions with estimates that rounded to zero in each year are not included in the table. Note: Three categories in the table are aggregated: Deductibility of charitable contributions, exclusion of interest for non-public purpose State and local debt, and excess of percentage over cost depletion for fuels and nonfuel minerals. 119 5. TAX EXPENDITURES Table 5–4. PRESENT VALUE OF SELECTED TAX EXPENDITURES FOR ACTIVITY IN CALENDAR YEAR 1999 (In millions of dollars) Present Value of Revenue Loss Provision 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 Deferral of income from controlled foreign corporations (normal tax method) ................................................... Deferred taxes for financial firms on income earned overseas .......................................................................... Expensing of research and experimentation expenditures (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 ................................................................................................................ Deferral for state prepaid tuition plans ................................................................................................................. Credit for holders of zone academy bonds ......................................................................................................... Credit for low-income housing investments ......................................................................................................... Exclusion of pension contributions—employer plans ........................................................................................... Exclusion of IRA contributions and earnings ....................................................................................................... Exclusion of contributions and earnings for Keogh plans ................................................................................... Exclusion of interest on public-purpose bonds .................................................................................................... Exclusion of interest on non-public purpose bonds ............................................................................................. Deferral of interest on U.S. savings bonds .......................................................................................................... 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 outlay-equivalent measure is larger than the revenue-loss estimate when the tax expenditure is judged to function as a Government payment for service. This 5,960 965 2,570 110 10 240 90 75 22,100 2,845 335 32,780 1,030 170 15 170 220 2,730 95,620 6,005 3,510 26,995 3,950 405 occurs because an outlay program would increase the taxpayer’s pre-tax 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. 120 ANALYTICAL PERSPECTIVES Table 5–5. OUTLAY EQUIVALENT ESTIMATES FOR TAX EXPENDITURES IN THE INCOME TAX (In millions of dollars) Outlay Equivalents 1999 2000 2001 2002 2003 2004 2005 2001–2005 1 National Defense Exclusion of benefits and allowances to armed forces personnel ....................................................... 2,470 2,495 2,520 2,545 2,570 2,600 2,630 12,865 2 3 4 5 6 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) .................................... Deferred taxes for financial firms on income earned overseas ............................................................ 3,940 5,600 1,620 5,800 960 4,270 5,980 1,690 6,200 1,190 4,625 6,400 1,770 6,600 1,290 5,000 6,860 1,920 7,000 540 5,370 7,340 2,080 7,450 0 5,760 7,850 2,230 7,900 0 6,185 8,400 2,380 8,400 0 26,940 36,850 10,380 37,350 1,830 7 8 General science, space, and technology: Expensing of research and experimentation expenditures (normal tax method) ................................. Credit for increasing research activities ................................................................................................. 1,890 2,625 1,865 1,550 1,875 5,175 1,960 5,710 2,090 4,570 2,245 4,010 2,415 2,320 10,585 21,785 9 10 11 12 13 14 15 16 17 18 19 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 credits 1 ............................................................................................................................... Tax credit and deduction for clean-fuel burning vehicles ..................................................................... Exclusion from income of conservation subsidies provided by public utilities ..................................... –80 325 1,495 30 85 165 315 70 15 110 115 –20 330 1,400 25 85 165 360 85 15 125 110 –30 335 1,315 25 95 165 415 120 15 135 105 –10 340 1,235 25 95 170 480 130 15 125 110 15 345 775 25 100 170 550 125 15 105 115 15 350 180 25 105 170 635 125 15 70 115 15 355 180 25 115 170 730 125 15 25 115 5 1,725 3,685 125 510 845 2,810 625 75 460 560 20 21 22 23 24 25 26 Natural resources and environment: Expensing of exploration and development costs, nonfuel minerals .................................................... Excess of percentage over cost depletion, nonfuel minerals ............................................................... 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 ............................................................................ 15 275 660 85 495 15 205 15 285 660 85 500 15 225 15 295 670 95 530 15 240 15 310 680 95 565 15 255 15 320 685 100 585 15 265 20 335 685 105 610 15 280 20 350 705 115 630 15 295 85 1,610 3,425 510 2,920 75 1,335 27 28 29 30 31 32 Agriculture: Expensing of certain capital outlays ...................................................................................................... Expensing of certain multiperiod production costs ................................................................................ Treatment of loans forgiven for solvent farmers ................................................................................... Capital gains treatment of certain income ............................................................................................. Income averaging for farmers ................................................................................................................ Deferral of gain on sale of farm refiners ............................................................................................... 65 85 10 845 75 10 70 85 10 885 75 10 75 90 10 925 80 10 75 95 10 965 80 10 80 100 10 1,015 80 15 85 105 10 1,060 85 15 85 110 10 1,105 85 15 400 500 50 5,070 410 65 1,910 75 13,920 5 295 135 2,015 85 14,985 5 300 135 2,160 70 16,130 5 315 135 2,320 55 17,365 5 320 135 2,490 40 18,870 5 335 135 2,675 25 20,130 5 340 140 2,865 5 21,680 5 355 140 12,510 195 94,175 25 1,665 685 1,300 220 56,920 21,215 995 22,500 5,315 0 3,710 1,310 220 58,815 22,185 1,015 23,175 5,035 0 3,985 1,320 230 60,925 23,075 1,035 23,870 4,790 0 4,225 1,330 230 63,240 24,000 1,055 24,590 4,555 5 4,495 1,345 230 65,955 24,980 1,075 25,325 4,330 5 4,760 1,365 230 68,965 25,915 1,095 26,090 4,100 5 4,975 1,370 230 72,160 26,840 1,115 26,870 3,885 5 5,145 6,730 1,150 331,245 124,810 5,375 126,745 21,660 20 23,600 40 160 52,540 5 34,400 175 45 1,655 25 160 54,100 5 36,120 185 45 705 15 160 55,705 5 37,655 195 55 –435 15 165 57,365 5 39,160 205 55 –755 20 165 59,065 5 40,725 210 55 –1,110 20 165 60,820 5 42,355 220 55 –1,695 25 165 62,620 5 44,045 230 55 –2,140 95 820 295,575 25 203,940 1,060 275 –6,135 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 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 certain 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 ....................................................................... Capital gains exclusion on home sales ............................................................................................. Exception from passive loss rules for $25,000 of rental loss .......................................................... Credit for low-income housing investments ....................................................................................... Accelerated depreciation on rental housing (normal tax method) .................................................... Commerce: Cancellation of indebtedness ............................................................................................................. Exceptions from imputed interest rules ............................................................................................. Capital gains (except 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) ................... 121 5. TAX EXPENDITURES Table 5–5. OUTLAY EQUIVALENT ESTIMATES FOR TAX EXPENDITURES IN THE INCOME TAX—Continued (In millions of dollars) Outlay Equivalents 1999 2000 2001 2002 2003 2004 2005 2001–2005 56 57 58 59 60 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 ....................................................................................... 26,440 1,465 200 9,790 445 27,735 1,590 205 9,690 450 32,825 1,920 205 9,655 450 33,340 1,965 215 9,940 460 34,260 1,915 215 9,985 460 36,380 1,890 220 10,325 465 37,325 1,900 225 10,485 475 174,130 9,590 1,080 50,390 2,310 61 62 63 Transportation: Deferral of tax on shipping companies .................................................................................................. Exclusion of reimbursed employee parking expenses .......................................................................... Exclusion for employer-provided transit passes .................................................................................... 20 2,225 180 20 2,330 205 20 2,450 235 20 2,575 265 20 2,710 295 20 2,855 330 20 3,005 360 100 13,595 1,485 64 65 66 67 68 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 ..................................................................................... 25 1,045 60 325 150 25 1,050 60 445 200 25 1,060 60 500 235 25 1,075 65 470 80 25 1,085 65 325 –40 25 1,095 65 300 –50 30 1,105 70 265 –40 130 5,420 325 1,860 185 1,190 5,890 2,780 0 300 120 355 845 5 15 1,010 25,915 3,435 275 1,220 6,310 3,045 10 335 175 360 855 15 20 1,070 26,100 3,685 290 1,235 6,570 3,100 25 390 225 365 860 30 20 1,125 25,975 3,850 310 1,240 6,595 3,160 40 440 275 365 860 50 20 1,165 25,290 4,040 215 1,255 6,080 5,645 60 470 320 365 875 75 20 1,225 24,205 4,250 0 1,265 5,915 5,675 80 495 355 370 880 90 30 1,280 23,385 4,395 0 1,280 6,845 5,935 105 535 385 370 890 100 30 1,310 22,475 4,610 0 6,275 32,005 23,515 310 2,330 1,560 1,835 4,365 345 120 6,105 121,330 21,145 525 83 84 85 86 87 88 89 90 91 92 93 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 for 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 redeemed to finance educational expenses ..................... 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 ................................................................................................... 270 35 860 160 795 3,225 65 0 25,750 45 395 455 60 890 175 830 3,185 65 0 26,955 50 420 465 80 930 180 865 3,145 75 5 28,115 50 450 350 80 970 160 905 3,110 75 5 29,380 55 480 215 60 1,020 55 945 3,075 75 5 30,790 55 515 95 25 1,075 20 990 3,035 80 5 32,200 60 550 35 10 1,135 10 1,030 3,000 80 5 33,755 60 585 1,160 255 5,130 425 4,735 15,365 385 25 154,240 280 2,580 94 95 96 97 98 99 100 101 102 Health: Exclusion of employer contributions for medical insurance premiums and medical care ................... Self-employed medical insurance premiums ......................................................................................... Workers’ compensation insurance premiums ........................................................................................ 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 ............................................................................................. 88,730 1,145 5,520 30 3,695 1,735 3,640 70 325 95,950 1,535 5,730 40 3,910 1,755 3,910 80 420 103,085 1,700 5,945 45 4,160 1,770 4,095 90 270 110,390 1,900 6,170 45 4,440 1,790 4,300 100 180 115,840 2,550 6,400 45 4,720 1,815 4,525 115 240 122,545 3,580 6,645 40 5,005 1,830 4,665 130 325 131,495 3,955 3,895 35 5,305 1,850 4,900 140 420 583,355 13,685 29,055 210 23,630 9,055 22,485 575 1,435 395 5,185 345 75 130 405 5,330 360 75 130 410 5,785 375 70 135 415 6,040 390 70 140 420 6,310 405 65 140 430 6,575 420 60 145 430 6,865 435 55 150 2,105 31,575 2,025 320 710 97,960 18,290 6,630 104,060 20,025 7,040 108,190 21,360 7,475 113,770 22,770 7,930 120,275 23,695 8,415 126,700 24,645 8,925 133,400 25,445 9,465 602,335 117,915 42,210 2,240 2,290 2,340 2,395 2,445 2,520 2,590 12,290 69 70 71 72 73 74 75 76 77 78 79 80 81 82 103 104 105 106 107 108 109 110 111 Income security: Exclusion of railroad retirement system benefits ................................................................................... Exclusion of workers’ 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 other employee benefits: Premiums on group term life insurance ............................................................................................ 122 ANALYTICAL PERSPECTIVES Table 5–5. OUTLAY EQUIVALENT ESTIMATES FOR TAX EXPENDITURES IN THE INCOME TAX—Continued (In millions of dollars) Outlay Equivalents 1999 2000 2001 2002 2003 2004 2005 2001–2005 112 113 114 115 116 117 118 119 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 ..................................................................................................................... 235 0 1,565 35 2,155 45 280 5,360 250 0 1,630 35 2,215 45 290 5,220 260 0 1,670 40 2,285 45 300 5,320 275 5 1,730 40 2,360 45 315 5,540 290 5 1,800 40 2,400 45 325 5,785 305 5 1,885 45 2,455 45 340 6,045 315 5 1,975 45 2,555 45 355 6,380 1,445 20 9,060 210 12,055 225 1,635 29,070 120 121 122 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 ..................................................................... 17,135 2,390 3,775 18,010 2,595 3,900 18,885 2,830 4,050 19,995 3,090 4,210 21,230 3,375 4,385 22,505 3,700 4,555 16,515 3,150 3,625 99,130 16,145 20,825 123 124 125 126 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 ................................................................................. 2,940 65 75 60 3,070 70 85 60 3,200 75 90 60 3,335 80 90 60 3,490 85 95 60 3,655 85 100 60 3,830 90 105 60 17,510 415 480 300 127 128 129 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 .................... 32,600 37,740 3,590 32,925 40,240 3,700 33,250 42,390 3,815 33,590 44,735 3,715 33,920 47,610 3,640 34,255 50,530 3,715 34,600 53,480 3,785 169,615 238,745 18,670 130 Interest: Deferral of interest on U.S. savings bonds ........................................................................................... 1,015 1,065 1,115 1,175 1,235 1,295 1,355 6,175 21,215 37,740 22,185 40,240 23,075 42,390 24,000 44,735 24,980 47,610 25,915 50,530 26,840 53,480 124,810 238,745 32,600 165 660 445 1,300 220 1,045 355 845 1,735 60 5 32,925 165 660 450 1,310 220 1,050 360 855 1,755 60 15 33,250 165 670 450 1,320 230 1,060 365 860 1,770 60 30 33,590 170 680 460 1,330 230 1,075 365 860 1,790 60 50 33,920 170 685 460 1,345 230 1,085 365 875 1,815 60 75 34,255 170 685 465 1,365 230 1,095 370 880 1,830 60 90 34,600 170 705 475 1,370 230 1,105 370 890 1,850 60 100 169,615 845 3,425 2,310 6,730 1,150 5,420 1,835 4,365 9,055 300 345 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 State and local bonds for: Public purposes .................................................................................................................................. Energy facilities ................................................................................................................................... Water, sewage, and hazardous waste disposal facilities ................................................................. Small-issues ........................................................................................................................................ Owner-occupied mortgage subsidies ................................................................................................. Rental housing .................................................................................................................................... Airports, docks, and similar facilities ................................................................................................. Student loans ...................................................................................................................................... Private nonprofit educational facilities ............................................................................................... Hospital construction .......................................................................................................................... Veterans’ housing ............................................................................................................................... Credit for holders of zone academy bonds ........................................................................................... 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: 1999 $760; 2000 $800; 2001 $805; 2002 $810; 2003 $815; 2004 $825; and 2005 $830. 2 The figures in the table indicate the effect of the child tax credit on receipts. The effect on outlays (in millions of dollars) is as follows: 1999 $445; 2000 $550; 2001 $520; 2002 $505; 2003 $460; 2004 $450; and 2005 $420. 3 The figures in the table indicate the effect of the earned income tax credit on receipts. The effect on outlays (in millions of dollars) is as follows: 1999 $25,632; 2000 $25,676; 2001 $25,799; 2002 $26,876; 2003 $27,638; 2004 $28,701; and 2005 $29,722. 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. Provisions with estimates that rounded to zero in each year are not included in the table. 5. TAX EXPENDITURES Tax Expenditure Baselines A tax expenditure is a preferential exception to the baseline provisions of the tax structure. The 1974 Congressional Budget Act did not, however, specify the baseline provisions of the tax law. Deciding whether provisions are preferential exceptions, therefore, is a matter of judgment. 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. The reference tax law baseline is also patterned on a comprehensive income tax, but 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. Tax expenditures under the reference law baseline are generally tax expenditures under the normal tax baseline, but the reverse is not always true. Both the normal and reference tax baselines allow several major departures from a pure comprehensive income tax. For example: • Income is taxable only when it is realized in exchange. Thus, neither the deferral of tax on unrealized capital gains nor the tax exclusion of imputed income (such as the rental value of owneroccupied housing or farmers’ consumption of their own produce) is regarded as a tax expenditure. Both accrued and imputed income would be taxed under a comprehensive income tax. • 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). Although the reference law and normal tax baselines are generally similar, areas of difference include: 123 • 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. • 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. 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. 124 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. Beyond these examples, there are still more areas of difference where the Joint Committee on Taxation considers a somewhat broader set of tax expenditures under its normal tax baseline than under the reference baseline considered here. Performance Measures and the Economic Effects of Tax Expenditures The Government Performance and Results Act of 1993 (GPRA) directs Federal agencies to develop annual and strategic plans for their programs and activities. These plans set out performance objectives to be achieved over a specific time period. Most of these objectives will be achieved through direct expenditure programs. However, tax expenditures may also contribute to achieving these goals. The report of the Senate Governmental Affairs Committee on GPRA 4 calls on the Executive branch to undertake a series of analyses to assess the effect of specific tax expenditures on the achievement of agencies’ performance objectives. One finding of pilot studies on selected tax expenditures undertaken by Treasury’s Office of Tax Analysis is that much of the data needed for thorough analysis are not currently available. Hence, assessment of data needs and availability from Federal statistical agencies, program-agency studies, or private-sector sources, should prove valuable to broader efforts to assess the effects of tax expenditures and to compare their effectiveness with other policy means of achieving important public objectives. This effort will complement information published by the Joint Committee on Taxation and the Senate Budget Committee on tax expenditures.5 Over the next few years, the Executive Branch’s focus will be on the availability of the data needed to assess the effects of the tax expenditures designed to increase savings. As one part of this effort, Treasury’s Office of Tax Analysis and its Statistics of Income Division (IRS) are developing the specifications for a new data sample which will follow the same individual income tax filers over an extended period of time. Such a sam4 Committee on Government Affairs, United States Senate, ‘‘Government Performance and Results Act of 1993’’ (Report 103–58, 1993). 5 Joint Committee on Taxation, ‘‘Estimates of Federal Tax Expenditures for Fiscal Years 1999–1993,’’ JCS–7–98, December 14, 1998; 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). ANALYTICAL PERSPECTIVES ple is called a ‘‘panel’’ sample. Current economic analyses of the effect of Federal tax laws are generally based on data from ‘‘cross-section’’ samples, which capture the demographic and economic circumstances of individuals and the provisions of Federal tax law only at a single point in time. However, over time, the demographic and economic status of individuals changes in ways that can significantly change how they are affected by current (or proposed) Federal tax laws. In addition, some provisions of the tax law have effects over multiple years, and the effects of some tax provisions change over time due to phase-ins, phase-outs, and other factors. The new panel sample will capture the changing demographic and economic circumstances of individuals and the effects of changes in tax law over an extended period of time. Data from the panel sample will therefore permit more extensive, and better, analyses of many tax provisions than can be performed using only cross-section data. In particular, data from the panel sample will enhance our ability to analyze the effect of tax expenditures designed to increase savings. Other efforts to improve data available for the analysis of savings tax expenditures will be undertaken over the next several years by OMB, Treasury and other agencies. Comparison of tax expenditure, spending, and regulatory policies. Tax expenditures by definition work through the tax system and, particularly, the income tax. Thus, they may be relatively advantageous policy approaches when the benefit or incentive is related to income and is intended to be widely available.6 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 some cases. In addition, some tax expenditures actually simplify the tax system (for example, the exclusion for up to $500,000 of capital gains on home sales). Tax expenditures also implicitly subsidize certain activities. Spending, regulatory or taxdisincentive policies, can also modify behavior, but may have different economic effects. Finally, a variety of tax expenditure tools can be used—e.g., deductions, credits, exemptions and deferrals; floors and ceilings; and phase-ins and phase-outs, dependent on income, expenses, or demographic characteristics (age, number of family members, etc.). This wide range means that tax expenditures can be flexible and can have very different economic effects. Tax expenditures also have limitations. In many cases they add to the complexity of the tax system, which raises both administrative and compliance costs. For example, various holding periods and tax rates for capital gains can complicate filing and decisionmaking. The income tax system may have little or no contact with persons who have no or very low incomes, and does not inquire into certain characteristics of individ6 Although 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 bases of those taxes, such as an excise tax exemption for certain types of consumption that are deemed meritorious. 5. TAX EXPENDITURES uals used in some spending programs, such as wealth. These features may reduce the effectiveness of tax expenditures for addressing certain income-transfer objectives. Tax expenditures also generally do not enable the same degree of agency discretion as outlay programs. 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 may not receive the same frequency or level of scrutiny afforded to other programs. 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, the availability of many different types of spending programs—including direct government provision; credit programs; and payments to State and local governments, the private sector, or individuals in the form of grants or contracts—provides flexibility for policy design. On the other hand, certain outlay programs—such as direct government service provision—may rely less directly on economic incentives and private-market provision than tax incentives, which may reduce the relative efficiency of spending programs for some goals. Spending programs also require resources to be raised via taxes, user charges, or government borrowing. Finally, spending programs, particularly on the discretionary side, may respond less readily to changing activity levels and economic conditions than tax expenditures. Regulations have more direct and immediate effects than outlay and tax-expenditure programs because regulations apply directly and immediately to the regulated party (i.e., the intended actor)—generally in the private sector. Regulations can also be fine-tuned more quickly than tax expenditures, because they can generally be changed by the executive branch without legislation. Like tax expenditures, regulations often rely largely upon voluntary compliance, rather than detailed inspections and policing. As such, the public administrative costs tend to be modest, relative to the private resource costs associated with modifying activities. Historically, regulations have tended to rely on proscriptive measures, as opposed to economic incentives. This reliance can diminish their economic efficiency, although this feature can also promote full compliance where (as in certain safety-related cases) policymakers believe that trade-offs with economic considerations are not of paramount importance. Also, regulations generally do not directly affect Federal outlays or receipts. Thus, like tax expenditures, they may escape the 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 125 for outlays and tax-expenditures. To some extent, the GPRA requirement for performance evaluation will address this lack of formal analysis. Some policy objectives are achieved using multiple approaches. For example, minimum wage legislation, the earned income tax credit, and the food stamp program are regulatory, tax expenditure, and direct outlay programs, respectively, all having the objective of improving the economic welfare of low-wage workers. Tax expenditures, like spending and regulatory programs, have a variety of objectives and effects. These include: encouraging certain types of activities (e.g., saving for retirement or investing in certain sectors); increasing certain types of after-tax income (e.g., favorable tax treatment of social security income); reducing private compliance costs and government administrative costs (e.g., the exclusion for up to $500,000 of capital gains on home sales); and promoting tax neutrality (e.g., accelerated depreciation in the presence of inflation). Some of these objectives are well suited to quantitative measurement, while others are less well suited. Also, many tax expenditures, including those cited above, may have more than one objective. For example, accelerated depreciation may encourage investment. In addition, the economic effects of particular provisions can extend beyond their intended objectives (e.g., a provision intended to promote an activity or raise certain incomes may have positive or negative effects on tax neutrality). Performance measurement is generally concerned with inputs, outputs, and outcomes. In the case of tax expenditures, the principal input is usually the 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). Effects on the incomes of members of particular groups may be an important measure for certain provisions. An overview of evaluation issues by budget function. The discussion below considers the types of measures that might be useful for some major programmatic groups of tax expenditures. The discussion is intended to be illustrative and not all encompassing. However, it is premised on the assumption that the data needed to perform the analysis are available or can be devel- 126 oped. In practice, data availability is likely to be a major challenge, and data constraints may limit the assessment of the effectiveness of many provisions. In addition, such assessments can raise significant challenges in economic modeling. National defense.—Some tax expenditures are intended to assist governmental activities. For example, tax preferences for military benefits reflect, among other things, the view that benefits such as housing, subsistence, and moving expenses are intrinsic aspects of military service, and are provided, in part, for the benefit of the employer, the U.S. Government. Tax benefits for combat service are intended to reduce tax burdens on military personnel undertaking hazardous service for the Nation. A portion of the tax expenditure associated with foreign earnings is targeted to benefit U.S. Government civilian personnel working abroad by offsetting the living costs that can be higher than those in the United States. These tax expenditures should be considered together with direct agency budget costs in making programmatic decisions. International affairs.—Tax expenditures are also aimed at 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—might also be estimated. In some cases, such as research, there is evidence that the investment can provide significant positive externalities—that is, economic benefits that are not reflected in the market transactions between private parties. It could be useful to quantify these externalities and compare them with the degree of tax subsidy provided. Measures could also indicate the provisions’ effects on production from these investments—such as ANALYTICAL PERSPECTIVES 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 producers) and their cost-effectiveness relative to other policies. Analysis could also consider objectives that are more difficult to measure but still are ultimate goals, such as promoting the Nation’s technological base, energy security, environmental quality, or economic growth. Such an assessment is likely to involve tax analysis as well as consideration of non-tax matters such as market structure, scientific, and other information (such as the effects of increased domestic fuel production on imports from various regions, or the effects of various energy sources on the environment). Housing investment also benefits from tax expenditures, 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 grants and other policies designed to spur economic development. 127 5. TAX EXPENDITURES Education, training, employment, and social services.—Major provisions in this function are intended to promote post-secondary education, to offset costs of raising children, and to promote a variety of charitable activities. The education incentives can be compared with loans, grants, and other programs designed to promote higher education and training. The child credits are intended to adjust the tax system for the costs of raising children; as such, they could be compared to other Federal tax and spending policies, including related features of the tax system, such as personal exemptions (which are not defined as a tax expenditure). Evaluation of charitable activities requires consideration of the beneficiaries of these activities, who are generally not the parties receiving the tax reduction. Health.—Individuals also benefit from favorable treatment of employer-provided health insurance. Measures of these benefits could include increased coverage and pooling of risks. The effects of insurance coverage on final outcome measures of actual health (e.g., infant mortality, days of work lost due to illness, or life expectancy) or intermediate outcomes (e.g., use of preventive health care or health care costs) could also be investigated. Income security, social security, and veterans benefits and services.—Major tax expenditures in the income security function benefit retirement savings, through employer-provided pensions, individual retirement accounts, and Keogh plans. These provisions might be evaluated in terms of their effects on boosting retirement incomes, private savings, and national savings (which would include the effect on private savings as well as public savings or deficits). Interactions with other programs, including social security, also may merit analysis. As in the case of employer-provided health insurance, analysis of employer-provided pension programs requires imputing the benefits provided at the firm level to individuals. Other provisions principally affect the incomes of members of certain groups, rather than affecting incentives. For example, tax-favored treatment of social security benefits, certain veterans benefits, and deductions for the blind and elderly provide increased incomes to eligible parties. The earned-income tax credit, in contrast, should be evaluated for its effects on labor force participation as well as the income it provides lowerincome workers. General purpose fiscal assistance and interest.— The tax-exemption for public purpose State and local bonds reduces the costs of borrowing for a variety of purposes (borrowing for non-public purposes is reflected under other budget functions). The deductibility of certain State and local taxes reflected under this function primarily relates to personal income taxes (property tax deductibility is reflected under the commerce and housing function). Tax preferences for Puerto Rico and other U.S. possessions are also included here. These provi- sions can be compared with other tax and spending policies as means of benefitting fiscal and economic conditions in the States, localities, and possessions. Finally, the tax deferral for interest on U.S. savings bonds benefits savers who invest in these instruments. The extent of these benefits and any effects on Federal borrowing costs could be evaluated. The above illustrative discussion, although broad, is nevertheless incomplete, both for the provisions mentioned and the many that are not explicitly cited. Developing a framework that is sufficiently comprehensive, accurate, and flexible to reflect the objectives and effects of the wide range of tax expenditures will be a significant challenge. OMB, Treasury, and other agencies will work together, as appropriate, to address this challenge. As indicated above, over the next few years the Executive Branch’s focus will be on the availability of the data needed to assess the effects of the tax expenditures designed to increase savings. Descriptions of Income Tax Provisions Descriptions of the individual and corporate income tax expenditures reported upon in this chapter follow. National Defense 1. Benefits and allowances to armed forces personnel.—The housing and meals provided military personnel, either in cash or in kind, as well as certain amounts of pay related to combat service, are excluded from income subject to tax. International Affairs 2. Income earned abroad.—U.S. citizens who lived abroad, worked in the private sector, and satisfyied a foreign residency requirement in 1999 may exclude up to $74,000 in foreign earned income from U.S. taxes. The exclusion increases in 2000, 2001, and 2002 to $76,000, $78,000, and $80,000, respectively. In addition, if these taxpayers receive a specific allowance for foreign housing from their employers, they may also exclude the value of that allowance. If they do not receive a specific allowance for housing expenses, they may deduct against their U.S. taxes that portion of such expenses that exceeds one-sixth the salary of a civil servant at grade GS-14, step 1 ($63,567 in 1999). Beginning this year, the value of U.S. tax benefits provided to employees of the U.S. government who live and work overseas is not included under this heading. Those tax benefits now are included under their own heading, Exclusion of Certain Allowances for Federal Employees Abroad (#3). 3. Exclusion of Certain Allowances for Federal Employees Abroad.—U.S. Federal civilian employees and Peace Corps members who work outside the continental United States are allowed to exclude from U.S. taxable income certain special allowances they receive to compensate them for the relatively high costs associated with living overseas. The allowances supplement wage income and cover expenses like rent, education, and the cost of travel to and from the United States. 128 ANALYTICAL PERSPECTIVES 4. 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. 5. Sales source rule exceptions.—The worldwide income of U.S. persons is taxable by the United States and a credit for foreign taxes paid is allowed. The amount of foreign taxes that can be credited is limited to the pre-credit U.S. tax on the foreign source income. The sales source rules for inventory property allow U.S. exporters to use more foreign tax credits by allowing the exporters to attribute a larger portion of their earnings abroad than would be the case if the allocation of earnings was based on actual economic activity. 6. Income of U.S.-controlled foreign corporations.—The income of foreign corporations controlled by U.S. shareholders is not subject to U.S. taxation. The income becomes taxable only when the controlling U.S. shareholders receive dividends or other distributions from their foreign stockholding. Under the normal tax method, the currently attributable foreign source pre-tax income from such a controlling interest is considered to be subject to U.S. taxation, whether or not distributed. Thus, the normal tax method considers the amount of controlled foreign corporation income not distributed to a U.S. shareholder as tax-deferred income. 7. Exceptions under subpart F for active financing income.—Financial firms can defer taxes on income earned overseas in an active business. Taxes on income earned through December 31, 2001 can be deferred. The Tax Relief Extension Act of 1999 extended the expiration date from December 31, 1999 to December 31, 2001. General Science, Space, and Technology 8. Expensing R&E expenditures.—Research and experimentation (R&E) projects can be viewed as investments because, if successful, their benefits accrue for several years. It is often difficult, however, to identify whether a specific R&E project is successful and, if successful, what its expected life will be. Under the normal tax method, the expensing of R&E expenditures is viewed as a tax expenditure. The baseline assumed for the normal tax method is that all R&E expenditures are successful and have an expected life of five years. 9. R&E credit.—The research and experimentation (R&E) credit, which expired on June 30, 1999, was reinstated (retroactively) in the Tax Relief Extension Act of 1999 for five years (through June 30, 2004). The Act also increased the credit rates for the alternative credit by one percentage point and extended the research credit to include research conducted in Puerto Rico and the U.S. possessions. 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’’ by the average amount of the company’s gross receipts for the prior four years. The taxpayer’s fixed base percentage generally is the ratio of its research expenses to gross receipts for 1984 through 1988. Taxpayers may also elect an alternative credit regime. Under the alternative credit regime the taxpayer is assigned a threetiered fixed-base percentage that is lower than the fixed-base percentage that would otherwise apply, and the credit rate is reduced (the rates range from 2.65 percent to 3.75 percent). A 20-percent credit with a separate threshold is provided for a taxpayer’s payments to universities for basic research. Energy 10. Exploration and development costs.—For successful investments in domestic oil and gas wells, intangible drilling costs (e.g., wages, the costs of using machinery for grading and drilling, the cost of unsalvageable materials used in constructing wells) may be expensed rather than amortized over the productive life of the property. Integrated oil companies may deduct only 70 percent of such costs and must amortize the remaining 30 percent over five years. The same rule applies to the exploration and development costs of surface stripping and the construction of shafts and tunnels for other fuel minerals. 11. Percentage depletion.—Independent fuel mineral producers and royalty owners are generally allowed to take percentage depletion deductions rather than cost depletion on limited quantities of output. Under cost depletion, outlays are deducted over the productive life of the property based on the fraction of the resource extracted. Under percentage depletion, taxpayers deduct a percentage of gross income from mineral production at rates of 22 percent for uranium; 15 percent for oil, gas and oil shale; and 10 percent for coal. The deduction is limited to 50 percent of net income from the property, except for oil and gas where the deduction can be 100 percent of net property income. Production from geothermal deposits is eligible for percentage depletion at 65 percent of net income, but with no limit on output and no limitation with respect to qualified producers. Unlike depreciation or cost depletion, percentage depletion deductions can exceed the cost of the investment. 12. Alternative fuel production credit.—A nontaxable credit of $3 per 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. 13. Oil and gas exception to passive loss limitation.—Owners of working interests in oil and gas properties are exempt from the ‘‘passive income’’ limitations. As a result, the working interest-holder, who manages on behalf of himself and all other owners the development of wells and incurs all the costs of their operation, may aggregate negative taxable income from such interests with his income from all other sources. 14. Capital gains treatment of royalties on coal.—Sales of certain coal under royalty contracts can be treated as capital gains rather than ordinary income. 129 5. TAX EXPENDITURES 15. Energy facility bonds.—Interest earned on State and local bonds used to finance construction of certain energy facilities is tax-exempt. These bonds are generally subject to the State private-activity bond annual volume cap. 16. Enhanced oil recovery credit.—A credit is provided equal to 15 percent of the taxpayer’s costs for tertiary oil recovery on U.S. projects. Qualifying costs include tertiary injectant expenses, intangible drilling and development costs on a qualified enhanced oil recovery project, and amounts incurred for tangible depreciable property. 17. New technology credits.—A credit of 10 percent is available for investment in solar and geothermal energy facilities. In addition, a credit of 1.5 cents is provided per kilowatt hour of electricity produced from renewable resources such as wind and biomass. The renewable resources credit applies only to electricity produced by a facility placed in service on or before December 31, 2001. The Tax Relief Extension Act of 1999 extended the expiration date from June 30, 1999 to December 31, 2001 and expanded the credit to apply to electricity produced from poultry waste facilities (placed in service after December 31, 1999). 18. Alcohol fuel credits.—An income tax credit is provided for ethanol that is derived from renewable sources and used as fuel. The credit equals 54 cents per gallon in 1998, 1999, and 2000; 53 cents per gallon in 2001 and 2002; 52 cents per gallon in 2003 and 2004; and 51 cents per gallon in 2005, 2006, and 2007. To the extent that ethanol is mixed with taxable motor fuel to create gasohol, taxpayers may claim an exemption of the Federal excise tax rather than the income tax credit. In addition, small ethanol producers are eligible for a separate 10 cents per gallon credit. 19. Credit and deduction for clean-fuel vehicles and property.—A tax credit of 10 percent (not to 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. 20. Exclusion of utility conservation subsidies.— Subsidies by public utilities for non-business customer expenditures on energy conservation measures are excluded from the gross income of the customer. Natural Resources and Environment 21. Exploration and development costs.—Certain capital outlays associated with exploration and development of nonfuel minerals may be expensed rather than depreciated over the life of the asset. 22. Percentage depletion.—Most nonfuel mineral extractors may use percentage depletion rather than cost depletion, with percentage depletion rates ranging from 22 percent for sulfur to 5 percent for sand and gravel. 23. Sewage, water, and hazardous waste bonds.—Interest earned on State and local bonds used to finance the construction of sewage, water, or haz- ardous 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 a capital gain rather than ordinary income. 25. Expensing multiperiod timber growing costs.—Most of the production costs of growing timber may be expensed rather than capitalized and deducted when the timber is sold. In most other industries, these costs are capitalized under the uniform capitalization rules. 26. 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 may be amortized 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, a 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 reduces carryover losses, then unused credits, and then basis; any remainder of the forgiven debt is excluded from tax. Farmers with forgiven debt are considered insolvent for tax purposes, and thus qualify for income tax forgiveness. 130 ANALYTICAL PERSPECTIVES 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.—Taxpayers can lower their tax liability by averaging, over the prior three-year period, their taxable income from farming. 33. Deferral of gain on sales of farm refiners.— A taxpayer who sells stock in a farm refiner to a farmers’ cooperative can defer recognition of gain if the taxpayer reinvests the proceeds in qualified replacement property. 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. 34. Credit union income.—The earnings of credit unions not distributed to members as interest or dividends are exempt from income tax. 35. 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. 36. 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. 37. 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 $2.1 million of net premium incomes may elect to pay tax only on the income earned by their investment portfolio. 38. 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. 39. 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. 40. 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. The volume cap increases to $55 per capita ($165 million minimum) in 2003 and ratably annually thereafter until the cap reaches $75 per capita ($225 million minimum) in 2007. States may issue mortgage credit certificates (MCCs) in lieu of mortgage revenue bonds. MCCs entitle home buyers to income tax credits for a specified percentage of interest on qualified mortgages. The total amount of MCCs issued by a State cannot exceed 25 percent of its annual ceiling for mortgage-revenue bonds. 41. 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. 42. 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. 43. 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. 44. Installment sales.—Dealers in real and personal property (i.e., sellers who regularly hold property for sale or resale) cannot defer taxable income from installment sales until the receipt of the loan repayment. Nondealers (i.e., sellers of real property used in their business) are required to pay interest on deferred taxes attributable to their total installment obligations in excess of $5 million. Only properties with sales prices exceeding $150,000 are includable in the total. The pay- 5. TAX EXPENDITURES ment of a market rate of interest eliminates the benefit of the tax deferral. The tax exemption for nondealers with total installment obligations of less than $5 million is, therefore, a tax expenditure. 45. Capital gains exclusion on home sales.—A homeowner can exclude from tax up to $500,000 ($250,000 for singles) of the capital gains from the sale of a principal residence. The exclusion may not be used more than once every two years. 46. 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. 47. Low-income housing credit.—Taxpayers who invest in certain low-income housing are eligible for a tax credit. The credit rate is set so that the present value of the credit is equal to 70 percent for new construction and 30 percent for (1) housing receiving other Federal benefits (such as tax-exempt bond financing), or (2) substantially rehabilitated existing housing. The credit is allowed in equal amounts over 10 years. State agencies determine who receives the credit; States are limited in the amount of credit they may authorize annually to $1.25 per resident. 48. Accelerated depreciation of rental property.— The tax depreciation allowance provisions are part of the reference law rules, and thus do not give rise to tax expenditures under the reference method. Under the normal tax method, however, a 40-year tax life for depreciable real property is the norm. Thus, a 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. 49. 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. 50. Imputed interest rules.—Holders (issuers) of debt instruments are generally required to report interest earned (paid) in the period it accrues, not when paid. In addition, the amount of interest accrued is determined by the actual price paid, not by the stated principal and interest stipulated in the instrument. In general, any debt associated with the sale of property worth less than $250,000 is excepted from the general interest accounting rules. This general $250,000 exception is not a tax expenditure under reference law but is under normal law. Exceptions above $250,000 are a tax expenditure under reference law; these exceptions include the following: (1) sales of personal residences worth more than $250,000, and (2) sales of farms and small businesses worth between $250,000 and $1 million. 51. 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 131 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, the top tax rate is 20 percent (10 percent for taxpayers who would otherwise pay capital gains tax at the 15-percent rate). 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. 52. 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. 53. 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. 54. Carryover basis of capital gains on gifts.— When a gift is made, the donor’s basis in the transferred property (the cost that was incurred when the transferred property was first acquired) carries-over to the donee. The carryover of the donor’s basis allows a continued deferral of unrealized capital gains. 55. 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. 56. Accelerated depreciation of non-rental-housing buildings.—The tax depreciation allowance provisions are part of the reference law rules, and thus do not give rise to tax expenditures under reference law. Under normal law, however, 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. 57. Accelerated depreciation of machinery and equipment.—The tax depreciation allowance provisions are part of the reference law rules, and thus do not give rise to tax expenditures under reference law. Statutory depreciation of machinery and equipment, however, is accelerated somewhat relative to the normal tax baseline, creating a tax expenditure. 58. Expensing of certain small investments.—In 1999, qualifying investments in tangible property up to $19,000 can be expensed rather than depreciated 132 ANALYTICAL PERSPECTIVES 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 1999, the amount expensed is completely phased out when qualifying investments exceed $219,000. 59. 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. 60. 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 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. 61. 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 62. 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. 63. Exclusion of employee parking expenses.— Employee parking expenses that are paid for by the employer or that are received in lieu of wages are excludable from the income of the employee. In 1999, the maximum amount of the parking exclusion was $175 (indexed, except in 1999) per month. The tax expenditure estimate does not include parking at facilities owned by the employer. 64. Exclusion of employee transit pass expenses.—Transit passes, tokens, fare cards, and vanpool expenses paid for by an employer or provided in lieu of wages to defray an employee’s commuting costs are excludable from the employee’s income. In 1999, the maximum amount of the exclusion wasis $65 (indexed, except in 1999) per month. Community and Regional Development 65. 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. 66. 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. 67. 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. 68. 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 on homes purchased on or before December 31, 2001, and investors in certain D.C. property can receive a capital gains break. 69. Expensing of environmental remediation costs.—Taxpayers who clean up hazardous substances at a qualified site may expense the clean-up costs, rather than capitalize the costs, even though the expenses will generally increase the value of the property significantly or appreciably prolong the life of the property. The expensing only applies to clean-up costs incurred on or before December 31, 2001. Tax Relief Extension Act of 1999 extended the expiration date from December 31, 2000 to December 31, 2001. 5. TAX EXPENDITURES Education, Training, Employment, and Social Services 70. 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). 71. HOPE tax credit.—The non-refundable HOPE tax credit allows a credit for 100 percent of an eligible student’s first $1,000 of tuition and fees and 50 percent of the next $1,000 of tuition and fees. The credit only covers tuition and fees paid during the first two years of a student’s post-secondary education. The credit is phased out ratably for taxpayers with modified AGI between $80,000 and $100,000 ($40,000 and $50,000 for singles). 72. Lifetime Learning tax credit.—The non-refundable Lifetime Learning tax credit allows a credit for 20 percent of an eligible student’s tuition and fees. For tuition and fees paid before January 1, 2003, 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 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. 73. Education Individual Retirement Accounts.— Contributions to an education IRA are not tax-deductible. Investment income earned by education IRAs is not taxed when earned, and investment income from an education IRA is tax-exempt when withdrawn to pay for a student’s tuition and fees. The maximum contribution to an education IRA is $500 per year per beneficiary. 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. 74. 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). 133 75. State prepaid tuition plans.—Some States have adopted prepaid tuition plans and prepaid room and board plans, which allow persons to pay in advance for college expenses for designated beneficiaries. Taxes on the earnings from these plans are paid by the beneficiaries and are deferred until the tuition is actually paid. 76. 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. 77. 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. 78. Credit for holders of zone academy bonds.— Financial institutions that own zone academy bonds receive a non-refundable tax credit (set by the Treasury Department) rather than interest. The credit is included in gross income. Proceeds from zone academy bonds may only be used to improve impoverished schools. The total amount of zone academy bonds that may be issued is limited to $1.6 billion—$400 million in each year between 1998 and 2001. The Tax Relief Extension Act of 1999 allowed bonds to be issued in 2000 and 2001. 79. U.S. savings bonds for education.—Interest earned on U.S. savings bonds issued after December 31, 1989 is tax-exempt if the bonds are transferred to an educational institution to pay for educational expenses. The tax exemption is phased out for taxpayers with AGI between $79,650 and $109,650 ($53,100 and $68,100 for singles) in 1999. 80. 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. 81. Child credit.—Taxpayers with children under age 17 can qualify for a $500 child credit. 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. 82. 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. 83. Employer-provided educational assistance.— Employer-provided educational assistance is excluded 134 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 on or before December 31, 2001. The Tax Relief Extension Act of 1999 extended the expiration date from May 31, 2000 to December 31, 2001. 84. Work opportunity tax credit.—Employers can claim a tax credit for qualified wages paid to individuals who begin work on or before December 31, 2000 and who are certified as members of various targeted groups. The Tax Relief Extension Act of 1999 extended the expiration date from June 30, 1999 to December 31, 2000. The amount of the credit that can be claimed is 25 percent for employment of less than 400 hours and 40 percent for employment of 400 hours or more. The maximum credit per employee is $2,400 and can only be claimed on the first year of wages an individual earns from an employer. Employers must reduce their deduction for wages paid by the amount of the credit claimed. 85. Welfare-to-work tax credit.—An employer is eligible for a tax credit on the first $20,000 of eligible wages paid to qualified long-term family assistance recipients during the first two years of employment. The credit is 35 percent of the first $10,000 of wages in the first year of employment and 50 percent of the first $10,000 of wages in the second year of employment. The maximum credit is $8,500 per employee. The credit applies to wages paid to employees who are hired on or before December 31, 2001. The Tax Relief Extension Act of 1999 extended the expiration date from June 30, 1999 to December 31, 2001. 86. Employer-provided child care.—Employer-provided child care is excluded from an employee’s gross income even though the employer’s costs for the child care are a deductible business expense. 87. Adoption credit and exclusion.—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. 88. 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. 89. 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 ANALYTICAL PERSPECTIVES 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. 90. 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. 91. 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. 92. 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. 93. 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. 94. 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 95. Employer-paid medical insurance and expenses.—Employer-paid health insurance premiums and other medical expenses (including long-term care) are deducted as a business expense by employers, but they are not included in employee gross income. The self-employed also may deduct part of their family health insurance premiums. 96. Self-employed medical insurance premiums.—Self-employed taxpayers may deduct a percentage of their family health insurance premiums. Taxpayers without self-employment income are not eligible for the special percentage deduction. The deductible percentage is 60 percent in 1999 through 2001, 70 percent in 2002, and 100 percent in 2003 and thereafter. 97. Workers compensation insurance premiums.—Workers compensation insurance premiums are paid by employers and deducted as a business expense, but the premiums are not included in employee gross income. 98. Medical savings accounts.—Some employees may deduct annual contributions to a medical savings 5. TAX EXPENDITURES 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. 99. 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. 100. Hospital construction bonds.—Interest earned on State and local government debt issued to finance hospital construction is excluded from income subject to tax. 101. 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. 102. 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. 103. 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. Income Security 104. 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. 105. Workers’ compensation benefits.—Workers compensation provides payments to disabled workers. These benefits, although income to the recipients, are not subject to the income tax. 106. 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. 107. Special benefits for disabled coal miners.— Disability payments to former coal miners out of the 135 Black Lung Trust Fund, although income to the recipient, are not subject to the income tax. 108. Military disability pensions.—Most of the military pension income received by current disabled retired veterans is excluded from their income subject to tax. 109. 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. 110. 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 1999, an employee could exclude up to $10,000 (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 taxpayers with AGI between $50,000 and $60,000 ($30,000 and $40,000 for singles). The phase-out range increases annually until it reaches $80,000 to $100,000 in 2007 ($50,000 to $60,000 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. 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). 111. 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. 136 112. 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 corporations by their employees: (1) annual employer contributions are subject to less restrictive limitations; (2) ESOPs may borrow to purchase employer stock, guaranteed by their agreement with the employer that the debt will be serviced by his payment (deductible by him) of a portion of wages (excludable by the employees) to service the loan; (3) employees who sell appreciated company stock to the ESOP may defer any taxes due until they withdraw benefits; and (4) dividends paid to ESOP-held stock are deductible by the employer. 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 ANALYTICAL PERSPECTIVES 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 $6,800 of earned income in 1999. The credit is 40 percent of the first $9,540 of income for a family with two or more qualifying children. When the taxpayer’s income exceeds $12,460, 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 $26,928 of modified adjusted gross income ($30,580 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 1999, the credit is 7.65 percent of the first $4,530 of earned income. When the taxpayer’s income exceeds $5,670, the credit is phased out at the rate of 7.65 percent. It is completely phased out at $10,200 of modified adjusted gross income. 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 137 5. TAX EXPENDITURES 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. 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 (indexed) 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 1999, this credit allows each taxpayer to make a $650,000 tax-free transfer of assets that otherwise would be liable to the unified transfer tax. This figure is scheduled to increase in steps to $1 million in 2005.7 • 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 1999–2005 are dis7 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 lease 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. 138 ANALYTICAL PERSPECTIVES played 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. Up to 40 percent of the value of land subject to certain conservation easements may be excluded from taxable estates; the maximum amount of the exclusion is $200,000 in 1999 and increases by $100,000 in each year through 2002. Agriculture 2. Special-use valuation of farms.—Up to $750,000 (indexed) 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. 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. 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 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.—Certain family-owned businesses that are bequeathed to qualified heirs can be excluded from taxable estates. The exclusion generally cannot exceed $1.3 million less the exemption value of the unified credit. The exclusion is recaptured if certain conditions are not maintained for 10 years. 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. 139 5. TAX EXPENDITURES Table 5–6. REVENUE LOSS ESTIMATES FOR TAX EXPENDITURES IN THE FEDERAL UNIFIED TRANSFER TAX (In millions of dollars) Description 1999 2000 2001 2002 2003 2004 2005 2001–2005 1 Natural Resources and Environment: Donations of conservation easements .......................................................... 10 25 40 55 75 95 105 370 2 3 Agriculture: Special use valuation of farm real property .................................................. Tax deferral of closely held farms ................................................................. 95 5 100 15 105 20 110 20 115 20 125 25 120 30 575 115 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 ......................................................... 10 35 505 10 100 520 10 110 535 10 110 550 15 120 495 15 130 440 15 180 395 65 650 2,415 7 8 Education, training, employment, and social services: Deduction for charitable contributions (education) ........................................ Deduction for charitable contributions (other than education and health) ... 682 2,015 760 2,240 830 2,450 855 2,525 910 2,680 930 2,750 1,020 3,015 4,545 13,420 9 Health: Deduction for charitable contributions (health) .............................................. 615 685 750 775 820 840 925 4,110 10 General government: Credit for State death taxes .......................................................................... 5,825 6,070 6,345 6,640 6,945 7,265 7,595 34,790 SPECIAL ANALYSES AND PRESENTATIONS 141 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: • a 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. The President’s Commission to Study Capital Budgeting The President established the Commission to Study Capital Budgeting in 1997 with a charge to prepare a wide-ranging report on different aspects of capital budgeting including practices outside the Federal Government, the definition of capital, the role of depreciation, and the effect of a capital budget on budgeting choices, macroeconomic stabilization, and budgetary discipline. The Commission issued its report in February 1999. The Commission proposed a series of recommendations to improve each part of the budget process: setting priorities, making current budget decisions, reporting on these decisions, and subsequently evaluating them. The Commission’s broadest and most fundamental conclusion was that insufficient attention is paid to the long-run consequences of all budget decisions. The report included two recommendations to facilitate the setting of priorities among all programs, not just those involving capital expenditures. The first recommended integration of the planning under the Government Performance and Results Act (GPRA) with budgeting in the form of annually revised five-year plans, and greater emphasis by decision-makers in the Executive Branch and Congress on the longer-run implications of current year decisions. The second recommended an ongoing effort within the Federal government to analyze the benefits and costs of all major government programs as a guide to future policies. The report also recommended evaluating the benefits and costs of major investment projects undertaken in the past. In the instructions for the FY 2001 budget, the Administration encouraged agencies to integrate their annual performance plan and budget justification. Although time for this undertaking was short, several agencies submitted integrated documents or more information on the budgetary resources to be applied to specific performance objectives. The same instructions provided guidance for the first annual performance reports due to Congress this March. They are to include, not only comparisons of actual performance with the projected levels that had been set forth in agency performance plans and analysis of those comparisons, but also summaries of all program evaluations, cost-benefit studies, and other policy, program, and management analyses. As noted in Section V of the Budget, the Admini(Continued on next page) 143 144 ANALYTICAL PERSPECTIVES The President’s Commission to Study Capital Budgeting—Continued stration’s Priority Management Objective #1 includes implementing greater integration of planning with budgeting, informing both with performance measures, and working to align cost with programs to better track what taxpayers are getting for their dollars. These steps will provide needed improvements to essential information and infrastructure to support attention to program performance and the long-range consequences of budget decisions in future years. The Commission did not endorse a single definition of capital, but said distinctions among different types of capital spending were warranted for different purposes. It did not recommend changing the budget to make the size of the deficit or surplus depend on the amount of expenditures defined as capital, to finance capital spending by borrowing, or to make a single decision about how much to spend for ‘‘capital’’ under some definition. The Commission found that the current system has biases toward both too much and too little capital spending, but did not believe anyone could say authoritatively which effect was stronger. It recommended up-front full funding for capital projects, or usable segments thereof, and strict adherence to existing rules that govern the scoring of leases. The Administration plans to continue these policies. However, the Commission concluded that capital spending is inefficiently allocated among projects, and that the current process shortchanges the maintenance of existing assets. To promote better planning and budgeting of capital expenditures for federally owned facilities, the Commission recommended that the Executive Branch and the Congress experiment with capital acquisition funds (CAFs) that would help smooth lumpiness in appropriations by aggregating capital requests for the agency, and match cost with program results by a capital usage charge on the asset-using programs. Another recommendation was to experiment with incentives for agencies to manage their assets more efficiently, for example by permitting them to keep a limited portion of revenues from selling assets. Other recommendations concerned developing and publishing more detailed information about the composition and condition of capital assets, and retrospectively assessing the extent to which major investment projects have produced returns in excess of the cost of capital. The Administration is exploring options for capital acquisition funds as part of its effort to integrate planning and budgeting, and to charge for resources in alignment with their use to achieve program results. Implementation would require better information on existing assets, and would provide an incentive for more attention to efficient asset management. The Capital Programming Guide is being updated to provide specific examples and to improve understanding of the linkages between its four stages: planning, budgeting, acquisition, and management-in-use. In particular, this will emphasize how knowledge of the condition, maintenance, use, and value of existing assets feed back into the next cycle of planning. An inter-agency task force is working to develop standardized methods to estimate deferred maintenance. Meanwhile, a variety of other efforts are ongoing to improve information on existing assets and new capital projects and to more fully implement existing guidance on improving capital planning and acquisition. Furthermore, the General Services Administration has developed a draft legislative proposal allowing agencies to keep a share of the proceeds from disposing of real property, which should give them an incentive to dispose of real property they no longer need. 1 The Report of the President’s Commission to Study Capital Budgeting (February 1999) was published by the U.S. Government Printing Office and is also available, together with testimony and other supporting materials, on the Internet at http:/www.whitehouse.gov/pcscb. 6. 145 FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING Part I: DESCRIPTION OF FEDERAL INVESTMENT For almost fifty 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 2005. The classification of spending between 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. The budget further classifies investments into those that are grants to State and local governments, such as grants for highways or for elementary and secondary education, and all other investments, called ‘‘direct Federal programs,’’ in this analysis. This ‘‘direct Federal’’ category consists primarily of spending for assets owned by the Federal Government, such as defense weapons systems and general purpose office buildings, but also includes grants to private organizations and individuals for investment, such as capital grants to Amtrak or higher education loans directly to individuals. 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 and education. • Focusing on the role of investment in improving national productivity and enhancing economic growth would exclude items such as national defense assets, the direct benefits of which enhance national security rather than economic growth. • Concern with the efficiency of Federal operations would confine the coverage to investments that 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 included 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 grants are 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 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 24, ‘‘Budget System and Concepts and Glossary.’’ 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 $240.2 billion in 1999. They are estimated to increase to $254.3 billion in 2000 and to increase further to $267.2 billion in 2001. Major Federal investment will comprise an estimated 14.6 percent of total Federal outlays in 2001 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. 146 ANALYTICAL PERSPECTIVES Physical investment.—Outlays for major public physical capital investment (hereafter referred to as physical investment outlays) are estimated to be $130.2 billion in 2001. Physical investment outlays are for construction and rehabilitation, the purchase of major equipment, and the purchase or sale of land and structures. An estimated 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 $53.9 billion in 1999 and are estimated to increase to $56.2 billion in 2001. Almost all of these outlays, or $51.1 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. These outlays are estimated to increase in 2002 and beyond in response to increases in defense budget authority enacted for 2000 and requested for 2001 and later years in this budget. Outlays for direct physical investment for nondefense purposes are estimated to be $22.4 billion in 2001. These outlays include $13.3 billion for construction and rehabilitation. This amount includes funds for water, power, and natural resources projects of the Army 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; facilities for space and science programs, and Indian Health Service hospitals and clinics. Outlays for the acquisition of major equipment are estimated to be $8.2 billion in 2001. The largest amounts are for the air traffic control system and the Postal Service. For the purchase or sale of land and structures, disbursements are estimated to exceed collections by $0.8 billion in 2001. These purchases are largely for buildings and land for parks and other recreation purposes. Grants to State and local governments for physical investment are estimated to be $51.7 billion in 2001. Almost two-thirds of these outlays, or $33.6 billion, are to assist States and localities with transportation infra- Table 6–1. COMPOSITION OF FEDERAL INVESTMENT OUTLAYS (In billions of dollars) 1999 actual Estimate 2000 2001 Federal Investment Major public physical capital investment: Direct Federal: National defense ................................................................................................... Nondefense ........................................................................................................... 53.9 20.8 53.3 22.4 56.2 22.4 Subtotal, direct major public physical capital investment ............................... Grants to State and local governments ........................................................................ 74.7 43.9 75.7 48.7 78.5 51.7 Subtotal, major public physical capital investment ........................................ Conduct of research and development: National defense ........................................................................................................ Nondefense ................................................................................................................ 118.6 124.4 130.2 40.3 33.9 40.4 36.1 40.9 39.4 Subtotal, conduct of research and development ............................................. Conduct of education and training: Grants to State and local governments ................................................................... Direct Federal ............................................................................................................ 74.1 76.5 80.4 28.4 19.0 33.1 20.3 34.9 21.7 Subtotal, conduct of education and training .................................................... 47.4 53.4 56.6 Total, major Federal investment outlays .................................................................. MEMORANDUM Major Federal investment outlays: National defense ........................................................................................................ Nondefense ................................................................................................................ 240.2 254.3 267.2 94.2 146.0 93.7 160.6 97.1 170.1 Total, major Federal investment outlays ....................................................................... Miscellaneous physical investments: Commodity inventories .............................................................................................. Other physical investment (direct) ............................................................................ 240.2 254.3 267.2 –* 2.6 –0.2 3.3 –0.3 4.1 Total, miscellaneous physical investment ............................................................ 2.5 3.1 3.8 Total, Federal investment outlays, including miscellaneous physical investment ....... 242.7 257.4 271.0 * Indicates $50 million or less. 6. 147 FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING structure, primarily highways. 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 $80.4 billion in 2001. These outlays are devoted to increasing basic scientific knowledge and promoting 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. Slightly more than half of these outlays, an estimated $40.9 billion in 2001, 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 $39.4 billion in 2001. This 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 $56.6 billion in 2001. 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 $34.9 billion in 2001, more than three-fifths 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 Federal education and training outlays are estimated to be $21.7 billion in 2001. Programs in this category are primarily aid for 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 $0.3 billion in 2001. Outlays for other miscellaneous physical investment are estimated to be $4.1 billion in 2001. This category includes primarily conservation programs. These are entirely direct Federal outlays. 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 2005. 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. 148 ANALYTICAL PERSPECTIVES Table 6–2. FEDERAL INVESTMENT BUDGET AUTHORITY AND OUTLAYS: DEFENSE AND NONDEFENSE PROGRAMS (in millions of dollars) 1999 Actual Description NATIONAL DEFENSE Major public physical investment: Construction and rehabilitation .................................................................... Estimate 2000 2001 2002 2003 2004 2005 BA O BA O BA O 5,083 4,871 51,165 49,040 –31 –31 5,556 4,915 54,351 48,444 –30 –30 4,568 5,120 60,045 51,076 –27 –27 4,775 4,577 62,276 53,405 –29 –29 4,434 4,471 65,915 59,248 –29 –29 4,590 4,444 67,063 62,874 –29 –29 4,810 4,588 70,444 65,607 –29 –29 Subtotal, major public physical investment ............................................ BA O 56,217 53,880 59,877 53,329 64,586 56,169 67,022 57,953 70,320 63,690 71,624 67,289 75,225 70,166 Conduct of research and development ........................................................... BA O BA O 41,275 40,276 3 6 41,263 40,409 8 8 41,369 40,914 7 7 41,867 40,990 10 10 41,096 40,827 10 10 40,890 40,621 10 10 39,794 39,987 10 10 BA O 97,495 94,162 101,148 93,746 105,962 97,090 108,899 98,953 111,426 104,527 112,524 107,920 115,029 110,163 BA O BA O BA O BA O BA O BA O BA O BA O BA O BA O BA O BA O BA O BA O 29,164 22,723 4,753 4,024 6 61 2,382 1,619 4,893 4,804 1,552 1,289 4,118 3,749 3,176 2,845 6,982 6,389 957 955 1,479 1,427 1,629 1,675 1,452 958 3,760 2,884 31,115 25,420 5,513 4,301 11 61 1,973 1,969 4,781 4,856 1,523 1,512 4,064 3,917 3,166 3,771 6,849 7,122 977 975 1,237 1,302 1,457 1,225 753 976 2,815 3,734 33,339 27,210 6,136 4,466 37 10 2,037 1,984 4,900 4,826 2,015 1,572 3,505 4,111 3,782 3,740 7,196 7,675 865 863 1,323 1,402 1,017 1,044 1,501 1,116 3,932 3,644 30,579 27,875 6,558 5,223 37 26 2,088 2,031 4,900 4,957 2,015 1,713 3,505 4,065 3,819 3,821 7,196 7,479 906 903 1,325 1,399 1,485 1,457 1,199 1,155 4,125 3,711 30,595 27,348 7,025 5,740 37 32 2,142 2,086 4,959 4,998 2,034 1,868 3,545 4,013 3,866 3,974 7,282 7,779 892 889 1,316 1,350 1,742 1,574 1,180 1,295 4,024 3,993 31,192 27,166 7,166 6,403 18 32 2,198 2,144 5,077 5,073 2,085 2,019 3,628 4,012 3,965 4,009 7,463 8,443 1,128 1,126 1,345 1,352 1,509 1,609 1,189 1,387 3,721 3,950 31,802 27,184 7,309 6,755 18 27 2,254 2,191 5,188 4,979 2,124 2,078 3,706 4,045 4,056 4,106 7,627 8,656 1,200 1,198 1,376 1,368 1,625 1,580 1,154 1,324 3,768 3,756 BA O 66,303 55,402 66,234 61,141 71,585 63,663 69,737 65,816 70,639 66,939 71,684 68,726 73,207 69,249 BA O BA O BA O 2,130 2,234 580 467 5,754 4,598 2,032 1,806 848 736 5,230 5,480 2,455 1,965 818 714 6,422 5,568 2,505 2,294 745 778 6,384 5,953 2,567 2,410 744 588 6,388 6,207 2,643 2,576 530 832 6,398 6,217 2,733 2,650 610 520 6,490 6,340 Subtotal, acquisition of major equipment ........................................... BA O 8,464 7,299 8,110 8,022 9,695 8,247 9,634 9,025 9,699 9,205 9,571 9,625 9,833 9,510 Purchase or sale of land and structures .................................................... BA O 676 1,014 921 910 688 866 365 581 375 640 700 896 704 921 Acquisition of major equipment ................................................................... Purchase or sale of land and structures .................................................... Conduct of education and training (civilian) .................................................... Subtotal, national defense investment .................................................... NONDEFENSE Major public physical investment: Construction and rehabilitation: Highways .................................................................................................. Mass transportation ................................................................................. Rail transportation .................................................................................... Air transportation ..................................................................................... Community development block grants .................................................... Other community and regional development .......................................... Pollution control and abatement ............................................................. Water resources ...................................................................................... Housing assistance .................................................................................. Energy ...................................................................................................... Veterans hospitals and other health ....................................................... Postal Service .......................................................................................... GSA real property activities .................................................................... Other programs ........................................................................................ Subtotal, construction and rehabilitation ............................................. Acquisition of major equipment: Air transportation ..................................................................................... Postal Service .......................................................................................... Other ........................................................................................................ 6. 149 FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING Table 6–2. FEDERAL INVESTMENT BUDGET AUTHORITY AND OUTLAYS: DEFENSE AND NONDEFENSE PROGRAMS—Continued (in millions of dollars) 1999 Actual Description Estimate 2000 2001 2002 2003 2004 2005 Other physical assets (grants) ..................................................................... BA O 990 1,048 1,074 1,023 1,481 1,280 1,504 1,314 1,555 1,379 1,587 1,446 1,629 1,491 Subtotal, major public physical investment ............................................ BA O 76,433 64,763 76,339 71,096 83,449 74,056 81,240 76,736 82,268 78,163 83,542 80,693 85,373 81,171 BA O BA O BA O BA O BA O BA O 12,983 12,547 1,196 1,285 1,665 1,582 15,476 13,696 1,997 1,732 3,245 3,018 13,386 13,100 1,259 1,373 1,495 1,249 17,683 15,448 1,911 1,671 3,294 3,213 14,355 13,564 1,340 1,543 1,534 1,507 18,634 17,703 1,941 1,689 3,504 3,441 14,792 14,327 1,341 1,660 1,524 1,531 18,626 18,759 1,943 1,748 3,379 3,560 15,297 15,098 1,356 1,667 1,557 1,558 18,821 18,652 1,967 1,797 3,423 3,712 15,928 15,638 1,401 1,660 1,583 1,581 19,283 18,895 2,017 1,825 3,506 3,793 16,345 16,191 1,432 1,658 1,601 1,597 19,706 19,284 2,062 1,852 3,581 3,873 BA O 36,562 33,860 39,028 36,054 41,308 39,447 41,605 41,585 42,421 42,484 43,718 43,392 44,727 44,455 BA O BA O BA O BA O BA O 16,804 17,530 13,674 11,773 2,277 2,036 6,683 4,890 7,371 7,178 17,113 21,240 12,356 11,634 2,303 2,409 2,849 6,024 6,668 7,708 26,744 22,406 13,448 12,387 2,424 2,427 5,997 6,441 9,187 8,277 26,742 24,088 14,849 4,043 2,439 2,389 5,950 5,930 8,910 8,697 26,876 26,590 16,046 5,130 2,477 2,407 6,022 6,186 9,060 8,715 27,161 26,916 16,436 15,833 2,504 2,463 6,171 6,108 9,299 8,841 27,419 27,170 17,086 16,397 2,560 2,514 6,306 6,152 9,524 9,033 Subtotal, education, training, and social services .............................. BA O 46,809 43,407 41,289 49,015 57,800 51,938 58,890 45,147 60,481 49,028 61,571 60,161 62,895 61,266 Veterans education, training, and rehabilitation .......................................... BA O BA O BA O 1,360 1,643 1,021 891 1,663 1,453 1,697 1,737 1,090 1,007 1,680 1,641 1,886 1,937 1,067 1,050 1,824 1,658 1,906 1,904 1,067 1,083 1,724 1,717 1,909 1,909 1,079 1,071 1,745 1,755 1,925 1,923 1,103 1,083 1,790 1,761 1,955 1,968 1,125 1,104 1,835 1,779 Subtotal, conduct of education and training ........................................... BA O 50,853 47,394 45,756 53,400 62,577 56,583 63,587 49,851 65,214 53,763 66,389 64,928 67,810 66,117 Subtotal, nondefense investment ............................................................ BA O 163,848 146,017 161,123 160,550 187,334 170,086 186,432 168,172 189,903 174,410 193,649 189,013 197,910 191,743 Total, Federal investment .............................................................................. BA O 261,343 240,179 262,271 254,296 293,296 267,176 295,331 267,125 301,329 278,937 306,173 296,933 312,939 301,906 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 ................................. Higher education ...................................................................................... Research and general education aids .................................................... Training and employment ........................................................................ Social services ......................................................................................... Health ........................................................................................................... Other education and training ....................................................................... 150 ANALYTICAL PERSPECTIVES Table 6–3. FEDERAL INVESTMENT BUDGET AUTHORITY AND OUTLAYS: GRANT AND DIRECT FEDERAL PROGRAMS (in millions of dollars) Estimate 1999 Actual 2000 2001 2002 2003 2004 2005 BA O BA O BA O BA O BA O BA O BA O BA O BA O BA O 28,964 22,722 4,753 4,024 .................. 32 2,322 1,565 2,769 2,180 52 53 4,893 4,804 1,208 983 6,956 6,368 166 126 31,115 25,416 5,517 4,301 .................. 17 1,896 1,896 2,787 2,470 46 72 4,781 4,856 1,210 1,252 6,821 7,096 264 220 33,339 27,205 6,136 4,466 .................. .................. 1,950 1,899 2,071 2,726 17 59 4,900 4,826 T21,435 1,222 7,156 7,643 251 294 30,579 27,875 6,558 5,223 .................. .................. 1,999 1,943 2,071 2,656 17 39 4,900 4,957 1,435 1,307 7,156 7,440 253 305 30,595 27,348 7,025 5,740 .................. .................. 2,050 1,994 2,096 2,551 17 34 4,959 4,998 1,449 1,356 7,242 7,739 254 295 31,192 27,166 7,166 6,403 .................. .................. 2,103 2,049 2,147 2,486 18 26 5,077 5,073 1,483 1,447 7,422 8,402 260 283 31,802 27,184 7,309 6,755 .................. .................. 2,158 2,095 2,195 2,466 18 27 5,188 4,979 1,511 1,493 7,585 8,614 264 287 Subtotal, construction and rehabilitation ............................................. BA O 52,083 42,857 54,437 47,596 57,255 50,340 54,968 51,745 55,687 52,055 56,868 53,335 58,028 53,900 Other physical assets .................................................................................. BA O 1,050 1,081 1,121 1,102 1,639 1,344 1,662 1,416 1,694 1,505 1,691 1,581 1,737 1,609 Subtotal, major public physical capital ................................................... BA O 53,133 43,938 55,558 48,698 58,894 51,684 56,630 53,161 57,381 53,560 58,559 54,916 59,767 55,509 BA O BA O 239 210 178 98 257 233 209 134 273 255 239 222 258 239 228 227 261 256 227 232 268 261 230 234 273 261 233 236 BA O 417 308 466 367 512 477 486 466 488 488 498 495 506 497 BA O BA O BA O BA O BA O BA O BA O 15,548 16,684 157 65 573 389 5,110 3,712 7,072 7,027 437 416 114 92 15,336 20,035 190 157 438 592 1,774 4,558 6,340 7,235 434 460 114 107 22,582 20,804 233 190 508 501 3,882 4,938 8,814 7,933 443 432 119 108 22,441 21,267 233 168 524 476 3,852 4,394 8,753 8,485 428 433 117 114 22,549 22,789 236 175 532 479 3,898 4,585 8,901 8,560 433 438 117 111 22,776 22,793 242 220 522 490 3,995 4,465 9,136 8,691 444 444 121 111 22,983 22,969 248 225 532 497 4,082 4,476 9,358 8,880 454 451 123 113 Subtotal, conduct of education and training ........................................... BA O 29,011 28,385 24,626 33,144 36,581 34,906 36,348 35,337 36,666 37,137 37,236 37,214 37,780 37,611 Subtotal, grants for investment ............................................................... BA O 82,561 72,631 80,650 82,209 95,987 87,067 93,464 88,964 94,534 91,185 96,293 92,625 98,051 93,617 BA 3,553 4,053 3,193 3,625 3,255 3,376 3,568 Description GRANTS TO STATE AND LOCAL GOVERNMENTS Major public physical investments: Construction and rehabilitation: Highways .................................................................................................. Mass transportation ................................................................................. Rail transportation .................................................................................... Air transportation ..................................................................................... Pollution control and abatement ............................................................. Other natural resources and environment .............................................. Community development block grants .................................................... Other community and regional development .......................................... Housing assistance .................................................................................. Other construction ................................................................................... Conduct of research and development: Agriculture ..................................................................................................... Other ............................................................................................................. Subtotal, conduct of research and development .................................... Conduct of education and training: Elementary, secondary, and vocational education ..................................... Higher education .......................................................................................... Research and general education aids ........................................................ Training and employment ............................................................................ Social services ............................................................................................. Agriculture ..................................................................................................... Other ............................................................................................................. DIRECT FEDERAL PROGRAMS Major public physical investment: Construction and rehabilitation: National defense: Military construction ............................................................................. 6. 151 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) 1999 Actual Description Estimate 2000 2001 2002 2003 2004 2005 O BA O BA O 3,369 709 731 821 771 3,274 772 898 731 743 3,660 752 801 623 659 3,468 527 445 623 664 3,335 549 464 630 672 3,292 566 467 648 685 3,407 581 481 661 700 Subtotal, national defense .............................................................. BA O 5,083 4,871 5,556 4,915 4,568 5,120 4,775 4,577 4,434 4,471 4,590 4,444 4,810 4,588 International affairs .................................................................................. BA O BA O BA O BA O BA O BA O BA O BA O BA O BA O BA O BA O 544 368 424 413 3,124 2,793 1,818 1,809 957 955 1,629 1,675 501 242 26 21 1,389 1,387 364 387 1,452 958 1,992 1,537 370 395 377 494 3,125 3,705 1,699 1,845 977 975 1,457 1,225 224 309 28 26 1,147 1,238 441 365 753 976 1,199 1,992 726 455 612 616 3,765 3,682 1,810 1,742 865 863 1,017 1,044 284 269 40 32 1,263 1,317 713 568 1,501 1,116 1,734 1,619 824 565 621 634 3,802 3,783 1,813 1,756 906 903 1,485 1,457 286 287 40 39 1,265 1,314 807 650 1,199 1,155 1,721 1,528 922 650 625 641 3,849 3,941 1,828 1,800 892 889 1,742 1,574 292 287 40 40 1,255 1,275 590 811 1,180 1,295 1,738 1,681 1,021 732 632 646 3,947 3,984 1,867 1,871 1,128 1,126 1,509 1,609 280 294 41 41 1,283 1,292 137 650 1,189 1,387 1,783 1,759 1,021 782 640 655 4,038 4,080 1,903 1,926 1,200 1,198 1,625 1,580 285 296 42 42 1,312 1,308 140 376 1,154 1,324 1,819 1,782 BA O 19,303 17,416 17,353 18,460 18,898 18,443 19,544 18,648 19,387 19,355 19,407 19,835 19,989 19,937 BA O BA O 50,983 48,824 182 216 54,191 48,282 160 162 59,890 50,918 155 158 62,121 53,243 155 162 65,760 59,082 155 166 66,902 62,706 161 168 70,281 65,436 163 171 Subtotal, national defense .............................................................. BA O 51,165 49,040 54,351 48,444 60,045 51,076 62,276 53,405 65,915 59,248 67,063 62,874 70,444 65,607 General science and basic research ...................................................... BA O BA O BA O BA O BA O BA O BA O BA O BA O BA O 398 372 666 662 123 123 580 467 2,130 2,234 418 266 609 244 .................. 72 253 172 389 338 410 382 582 581 121 121 848 736 2,032 1,806 254 282 571 597 .................. 44 550 474 566 686 476 411 587 575 118 118 818 714 2,455 1,965 343 269 989 598 .................. 21 626 561 612 570 481 448 586 581 241 241 745 778 2,505 2,294 343 313 521 686 .................. 22 626 555 613 628 477 473 558 562 247 247 744 588 2,567 2,410 347 317 527 901 .................. 24 634 562 619 644 482 481 559 554 165 165 530 832 2,643 2,576 356 328 540 958 .................. 26 649 574 636 659 488 488 555 551 187 187 610 520 2,733 2,650 364 340 552 1,025 .................. 27 663 587 650 673 Family housing .................................................................................... Atomic energy defense activities and other ....................................... General science, space, and technology ............................................... Water resources projects ........................................................................ Other natural resources and environment .............................................. Energy ...................................................................................................... Postal Service .......................................................................................... Transportation .......................................................................................... Housing assistance .................................................................................. Veterans hospitals and other health facilities ......................................... Federal Prison System ............................................................................ GSA real property activities .................................................................... Other construction ................................................................................... Subtotal, construction and rehabilitation ............................................. Acquisition of major equipment: National defense: Department of Defense ....................................................................... Atomic energy defense activities ........................................................ Space flight, research, and supporting activities .................................... Energy ...................................................................................................... Postal Service .......................................................................................... Air transportation ..................................................................................... Water transportation (Coast Guard) ........................................................ Other transportation (railroads) ............................................................... Social security .......................................................................................... Hospital and medical care for veterans .................................................. Department of Justice ............................................................................. 152 ANALYTICAL PERSPECTIVES Table 6–3. FEDERAL INVESTMENT BUDGET AUTHORITY AND OUTLAYS: GRANT AND DIRECT FEDERAL PROGRAMS—Continued (in millions of dollars) 1999 Actual Description Department of the Treasury .................................................................... Estimate 2000 2001 2002 2003 2004 2005 BA O BA O BA O 852 594 585 534 1,401 1,188 293 489 610 610 1,226 1,135 403 406 644 644 1,466 1,331 571 452 676 676 1,568 1,249 574 516 709 709 1,557 1,126 581 530 744 744 1,582 1,063 588 539 781 781 1,554 1,024 BA O 59,569 56,306 62,414 56,387 69,582 59,259 71,752 62,328 75,475 68,327 76,530 72,364 80,169 74,999 BA O BA O BA O BA O –31 –31 83 83 .................. .................. 593 931 –30 –30 254 167 .................. .................. 667 743 –27 –27 27 177 .................. .................. 661 689 –29 –29 31 195 .................. .................. 334 386 –29 –29 35 204 –323 –323 663 759 –29 –29 38 186 .................. .................. 662 710 –29 –29 38 194 .................. .................. 666 727 Subtotal, purchase or sale of land and structures ............................ BA O 645 983 891 880 661 839 336 552 346 611 671 867 675 892 Subtotal, major public physical investment ............................................ BA O 79,517 74,705 80,658 75,728 89,141 78,541 91,632 81,526 95,208 88,293 96,608 93,065 100,833 95,828 BA O BA O 38,569 37,571 2,706 2,705 38,471 37,619 2,792 2,790 38,254 37,805 3,115 3,109 38,752 37,845 3,115 3,145 37,945 37,653 3,151 3,174 37,633 37,364 3,257 3,257 36,492 36,691 3,302 3,296 Subtotal, national defense .................................................................. BA O 41,275 40,276 41,263 40,409 41,369 40,914 41,867 40,990 41,096 40,827 40,890 40,621 39,794 39,987 International affairs ....................................................................................... BA O 190 220 142 179 114 189 114 304 115 329 118 342 120 365 BA O BA O BA O 8,281 8,316 2,477 2,144 2,225 2,087 8,481 8,479 2,676 2,364 2,229 2,257 8,813 8,503 3,193 2,701 2,349 2,360 9,240 8,849 3,189 3,010 2,363 2,468 9,732 9,419 3,227 3,196 2,338 2,483 10,291 9,938 3,306 3,229 2,331 2,471 10,614 10,388 3,378 3,323 2,353 2,480 Subtotal, general science, space and technology ............................. BA O 13,173 12,767 13,528 13,279 14,469 13,753 14,906 14,631 15,412 15,427 16,046 15,980 16,465 16,556 Energy .......................................................................................................... BA O 1,196 1,285 1,259 1,373 1,340 1,543 1,341 1,660 1,356 1,667 1,401 1,660 1,432 1,658 BA O BA O 428 395 1,098 1,117 422 403 924 759 566 511 819 826 535 540 851 815 542 516 877 869 555 527 888 883 571 538 887 887 BA O 2,722 2,797 2,605 2,535 2,725 2,880 2,727 3,015 2,775 3,052 2,844 3,070 2,890 3,083 BA O BA O 14,778 13,027 688 659 16,900 14,702 772 735 17,909 16,932 714 760 17,909 18,025 706 723 18,098 17,930 712 711 18,546 18,172 725 711 18,953 18,553 741 719 BA 15,466 17,672 18,623 18,615 18,810 19,271 19,694 GSA general supply fund ........................................................................ Other ........................................................................................................ Subtotal, acquisition of major equipment ........................................... Purchase or sale of land and structures: National defense ...................................................................................... International affairs .................................................................................. Privatization of Elk Hills ........................................................................... Other ........................................................................................................ Conduct of research and development: National defense Defense military ....................................................................................... Atomic energy and other ......................................................................... General science, space and technology NASA ........................................................................................................ National Science Foundation .................................................................. Department of Energy ............................................................................. Transportation: Department of Transportation ................................................................. NASA ........................................................................................................ Subtotal, transportation ....................................................................... Health: National Institutes of Health .................................................................... All other health ........................................................................................ Subtotal, health ................................................................................... 6. 153 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) 1999 Actual Description Estimate 2000 2001 2002 2003 2004 2005 O 13,686 15,437 17,692 18,748 18,641 18,883 19,272 BA O BA O BA O BA O BA O 1,049 990 1,997 1,732 392 404 641 637 705 539 1,148 1,069 1,911 1,671 336 377 652 643 710 676 1,177 1,139 1,941 1,689 449 412 652 666 760 739 1,117 1,147 1,943 1,748 449 387 652 658 710 785 1,133 1,168 1,967 1,797 454 441 660 663 722 807 1,158 1,178 2,017 1,825 466 458 676 678 742 825 1,181 1,188 2,062 1,852 476 468 691 693 762 846 BA O 77,420 73,828 79,825 76,096 82,165 79,884 82,986 82,109 83,029 82,823 84,110 83,518 84,015 83,945 BA O BA O BA O BA O BA O BA O BA O BA O BA O BA O 1,256 846 13,517 11,708 1,704 1,647 1,573 1,178 1,007 877 1,360 1,643 673 560 3 6 293 273 459 277 1,777 1,205 12,166 11,477 1,865 1,817 1,075 1,466 1,076 993 1,697 1,737 684 649 8 8 209 247 581 665 4,162 1,602 13,215 12,197 1,916 1,926 2,115 1,503 1,053 1,036 1,886 1,937 750 680 7 7 226 226 673 570 4,301 2,821 14,616 3,875 1,915 1,913 2,098 1,536 1,053 1,068 1,906 1,904 725 691 10 10 226 231 399 475 4,327 3,801 15,810 4,955 1,945 1,928 2,124 1,601 1,065 1,056 1,909 1,909 734 709 10 10 229 235 405 432 4,385 4,123 16,194 15,613 1,982 1,973 2,176 1,643 1,088 1,068 1,925 1,923 752 720 10 10 234 236 417 415 4,436 4,201 16,838 16,172 2,028 2,017 2,224 1,676 1,110 1,088 1,955 1,968 768 736 10 10 239 238 432 410 Subtotal, conduct of education and training ........................................... BA O 21,845 19,015 21,138 20,264 26,003 21,684 27,249 14,524 28,558 16,636 29,163 27,724 30,040 28,516 Subtotal, direct Federal investment ........................................................ BA O 178,782 167,548 181,621 172,087 197,309 180,109 201,867 178,161 206,795 187,752 209,880 204,308 214,888 208,289 Total, Federal investment .............................................................................. BA O 261,343 240,179 262,271 254,296 293,296 267,176 295,331 267,125 301,329 278,937 306,173 296,933 312,939 301,906 Agriculture ..................................................................................................... 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 .................................... Conduct of education and training: Elementary, secondary, and vocational education ..................................... Higher education .......................................................................................... Research and general education aids ........................................................ Training and employment ............................................................................ Health ........................................................................................................... Veterans education, training, and rehabilitation .......................................... General science and basic reserach .......................................................... National defense .......................................................................................... International affairs ....................................................................................... Other ............................................................................................................. 154 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 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. 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 comingyear appropriations, and justifications are often limited to lists of desired projects. The increased use of long1 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. 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 the Office of Management and Budget (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 has been 6. 155 FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING issued for several years, most recently as OMB Circular A–11: Part 3: ‘‘Planning, Budgeting, and Acquisition of Capital Assets’’ (July 1999) (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, a Supplement to Part 3. This Guide was developed by an interagency task force with representation from 14 executive agencies and 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. This guidance is now part OMB Circular A–11. • 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. These principles offer guidelines to agencies to help carry out better planning, anal2 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 (a further revision is currently under review); 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 systems. ysis, risk management, and budgeting for capital asset acquisitions. 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 2005 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. As noted at the beginning of this chapter, the Report of the President’s Commission to Study Capital Budgeting endorsed full funding of capital assets. 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. Efforts continue to include full funding for new capital projects, or at least economically 156 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 to complete acquisitions efficiently, and Part 3 encourages 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. One of the first efforts was the issuance of OMB Circular A–11, Part 3, ‘‘Planning, Budgeting and Acquisition of Capital Assets,’’ in July 1996. Part 3 has been reissued annually since then. The Capital Programming Guide was issued as a Supplement to Part 3 in June 1997. These documents present unified guidance on planning, budgeting, acquisition, and management of capital assets. They also present 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 ANALYTICAL PERSPECTIVES 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 taken, or contemplated, to bring the project within goals. If the project cannot be brought within goals, agencies should explain how and why the goals should be revised and whether the project is still cost beneficial and justifies continued funding, or whether the project should be canceled. Approved acquisition goals submitted with the 2001 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 incorporates 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 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 2000 and 2001 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 2000 and 2001. • 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, the Chief Infor- 6. 157 FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING mation Officers Council, the Procurement Executives Council, and other groups 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 encourage 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. Major Acquisition Proposals For the definition of major capital assets described above, this budget requests $86.0 billion of budget authority for 2001. This includes $63.8 billion for the Department of Defense and $22.2 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 $17.0 billion of budget authority for 2001 for construction and rehabilitation. Department of Defense.—The budget requests $3.9 billion for 2001 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. Corps of Engineers.—This budget requests $3.4 billion for 2001 for construction and rehabilitation for the 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 6–4. CAPITAL ASSET ACQUISITIONS (Budget authority in billions of dollars) MAJOR ACQUISITIONS Construction and rehabilitation: Defense military construction and family housing ........ Corps of Engineers ....................................................... General Services Administration ................................... Department of Energy ................................................... Other agencies .............................................................. 1999 actual 2000 estimate 2001 proposed 4.3 2.7 1.5 1.2 7.8 4.8 2.7 0.8 1.1 6.4 3.9 3.4 1.5 1.2 7.0 Subtotal, construction and rehabilitation .................. Major equipment: Department of Defense ................................................. Department of Transportation ....................................... General Services Administration ................................... Department of Justice ................................................... NASA ............................................................................. Department of Commerce ............................................. Department of Veterans Affairs .................................... Other agencies .............................................................. 17.4 15.8 17.0 51.0 2.5 0.6 0.4 0.7 0.6 0.3 2.7 54.2 2.2 0.6 0.6 0.6 0.6 0.6 2.2 1 59.9 Subtotal, major equipment ........................................ Purchases of land and structures ..................................... 58.8 0.6 61.6 0.9 68.4 0.7 Total, major acquisitions 2 .................................................. 76.9 78.3 86.0 2.8 0.7 0.6 0.6 0.6 0.6 2.5 1 Does not include $0.4 billion of non-equipment expenditures related to procurement for 2001. The 2001 request for total Procurement for the Department of Defense is $60.3 billion. 2 This total is derived from the direct Federal major public physical investment budget authority on Table 6–3 ($89.1 billion for 2001). Table 6–4 excludes an estimate of spending for assets not owned by the Federal Government ($3.1 billion for 2001). General Services Administration (GSA).—The 2001 budget includes $1.5 billion in budget authority for GSA for the construction or major renovation of buildings. These funds will allow for new construction and the acquisition of courthouses, border stations, and general purpose office space in locations where long-term needs show that ownership is preferable to leasing. Department of Energy.—This budget requests $1.2 billion for 2001 for construction and rehabilitation for the Department of Energy. One of the largest projects is the National Ignition Facility, which will be used to perform experiments, including inertial confinement fusion experiments, at high pressures and temperatures. The Spallation Neutron Source is discussed in the text that accompanies Table 6–5. Other agencies.—This budget includes $7.0 billion for construction and rehabilitation for other agencies in 2001. The largest items are for the Postal Service ($1.0 billion); the Department of the Interior ($1.0 billion), largely for the Bureau of Indian Affairs, water resources, and parks; and the Department of Justice ($0.8 billion), mostly for prisons. Major Equipment This category covers capital purchases for major equipment, including weapons systems; information technology, such as computer hardware, major software, and renovations required for this equipment; and other types of equipment. This budget requests $68.4 billion in budget authority for 2001 for the purchase of major equipment. For information on information technology investments, see Chapter 23 in this volume, ‘‘Program 158 ANALYTICAL PERSPECTIVES Performance Benefits from Major Information Technology Investments.’’ Department of Defense.—The budget includes $59.9 billion for equipment purchases and $0.4 billion for nonequipment purchases related to procurement for 2001 of 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 $2.8 billion in budget authority for the Department of Transportation for major equipment, which includes $2.4 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 Justice.—The budget requests $0.6 billion for the Department of Justice, largely for the Federal Bureau of Investigation and the Drug Enforcement Administration. National Aeronautics and Space Administration (NASA).—The budget requests $0.6 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. Department of Commerce.—The budget requests $0.6 billion for the Department of Commerce, largely for the continued acquisition of more sophisticated and advanced weather satellites and related technology. Department of Veterans Affairs.—This budget requests $0.6 billion for medical equipment for health care facilities. These funds will be used to continue to provide quality health care services for veterans. Other agencies.—This budget requests $2.5 billion for major equipment for other agencies for 2001. The largest amount is for the Postal Service ($0.8 billion). Other agencies include the General Services Administration ($0.7 billion), largely for vehicles; and the Department of Energy ($0.5 billion) for science and other projects. Purchase and Sale of Land and Structures This budget includes $0.7 billion for 2001 for the purchase of land and structures. This includes $0.4 billion for purchases by the Department of the Interior for parks and other recreational purposes. Full Funding of Major Projects This budget proposes full funding for new capital projects and for many projects formerly funded incrementally. The requests for advance appropriations shown in Table 6–5 demonstrate the Administration’s continuing support for full funding of capital investments. 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. Full funding was also supported by the Report of the President’s Commission to Study Capital Budgeting, as noted at the beginning of this chapter. This budget requests $5.9 billion in budget authority for 2001 and $22.9 billion in advance appropriations for later years, for a total request of $28.8 billion for these projects for these years. Department of Commerce National Oceanic and Atmospheric Administration (NOAA).—This budget requests $635 million for 2001 and $6,417 million in advance appropriations for capital asset acquisitions in NOAA for 2002–2019. 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. Department of Defense This budget requests $821million in advance appropriations for 2002–2005 to fully fund selected military construction and family housing projects in the Department of Defense. The budget requests $414 million for these projects in 2001. Department of Energy This budget requests $281 million in 2001 and $797 million in advance appropriations to finance the Spallation Neutron Source (SNS). This facility is being built at Oak Ridge National Laboratory in Tennessee and will deliver the world’s highest power neutron pulse to a suite of ‘‘best of class’’ scientific instruments. Neutron scattering and materials irradiation research helps scientists design higher performing electronic, magnetic, ceramic, and plastic materials and design better pharmaceuticals by providing information about the shapes of biological molecules. Department of Health and Human Services This budget requests $259 million for 2001 in regular appropriations and $109 million in advance appropriations for projects in the Department of Health and Human Services for the Food and Drug Administration, the Indian Health Service, the Centers for Disease Control and Prevention, and the National Institutes of Health. The funds will allow for the construction of new facilities and improvements to existing facilities. Department of the Interior National Park Service.—This budget requests $20 million in budget authority for 2001 and $49 million in advance appropriations for 2002–2004 to fully fund projects in the National Park Service. 6. 159 FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING Table 6–5. PROPOSED SPENDING TO FULLY FUND SELECTED CAPITAL ASSET ACQUISITIONS (Budget authority in millions of dollars) Advance appropriations Regular appropriations 2001 2002 2003 2004 2005 After 2005 Total Advance Appropriations DEPARTMENT OF COMMERCE National Oceanic and Atmospheric Administration Procurement, acquisition and construction ........................ 635 732 705 706 657 3,617 6,417 DEPARTMENT OF DEFENSE Military construction and family housing ............................................................................................................... 414 510 231 61 19 ............ 821 DEPARTMENT OF ENERGY Science programs .................................................................................................................................................. 281 300 232 150 115 ............ 797 DEPARTMENT OF HEALTH AND HUMAN SERVICES Food and Drug Administration .............................................................................................................................. Indian Health Service ............................................................................................................................................ Centers for Disease Control and Prevention ....................................................................................................... National Institutes of Health .................................................................................................................................. 20 65 127 47 23 18 21 26 ............ ............ 21 ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ ............ 23 18 42 26 Subtotal, Department of Health and Human Services .................................................................................... 259 88 21 ............ ............ ............ 109 DEPARTMENT OF THE INTERIOR National Park Service: Construction and major maintenance ............................................................................. 20 21 17 11 ............ ............ 49 DEPARTMENT OF JUSTICE Federal Prison System buildings and facilities ..................................................................................................... 713 791 535 ............ ............ ............ 1,326 DEPARTMENT OF STATE Embassy security, construction, and maintenance .............................................................................................. 500 650 800 950 950 ............ 3,350 DEPARTMENT OF TRANSPORTATION Federal Aviation Administration: Facilities and equipment .................................................................................. 622 638 590 565 537 614 2,944 DEPARTMENT OF THE TREASURY Internal Revenue Service: Information technology investments .......................................................................... 119 375 ............ ............ ............ ............ 375 DEFENSE CIVILIAN PROGRAMS Armed forces retirement home ............................................................................................................................. 8 6 ............ ............ ............ ............ 6 GENERAL SERVICES ADMINISTRATION Federal buildings fund ........................................................................................................................................... 101 219 163 96 ............ ............ 478 NATIONAL AERONAUTICS AND SPACE ADMINISTRATION Human space flight ................................................................................................................................................ 2,115 1,859 1,452 1,327 1,275 ............ 5,913 NATIONAL SCIENCE FOUNDATION Major research equipment ..................................................................................................................................... 119 144 58 50 14 ............ 266 SMITHSONIAN INSTITUTION Repair, restoration, and alteration of facilities ...................................................................................................... Construction ........................................................................................................................................................... 17 2 17 2 18 ............ ............ ............ ............ ............ ............ ............ 35 2 Subtotal, Smithsonian Institution ....................................................................................................................... 19 19 18 ............ ............ ............ 37 Total .................................................................................................................................................................. 5,925 6,352 4,822 3,916 3,567 4,231 22,888 Note: For these capital projects, budget authority for the project is requested partly in the budget year and partly in future years in advance appropriations. Department of Justice Department of State This budget requests $713 million in 2001 and advanced appropriations of $791 million in 2002 and $535 million in 2003 for the Federal Prison System to support a multi-year prison construction program aimed at reversing worsening overcrowding in Federal facilities. This budget requests $500 million in regular appropriations in 2001 and $3,350 million in advance appropriations for 2002–2005 for embassy and consultate construction. This request would support a program to provide a sustained, increasing funding path to meet overseas facility security needs. 160 Department of Transportation Federal Aviation Administration.—This budget requests $622 million in 2001 and an additional $2,944 million for 2002–2008 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 $119 million in 2001 and $375 million in advance appropriations for 2002 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. Defense Civilian Programs Armed Forces Retirement Home. This request for $8 million in regular appropriations in 2001 and $6 million in 2002 in advance appropriations will allow for construction of a 110-bed health care addition to the Naval home in Gulfport, Mississippi. General Services Administration This budget requests $101 million for 2001 and $478 million in advance appropriations for 2002–2004. The Budget requests $219 million in advance appropriations for 2002, including $185 million for the construction of new laboratory and office space for the Food and Drug Administration’s Center for Devices and Radiological Health in White Oak, Maryland, and $34 million for construction of a new office building to replace the deteriorating National Oceanic and Atmospheric Administration building in Suitland, Maryland. In addition, advance appropriations of $163 million in 2003 and $96 million in 2004 are provided for the FDA consolidation project in White Oak, MD. ANALYTICAL PERSPECTIVES National Aeronautics and Space Administration (NASA) Human Space Flight (International Space Station).— This budget requests $2,115 million in budget authority for 2001, and $5,913 million in advance appropriations over the years 2002–2005 for the 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 two launches beginning construction of the Station took place in 1998 and final assembly will be complete by 2005. Advance appropriations will enable NASA to complete the development program on schedule and at minimal total cost. National Science Foundation (NSF) This budget requests $119 million in 2001 and $266 million in advance appropriations for 2002–2005 for five NSF projects. 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 Network for Earthquake Engineering Simulation is a network to connect and integrate a distributed collection of earthquake engineering facilities that will facilitate the future replacement of mechanical earthquake simulation with model-based computer simulation. The Terascale Computing System will provide two sites in the United States with supercomputer capability of at least 10 teraflops that will be available for use by U.S. researchers through a merit-based, competitive process. Earthscope: SAFOD/U.S. Array is an array of seismic instruments that will be displayed at depth in the San Andreas fault and on the surface throughout the United States to greatly improve resolution of subsurface and fault structure. The National Ecological Observatory Network is a pole-to-pole network of research sites with state-of-theart platforms and equipment to enable ecological and biocomplexity research. Smithsonian Institution The budget requests $19 million in budget authority in 2001 and $37 million in advance appropriations for 2002–2003 primarily for the major capital renewal of the Patent Office Building. This building houses the Smithsonian’s Museum of American Art and the National Portrait Gallery. 6. 161 FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING 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 compliance plan for this budget year; 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 162 ANALYTICAL PERSPECTIVES 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 2000 and 2001 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 Officer of the probability of achieving the proposed goals; 3. 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 4. 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,’’ (July 1999), 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 6. 163 FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING 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 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. 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 164 ANALYTICAL PERSPECTIVES increased funding to the Congress, or termination of 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’’ (July 1999), 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; • 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 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 6. FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING 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. 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. 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 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 165 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. 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’’ (July 1999), Appendix 300C. 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 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: 166 • • • • ANALYTICAL PERSPECTIVES 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. 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 may not accurately measure 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 spend- ing 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 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 1996 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 $2,013 billion in 1999 and is estimated to increase slightly to $2,065 billion by 2001. In 1999, the national defense capital stock accounted for $671 billion, or 33 percent of the total, and nondefense stocks for $1,342 billion, or 67 percent of the total. Real stocks of defense and nondefense capital show very different trends. Nondefense stocks have grown consistently since 1970, increasing from $536 billion in 1970 to $1,342 billion in 1999. With the investments proposed in the budget, nondefense stocks are estimated to grow to $1,417 billion in 2001. During the 1970s, the nondefense capital stock grew at an average annual rate of 4.3 percent. In the 1980s, however, the growth rate slowed to 2.7 percent annually, with growth continuing at about that rate since then. 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 $671 billion in 1999 to $648 billion in 2001. 3 Constant dollar stock estimates are expressed in chained 1996 dollars, consistent with the October 1999 revisions to the National Income and Product Accounts (NIPAs). The shift to a more recent base year changes the reported level of real stocks, but leaves the year-to-year trends largely the same. 6. 167 FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING Table 6–6. NET STOCK OF FEDERALLY FINANCED PHYSICAL CAPITAL (In billions of 1996 dollars) Nondefense Fiscal Year Five year intervals: 1960 .................................................... 1965 .................................................... 1970 .................................................... 1975 .................................................... 1980 .................................................... 1985 .................................................... 1990 .................................................... Annual data: 1995 .................................................... 1996 .................................................... 1997 .................................................... 1998 .................................................... 1999 .................................................... 2000 est. ............................................. 2001 est. ............................................. Total National Defense Direct Federal Capital Total Nondefense Total Water and Power Capital Financed by Federal Grants Other Total Transportation Community and Regional Natural Resources Other 978 1,056 1,200 1,245 1,338 1,550 1,823 682 644 664 587 518 606 756 296 412 536 658 820 944 1,068 145 181 205 226 253 278 309 89 108 123 139 159 171 180 56 72 82 88 94 107 129 151 231 331 432 567 666 759 93 163 237 291 350 406 473 27 33 47 75 116 140 151 21 23 27 41 76 96 108 10 12 20 25 26 25 27 1,956 1,969 1,982 1,993 2,013 2,038 2,065 742 721 701 685 671 658 648 1,214 1,248 1,281 1,308 1,342 1,380 1,417 347 355 362 364 372 380 387 187 188 187 187 187 188 189 160 168 175 178 185 192 199 867 893 919 944 970 1,000 1,030 546 562 578 594 611 631 651 160 163 166 169 171 174 177 117 119 120 121 123 124 125 44 49 54 60 65 71 77 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 1999, 28 percent of the nondefense stock was owned by the Federal Government and 72 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 increased about 30 percent 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. For some categories in the table, such as water and power programs, however, 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 $898 billion in 1999 in constant 1996 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 1999 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 1981, 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 development, 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 1990 led to a more rapid growth of the R&D stock. Since then, real 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 168 ANALYTICAL PERSPECTIVES Table 6–7. COMPOSITION OF GROSS AND NET FEDERAL AND FEDERALLY FINANCED NONDEFENSE PUBLIC PHYSICAL INVESTMENT (In billions of 1996 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 ........................ 1990 ........................ Annual data: 1995 ........................ 1996 ........................ 1997 ........................ 1998 ........................ 1999 ........................ 2000 est. ................. 2001 est. ................. Depreciation Net Depreciation Gross Net Water and power Composition of net investment Gross Depreciation Net Other Transportation (mainly highways) Community and regional development Natural resources and environment Other 26.6 35.4 33.9 34.8 49.2 46.2 46.5 5.7 7.8 10.2 12.3 15.0 18.0 22.4 21.0 27.6 23.7 22.4 34.2 28.1 24.1 9.8 11.7 7.4 10.1 12.0 14.1 16.2 3.3 4.3 5.0 5.4 6.0 7.4 10.2 6.4 7.4 2.5 4.7 6.1 6.7 6.1 3.4 3.4 2.0 3.7 3.9 2.2 1.9 3.0 4.0 0.4 1.0 2.1 4.6 4.1 16.9 23.8 26.5 24.6 37.1 32.1 30.3 2.3 3.6 5.2 6.9 9.0 10.7 12.2 14.5 20.2 21.3 17.7 28.1 21.4 18.1 13.8 17.0 13.3 8.0 13.6 14.2 13.0 0.1 2.2 5.4 4.4 7.7 4.1 1.6 0.1 0.4 1.0 4.6 7.0 3.2 2.0 0.5 0.5 1.7 0.7 –0.2 –0.1 1.4 59.9 61.1 60.9 55.7 63.1 67.7 68.8 26.1 26.9 27.8 28.5 29.2 30.1 31.1 33.9 34.1 33.1 27.2 33.9 37.6 37.7 19.5 20.7 20.0 15.5 21.1 22.3 21.9 12.2 12.6 13.1 13.3 13.6 14.0 14.5 7.4 8.1 6.9 2.2 7.4 8.3 7.4 1.4 0.4 –0.5 –0.4 0.2 1.1 0.8 6.0 7.7 7.5 2.6 7.2 7.2 6.6 40.4 40.3 40.9 40.2 42.1 45.4 46.9 13.9 14.3 14.8 15.2 15.6 16.1 16.6 26.5 26.0 26.1 25.0 26.5 29.3 30.3 16.4 16.1 16.5 15.5 17.4 19.5 20.1 2.7 3.0 2.8 2.7 2.7 2.7 2.5 2.0 1.5 1.4 1.0 1.1 1.3 1.5 5.4 5.5 5.3 5.8 5.2 5.7 6.2 Table 6–8. NET STOCK OF FEDERALLY FINANCED RESEARCH AND DEVELOPMENT 1 (In billions of 1996 dollars) National Defense Fiscal Year Total Five year intervals: 1970 .................................................................. 1975 .................................................................. 1980 .................................................................. 1985 .................................................................. 1990 .................................................................. Annual data: 1995 .................................................................. 1996 .................................................................. 1997 .................................................................. 1998 .................................................................. 1999 .................................................................. 2000 est. .......................................................... 2001 est. .......................................................... 1 Excludes Basic Research Nondefense Applied Research and Development Total Basic Research Total Federal Applied Research and Development Total Basic Research Applied Research and Development 245 260 263 302 379 15 19 23 28 34 231 240 240 274 345 202 247 292 319 360 63 91 124 164 215 139 155 169 155 145 447 507 555 621 739 78 111 147 192 249 370 396 408 429 490 398 400 402 403 404 405 405 40 41 42 43 44 46 47 358 359 359 359 360 359 359 434 447 461 477 494 512 532 277 289 303 315 329 343 359 157 157 158 161 165 169 173 832 847 863 879 898 917 938 317 331 345 359 373 389 406 515 516 518 521 524 528 532 outlays for physical capital for research and development, which are included in Table 6–6. 3.8 percent in the 1970s to a rate of 1.8 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 $964 billion in 1999 in constant 1996 dollars, rising to $1,085 billion in 2001. 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 5.4 percent from 1970 to 1999, and the expansion of the education stock is projected to continue under this budget. 4 For estimates of the total education stock, see Table 2–4 in Chapter 2, ‘‘Stewardship: Toward a Federal Balance Sheet.’’ 6. 169 FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING Table 6–9. NET STOCK OF FEDERALLY FINANCED EDUCATION CAPITAL (In billions of 1996 dollars) Total Education Stock Fiscal Year Five year intervals: 1960 ............................................................................... 1965 ............................................................................... 1970 ............................................................................... 1975 ............................................................................... 1980 ............................................................................... 1985 ............................................................................... 1990 ............................................................................... Annual data: 1995 ............................................................................... 1996 ............................................................................... 1997 ............................................................................... 1998 ............................................................................... 1999 ............................................................................... 2000 est. ........................................................................ 2001 est. ........................................................................ 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: Methodological issues.—The stocks of physical capital and research and development are estimated with the perpetual inventory method. A fundamental assumption of this method is that each dollar of investment spending adds a dollar to the value of the capital stock in the period in which the spending takes place. In reality, the value of the asset created could be more or less than the investment spending. As an extreme example, in cases where a project is canceled before completion, the spending on the project does not result in the creation of any asset. Even where asset value is equal to investment spending, there might be timing differences in spending and the creation of a capital asset. For example, payments for constructing an aircraft carrier might be made over a period of years, with the capital asset only created at the end of the period. 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 Elementary and Secondary Education Higher Education 66 92 212 305 432 533 701 48 66 166 245 336 397 517 19 26 46 60 96 136 184 791 822 859 912 964 1,027 1,085 574 596 623 663 705 756 804 217 226 237 249 260 271 282 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 1996 prices were made through the application of price measures from the National Income and Product Accounts (NIPAs), but these should be considered only approximations of the costs of these assets in 1996 prices. Depreciation.—The useful lives of physical, R&D, and education capital, as well as the pattern by which 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. 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 two recent comprehensive revisions of the NIPAs in January 1996 and October 1999, government investment has taken 170 increased prominence. Government investment in physical capital is now reported separately from government consumption expenditures, and government consumption expenditures include depreciation as a measure of the services provided by the existing capital stock. Government purchases of software are now included as investment.5 In addition, as part of the most recent revisions, a new table will explicitly link investment and capital stocks by reporting the net stock of Government physical capital and decomposing the annual change in the stock into investment, depreciation, extraordinary changes such as disasters, and revaluation.6 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 these reasons, OMB prepares separate estimates for budgetary purposes, 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 1996 dollars were based on composite NIPA deflators for Federal, State, and local consumption of durables and gross investment, as revised in BEA’s October 1999 comprehensive NIPA revisions. Because BEA had not yet released certain revised data prior to calendar year 1959, deflators were estimated for 1930 to 1959 based on the growth rates in BEA’s prerevision data. 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.7 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. Research and Development Capital Stocks Method of estimation.—The estimates were developed from a data base for the conduct of research and devel5 This change aligns BEA’s treatment of software with OMB’s definitions, which include purchase and in-house development of major software as investment. 6 BEA’s most recent estimates of capital stocks, prepared prior to the October 1999 comprehensive revisions, appear in ‘‘Fixed Reproducible Tangible Wealth in the United States: Revised Estimates for 1995–97 and Summary Estimates for 1925–97,’’ Survey of Current Business, September 1998, pp. 36–46. Estimates reflecting the October 1999 revisions are tentatively scheduled for publication in the March 2000 Survey of Current Business. ANALYTICAL PERSPECTIVES opment 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 1996 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.8 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.9 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, including opportunity costs. 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 BEA presented its depreciation methods and rates in ‘‘Improved Estimates of Fixed Reproducible Tangible Wealth, 1929–95,’’ Survey of Current Business, May 1997, pp. 69–76. 8 See U.S. Department of Labor, Bureau of Labor Statistics, The Impact of Research and Development on Productivity Growth, Bulletin 2331, September 1989. 9 See ‘‘A Satellite Account for Research and Development,’’ Survey of Current Business, November 1994, pp. 37–71. 6. 171 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, and a capital budget process may take many different forms. 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 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 Part I of 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 Table 6–10. ALTERNATIVE DEFINITIONS OF INVESTMENT OUTLAYS, 2001 (In millions of dollars) Investment Outlays All types of capital 1 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 ...................................................................................... Federal capital National capital 33,570 2,785 6,048 7,643 294 ................ ................ ................ ................ ................ 33,570 2,785 1,009 ................ 182 5,120 616 5,424 863 269 1,317 1,044 1,116 2,674 5,120 584 4,128 863 259 1,317 1,044 1,116 2,193 ................ 616 5,129 863 269 1,317 1,044 ................ 1,237 Total construction and rehabilitation ..................................................... Acquisition of major equipment (direct): National defense ............................................................................................. Postal Service ................................................................................................. Air transportation ............................................................................................ Other ............................................................................................................... 68,783 16,624 48,021 51,076 714 1,965 5,504 51,076 714 1,965 4,728 ................ 714 1,965 3,333 Total major equipment ............................................................................... Purchase or sale of land and structures ........................................................... Other physical assets (grants) ........................................................................... 59,259 839 1,344 58,483 839 ................ 6,012 ................ 64 Total physical investment ............................................................................... Research and development: Defense ........................................................................................................... Nondefense ..................................................................................................... 130,225 75,946 54,097 40,914 39,447 ................ ................ 1,184 38,889 Total research and development ............................................................... Education and training ........................................................................................ 80,361 56,590 ................ ................ 40,073 56,214 Total investment outlays ..................................................................................... 267,176 75,946 150,384 1 Total outlays for ‘‘all types of capital‘‘ are equal to the total for ‘‘major Federal investment outlays’’ in Table 6–1. Some capital is not classified as either Federal or national capital, and a relatively small part is included in both categories. 172 ANALYTICAL PERSPECTIVES 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 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. As discussed at the beginning of this chapter, the Report of the President’s Commission to Study Capital Budgeting considered both capital budgets and the broader question of the planning and budgeting process for capital assets. It made a series of recommendations to improve budgeting for capital and setting priorities for the Federal Government, but it did not recommend changing the budget to make the size of the deficit or surplus depend on the amount of expenditures defined as capital, to finance capital spending by borrowing, or to make a single decision about how much to spend for ‘‘capital’’ under some definition. 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 either for a single agency or for the Government as a whole. The universe of Federal capital encompasses all 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 2001 is estimated to be $75.9 billion, or 28 percent of the total Federal investment outlays shown in Table 6–1. Of the investment in Federal capital, 74 percent is for defense and 26 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, equipment, and software 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.10 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 smaller surplus than 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. Depreciation is larger than capital expenditures by $4 billion. 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. 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 a little more than the unified budget surplus: a surplus $6 billion higher than the unified budget surplus instead of $4 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 sec10 This definition of ‘‘capital assets’’ is the same as used in the budget in recent years. Narrower definitions of ‘‘fixed assets’’ were used in earlier budgets. 6. FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING Table 6–11. CAPITAL, OPERATING, AND UNIFIED BUDGETS: FEDERAL CAPITAL, 2001 1 (In billions of dollars) Operating Budget Receipts .................................................................................................. Expenses: Depreciation ....................................................................................... Other .................................................................................................. 80 1,759 Subtotal, expenses ........................................................................ 1,839 Surplus or deficit (–) .......................................................................... Capital Budget Income: depreciation .............................................................................. Capital expenditures .............................................................................. 180 Surplus or deficit (–) .......................................................................... Unified Budget Receipts .................................................................................................. Outlays ................................................................................................... 4 2,019 1,835 Surplus or deficit (–) 2 ....................................................................... 184 2,019 80 76 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 surplus allocation for debt reduction is part of the President’s overall budgetary framework to extend the solvency of Social Security and Medicare, and is shown in Table S–1 in Part 6 of the 2001 Budget. tion of this chapter.) As a result, capital expenditures for defense in 2001 are estimated to be $10 billion less than depreciation, whereas capital expenditures for nondefense purposes (plus military family housing) are estimated to be $6 billion more. 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.11 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 perma11 The amount of depreciation that typically would be recorded as an expense in the budget year is 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. 173 nent, 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 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 in setting priorities. 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).12 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.13 Regardless of the 12 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. 13 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, 174 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.14 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 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.15 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 objective 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 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, ‘‘Capital-Investment Budgeting Process’’ and ‘‘Capital-Expenditure Evaluation Methods,’’ chap. 19 and 20 in Robert Rachlin, ed., Handbook of Budgeting (4th ed.; New York: Wiley, 1999). 14 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. 15 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. ANALYTICAL PERSPECTIVES measure of expense in financial statements and cost accounting for Federal agencies.16 Businesses finance investment from net income, cash on hand, and other sources 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. 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 as expenditures in the operating budget. For the portion of investment purchased in the capital budget but financed by Federal grants or State taxes, which may be substantial, State operating budgets do not record any amount. No State operating budget is charged for depreciation.17 States also do not record depreciation expense in the financial accounting statements for governmental funds. They currently record depreciation expense only in their proprietary (commercial-type) funds and in those trust funds where net income, expense, or capital 16 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. This Statement was recommended by the Federal Accounting Standards Advisory Board. Depreciation is not used as a measure of expense for heritage assets, or for weapons systems and other national defense property, plant, and equipment. 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. 17 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). 6. FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING 175 maintenance is measured.18 Under new financial accounting standards, however, depreciation on most capital assets will be recognized as an expense in government-wide financial statements. This will become effective for fiscal periods beginning during 2001–03, depending on the size of the government.19 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, which is reflected in the credit ratings of its bonds. Rating agencies place significant weight on the amount of debt outstanding compared to the economic output generated by the State. Furthermore, borrowing 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. The French budget, for example, is divided into separate titles of which some are for current expenditures and others for capital expenditures. However, a recent study of European countries found only four that had a real difference between a current budget and a capital budget (Greece, Ireland, Luxembourg, and Portugal); 20 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.21 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 or before the government can acquire certain capital assets such as state highways.22 More recently, Australia has adopted an accrual budget as of its 1999–2000 fiscal year, although appropriations are required for departments with inadequate funds to replace capital assets. The budget has several measures of fiscal position: the operating balance is fully accrual; while the fiscal balance, the primary fiscal measure, is closer to a cash basis and includes the purchase of property, plant, and equipment rather than depreciation. The United Kingdom has adopted a rule that it will borrow only for net investment (after depreciation), averaged over the economic cycle. It plans to budget on an accrual basis, including the depreciation of capital assets, beginning with its budget for 2001–02; an appropriation would be required for cash payments for capital assets made in the fiscal year, but this would not be included in the ‘‘resource budget.’’ On the other hand, some countries—including Sweden, Denmark, Finland, and the Netherlands—formerly had separate capital budgets but abandoned them a number of years ago.23 Many developing countries operate a dual budget system comprising a regular or recurrent budget and a capital or development budget. The World Bank staff has concluded that: ‘‘The dual budget may well be the single most important culprit in the failure to link planning, policy and budgeting, and poor budgetary outcomes. The dual budget is misconceived because it is based on a false premise that capital expenditure by government is more productive than current expenditure. Separating development and recurrent budgets usually leads to the development budget having a lower hurdle for entry. The result is that everyone seeks to redefine their expenditure as capital so it can be included in the development budget. Budget realities are left to the recurrent budget to deal with, and there is no pretension that expenditure proposals relate to policy priorities.’’ 24 18 Governmental Accounting Standards Board (GASB), Codification of Governmental Accounting and Financial Reporting Standards as of June 30, 1999, sections 1100.107 and 1400.114–1400.118. 19 Governmental Accounting Standard Board, Statement No. 34, Basic Financial Statements—and Management’s Discussion and Analysis—for State and Local Governments (October 1999), paragraphs 18–29 and 44–45. For discussion, see paragraphs 330–43. 20 M. Peter van der Hoek, ‘‘Fund Accounting and Capital Budgeting: European Experience,’’ Public Budgeting and Financial Management, vol. 8 (Spring 1996), pp. 39–40. 21 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.’’ 22 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. 23 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. 24 The World Bank, Public Expenditure Management Handbook (Washington, D.C.: The World Bank, 1998), Box 3.11, page 53. 25 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. 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.’’ 25 After further study of the role of depreciation in budgeting for national capital, GAO reiterated that con- 176 ANALYTICAL PERSPECTIVES clusion in another study in 1995.26 ‘‘The greatest disadvantage . . . was that depreciation would result in a loss of budgetary control under an obligation-based budgeting system.’’ 27 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.’’ 28 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.29 GAO defined this investment as ‘‘federal spending, either direct or through grants, that is directly intended to enhance the private sector’s longterm productivity.’’ 30 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.31 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 forma26 GAO, Budget Issues: The Role of Depreciation in Budgeting for Certain Federal Investments, GAO/AIMD–95–34 (February 1995), pp. 1 and 19–20. 27 Ibid., p. 17. Also see pp. 1–2 and 16–19. 28 GAO, Budget Issues: Budgeting for Federal Capital, GAO/AIMD–97–5 (November 1996), p. 28. Also see p. 4. 29 Incorporating an Investment Component in the Federal Budget, pp. 1–2, 9–10, and 15. 30 Ibid., pp. 1 and 5. 31 Ibid., pp. 2 and 13–16. tion of national capital. GAO reiterated its recommendation in another report in 1995.32 Table 6–12. UNIFIED BUDGET WITH NATIONAL INVESTMENT COMPONENT, 2001 (In billions of dollars) Receipts .................................................................................................... Outlays: National investment ............................................................................. Other .................................................................................................... 2,019 150 1,685 Subtotal, outlays .............................................................................. 1,835 Surplus or deficit (–) 1 ......................................................................... 184 1 The surplus allocation for debt reduction is part of the President’s overall budgetary framework to extend the solvency of Social Security and Medicare, and is shown in Table S–1 in Part 6 of the 2001 Budget. 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 $150 billion in 2001. 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 10 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.33 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 32 The Role of Depreciation in Budgeting for Certain Investments, pp. 2 and 19–20. 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.’’ 33 GAO’s 6. FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING Table 6–13. CAPITAL, OPERATING, AND UNIFIED BUDGETS: NATIONAL CAPITAL, 2001 1 (In billions of dollars) Operating Budget Receipts .................................................................................................. Expenses: Depreciation 2 ..................................................................................... Other .................................................................................................. 74 1,685 Subtotal, expenses ........................................................................ 1,758 Surplus or deficit (–) .......................................................................... Capital Budget Income: Depreciation 2 ..................................................................................... Earmarked tax receipts 3 ................................................................... 222 Subtotal, income ............................................................................ Capital expenditures .............................................................................. 112 150 Surplus or deficit (–) .......................................................................... Unified Budget Receipts .................................................................................................. Outlays ................................................................................................... –38 2,019 1,835 Surplus or deficit (–) 4 ................................................................... 184 1,981 74 38 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 Excludes depreciation on capital financed by earmarked tax receipts allocated to the capital budget. 3 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. 4 The surplus allocation for debt reduction is part of the President’s overall budgetary framework to extend the solvency of Social Security and Medicare, and is shown in Table S–1 in Part 6 of the 2001 Budget. 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 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.34 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 34 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). 177 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 depreciation). 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 (NIPA) according to one definition of investment. The NIPA Federal sector measures the impact of Federal current receipts, current expenditures, and the current surplus or 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.35 Until four 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.36 The revised NIPA Federal Government account is a current account or an operating account for the Federal Government and accordingly shows current receipts and current expenditures. It excludes expenditures for structures, equipment, and software owned by the Federal Government; it includes depreciation on the federally owned stock of structures, equipment, and software as a proxy for the services of capital assets consumed in production and thus as part of the Federal Government’s current expenditures. It applies this treatment to a comprehensive definition of federally owned structures, equipment, and software, both defense and nondefense, similar to the definition of ‘‘capital assets’’ in this chapter.37 35 See chapter 16 of this volume, ‘‘National Income and Product Accounts,’’ for the NIPA current account of the Federal Government based on the budget estimates for 2000 and 2001, and for a discussion of the NIPA Federal sector and its relationship to the budget. 36 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 vary. For example, the SNA does not include the purchase of military equipment as investment. 37 The treatment of investment (except for the recent recognition of software) in the 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, equipment, and software remain a part of gross domestic product (GDP) as a separate component. The NIPA State and local government account is defined in the same way and includes depreciation on structures, equipment, and software 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 government account: 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.’’ 178 ANALYTICAL PERSPECTIVES 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 1999 Federal Government current account surplus was increased $2 billion by including depreciation rather than gross investment, because depreciation of federally owned structures, equipment, and software was less than gross investment. The 2001 Federal current account surplus is estimated to be increased $16 billion. 38 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 the current replacement cost, not the historical cost. Current cost depreciation is needed in order to measure all activities in the budget on a consistent basis, since other outlays and receipts are automatically measured in the prices of the current year. Current cost depreciation is also needed to obtain a valid measure of net investment. This requires that the addition to the capital stock from new purchases and the subtraction from depreciation on existing assets both be measured in the prices of the same year. 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 a great deal of 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 $4 billion. The rationale of borrowing to finance net invest38 See actuals and estimates for 1990–2001 in table 16–2 of chapter 16 of this volume, ‘‘National Income and Product Accounts.’’ ment 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 ($4 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 39) is less than gross investment but not by a great deal—the capital budget deficit is $38 billion. The rationale of borrowing to finance net investment would justify the Federal Government borrowing this amount ($38 billion) and no more to finance its investment in national capital.40 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 government) 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.41 From its outset, this Administration has taken major steps to increase the saving available for private investment while also increasing Federal investment for national capital. During the past seven years, the large deficit has been replaced by a substantial surplus, and available resources have been shifted to investment in education and training and in science and technology. The present budget proposes to continue to run substantial surpluses, paying down the debt to make room for financing private investment, while protecting high 39 The capital budget deficit would be about $27 billion larger if current cost depreciation were used instead of earmarked excise taxes for investment in highways and airports and airways. 40 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 disbursements of the direct loan and guaranteed loan financing accounts. See chapter 12 of this volume, ‘‘Federal Borrowing and Debt,’’ and the explanation of Table 12–2. 41 GAO considered deficit financing of investment but did not recommend it. See Incorporating an Investment Component in the Federal Budget, pp. 12–13. 6. 179 FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING priority Federal investment. A capital budget is not a justification to relax the budget constraints that are contributing to this accomplishment. Any easing would undo the gains from achieving a surplus that have already been achieved and the further gains from the proposals in this budget. 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 2000 enacted appropriations and adjusted for inflation in later years. The current services concept is discussed in Chapter 14, ‘‘Current Services Estimates.’’ Federal public physical capital spending was $118.6 billion in 1999 and is projected to increase to $154.4 billion by 2009 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 1999. 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 $31.0 billion in 1999, and current services outlays are estimated to increase to $45.3 billion by 2009. Outlays for nondefense housing and buildings were $11.3 billion in 1999 and are estimated to be $15.6 billion in 2009. Physical capital outlays for other nondefense categories were $22.4 billion in 1999 and are projected to be $27.8 billion by 2009. For national defense, this spending was $53.9 billion in 1999 and is estimated on a current services basis to be $65.7 billion in 2009. Table 6–15 shows current services projections on a constant dollar basis, using fiscal year 1996 as the base year. 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. 180 ANALYTICAL PERSPECTIVES Table 6–14. CURRENT SERVICES OUTLAY PROJECTIONS FOR FEDERAL PHYSICAL CAPITAL SPENDING (In billions of dollars) 1999 Actual Nondefense: Transportation-related categories: Roadways and bridges ................................................................................... Airports and airway facilities ......................................................................... Mass transportation systems ......................................................................... Railroads ........................................................................................................ Estimate 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 22.8 3.9 4.0 0.3 25.5 3.8 4.3 0.7 27.2 3.8 4.5 0.6 28.1 4.1 5.2 0.6 28.7 4.1 5.7 0.6 29.2 4.3 6.4 0.6 29.8 4.4 6.8 0.7 30.5 4.5 7.0 0.7 31.1 4.6 7.2 0.7 31.7 4.6 7.4 0.7 32.3 4.8 7.5 0.7 Subtotal, transportation ............................................................................... Housing and buildings categories: Federally assisted housing ............................................................................ Hospitals ......................................................................................................... Public buildings 1 ............................................................................................ 31.0 34.3 36.1 38.0 39.2 40.6 41.6 42.6 43.6 44.5 45.3 7.0 1.3 3.0 7.6 1.4 3.5 8.0 1.9 3.6 7.7 1.9 3.6 8.0 1.9 3.8 8.7 1.9 3.8 8.9 2.0 3.9 9.2 2.0 4.0 9.1 2.1 4.1 9.0 2.1 4.2 9.1 2.2 4.3 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 .......................................................................................... 11.3 12.5 13.5 13.2 13.7 14.5 14.8 15.2 15.2 15.3 15.6 2.5 2.8 3.6 1.1 5.4 7.1 2.9 3.8 3.2 1.1 5.6 7.7 3.1 3.4 3.1 1.0 5.6 7.3 3.4 3.3 3.6 1.0 5.8 6.9 3.6 3.5 3.6 1.1 5.9 7.1 3.8 3.6 3.9 1.0 6.0 7.6 3.9 3.7 3.6 0.9 6.0 7.8 3.9 3.8 3.9 0.8 6.1 8.0 4.0 3.8 4.0 0.8 6.2 8.2 4.0 3.9 3.9 0.8 6.3 8.4 4.1 4.0 3.9 0.8 6.4 8.6 Subtotal, other nondefense ........................................................................ 22.4 24.1 23.5 24.0 24.8 25.9 25.9 26.5 27.0 27.3 27.8 Subtotal, nondefense ...................................................................................... National defense ...................................................................................................... 64.8 53.9 71.0 53.3 73.1 56.1 75.2 57.7 77.6 60.2 80.9 61.8 82.3 63.3 84.3 61.9 85.8 63.1 87.1 64.4 88.7 65.7 Total .......................................................................................................................... 118.6 124.3 129.2 132.9 137.8 142.8 145.6 146.2 148.9 151.4 154.4 1 Excludes outlays for public buildings that are included in other categories in this table. Table 6–15. CURRENT SERVICES OUTLAY PROJECTIONS FOR FEDERAL PHYSICAL CAPITAL SPENDING (In billions of constant 1996 dollars) 1999 Actual Nondefense: Transportation-related categories: Roadways and bridges .................................................................................................... Airports and airway facilities .......................................................................................... Mass transportation systems ......................................................................................... Railroads ......................................................................................................................... Estimate 2000 2001 2002 2003 2004 21.8 3.8 3.9 0.3 23.7 3.6 4.0 0.7 24.7 3.6 4.1 0.6 24.9 3.7 4.6 0.6 24.7 3.7 4.9 0.6 24.6 3.8 5.4 0.6 Subtotal, transportation ................................................................................................ Housing and buildings categories: Federally assisted housing ............................................................................................. Hospitals ......................................................................................................................... Public buildings 1 ............................................................................................................ 29.8 32.1 33.0 33.8 34.0 34.3 6.8 1.3 3.1 7.1 1.4 3.5 7.2 1.8 3.6 6.8 1.8 3.5 6.9 1.8 3.6 7.3 1.8 3.5 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 12.0 12.6 12.1 12.3 12.6 2.4 2.8 3.7 1.1 5.2 7.1 2.7 3.8 3.2 1.1 5.2 7.5 2.8 3.4 3.0 1.0 5.1 7.0 3.0 3.2 3.4 0.9 5.1 6.5 3.1 3.3 3.4 1.0 5.1 6.6 3.2 3.3 3.6 0.9 5.1 6.9 Subtotal, other nondefense ......................................................................................... 22.2 23.4 22.3 22.2 22.5 23.0 Subtotal, nondefense ........................................................................................................... National defense ....................................................................................................................... 63.1 54.6 67.5 53.2 67.9 54.9 68.2 55.4 68.7 56.6 69.9 57.0 Total .......................................................................................................................................... 117.7 120.8 122.8 123.5 125.3 126.9 1 Excludes outlays for public buildings that are included in other categories in this table. 6. 181 FEDERAL INVESTMENT SPENDING AND CAPITAL BUDGETING Significant Factors Affecting Infrastructure Needs Assessments Highways 1. Projected annual average growth in travel to the year 2015 ................................................................................... 2. Annual cost to maintain overall 1995 conditions and performance on highways eligible for Federal-aid ........... 3. Annual cost to maintain overall 1995 conditions on bridges .................................................................................... 1.96 percent $33.4 billion (1995 dollars) $5.6 billion (1995 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 .................................... 528 451 $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 ..................... $6.1 billion (1995 dollars) $3.6 billion (1995 dollars) Wastewater Treatment 1. Total remaining needs of sewage treatment facilities ............................................................................................... 2. Total Federal expenditures under the Clean Water Act of 1972 through 2000 ...................................................... 3. The population served by centralized treatment facilities: percentage that benefits from at least secondary sewage treatment systems ........................................................................................................................................... 4. States and territories served by State Revolving Funds ........................................................................................... $128 billion (1996 dollars) $74 billion 98 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 (1999) ........................................................................................................................... Average length of stay, IHS hospitals (days) (1999) ................................................................................................. Hospital admissions (1999) .......................................................................................................................................... Outpatient visits (1998) ............................................................................................................................................... Eligible population (2000) ............................................................................................................................................ 48.0 percent 3.9 49,753 4,407,000 1,511,135 1. 2. 3. 4. 5. Department of Veterans Affairs (VA) Hospitals (1998) Hospitals ........................................................................................................................................................................ Ambulatory clinics ........................................................................................................................................................ Domiciliaries ................................................................................................................................................................. Vet centers .................................................................................................................................................................... Nursing homes .............................................................................................................................................................. 166 544 40 206 132 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. Surface Transportation Department of Transportation. 1997 Status of the Nation’s Surface Transportation System: Conditions and 182 Performance: Report to Congress. 1997. This report discusses roads, bridges, and mass transit. 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— 1998. 1998. Office of Audit, Office of Inspector General, U.S. Department of Health and Human Services. Review of Health Facilities Construction Program. Indian Health ANALYTICAL PERSPECTIVES Service Proposed Replacement Hospital at Shiprock, New Mexico (CIN A–09–88–00008). June, 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 FUNDING Investments in scientific discovery and technological development—both public and private—have driven economic growth and improvements in the quality of life in America for long as our Nation has existed. In the last 50 years, developments in science and technology have generated at least half of the Nation’s productivity growth, creating millions of high-skill, highwage jobs and leading to advances in the economy, national security, the environment, transportation and medical care. Federal government support for science and technology has helped put Americans on the moon, boosted agricultural productivity, harnessed the atom, devised more effective treatments for cancers, tracked weather patterns and earthquake faults, and deciphered the chemistry of life. Because technological advances are key to progress and economic growth, in 1993 President Clinton took office committed to expanding Federal investment in civilian research and development. The President’s economic strategy relied upon the critical element of investing in people and proposed targeted investments to help the Nation compete in the global economy and improve our quality of life. The Administration’s support for R&D has been essential to the flow of innovative ideas, which have resulted in everything from the discovery of the first multi-planet system beyond our own to unraveling human, plant and microbial genomes, a critical step in understanding the function of genes, and, in turn, potentially treating and curing diseases that are now beyond the reach of medical science. Investments in science and technology can bring us breakthroughs in the areas of the environment, health, national security, and more, including, for example: fuel economies that are double those of today; a strong defense that continually hones its technological edge; and fundamental research that may be able to unlock the answers to some of the most basic questions: why cells age and die, how human beings learn and remember information, and whether there is life on other planets. Over the last several years, private industry has expanded its support for research and development, but most of these efforts focus on bringing new products to market rather than funding the basic research that can lead to break-through applications in a wide range of fields. By supporting fundamental research that can provide the foundation for tomorrow’s technologies, the Federal Government can act as a catalyst for these breakthroughs. Federal investment in basic research increased by nearly 45 percent from 1993 to 2000, with emphasis on health research. The budget proposes $20.3 billion to advance a balanced portfolio in basic research, an increase of $1.3 billion, or 7 percent, over 2000. Basic university-based research plays a special role in the development of scientific advances. The competitive grants process upon which university research relies fosters innovation and expands scientific frontiers. At the same time, these research grants provide a training ground for the next generation of scientists and engineers. Funding support for universities has grown to roughly $17.8 billion, a 53 percent increase, since 1993. Funding the academic researcher through a peer-reviewed, merit-based competitive process is the Federal government’s strategy for pursuing the most promising long-term research. Researchers at national laboratories, in the private sector, and at non-profit companies may also be funded through such a competition. In 2001, $28.2 billion in research funds will be awarded through a peer-reviewed, merit-based competitive process. Other processes for allocating research dollars are appropriate in special cases. For example, agencies may decide that they wish to spearhead research in a particularly risky, but highly promising, field that can further the agency’s mission. Agency program managers with in-depth knowledge and expertise are likely to have the best judgement for making such decisions. One example of this approach is the National Science Foundation, where program managers may award up to 5 percent of their funds through ‘‘Small Grants for Exploratory Research,’’ which are made at the program manager’s discretion, without peer review. In other agencies, there are well-known centers of excellence at the national laboratories, where there are unique capabilities. An agency may determine that maintaining and exploiting this excellence requires long-term financial stability for expensive world-class machines that will ultimately benefit many researchers. In the appropriations process, Congress may require awards to be made to a single performer or collection of performers without competitive selection. This Congressional direction may be established in law, report language, or by other means. As a result of a recommendation in the National Science and Technology Council’s report on the Government-University Partnership, agencies have reported the amount of funding that was awarded through such Congressional direction. The Administration is in the process of developing consistent measures across Federal agencies for these latter two categories of research, in order to publish the data in the 2002 budget. 183 184 ANALYTICAL PERSPECTIVES The tables below provide data on Federal spending for research and development. Table 7–1 shows agencyby-agency spending on basic and applied research, development, and equipment and facilities. Table 7–2 shows agency-by-agency spending for two initiatives of the National Science and Technology Council, which are required by statute. Table 7–1. FEDERAL RESEARCH AND DEVELOPMENT SPENDING (Budget authority, dollar amounts in millions) 1999 Actual 2000 Estimate 2001 Proposed Dollar Change: 2000 to 2001 Percent Change: 2000 to 2001 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 ............................................................................. Education ................................................................................................................... Other .......................................................................................................................... 38,850 15,797 9,715 6,992 2,702 1,645 1,084 786 670 644 500 205 752 38,719 18,063 9,753 7,091 2,903 1,773 1,073 585 648 655 584 233 664 38,640 18,998 10,035 7,655 3,464 1,828 1,152 731 679 655 590 271 635 –79 935 282 564 561 55 79 146 31 0 6 38 –26 0% 5% 3% 8% 19% 3% 7% 25% 5% 0% 1% 16% –4% TOTAL ................................................................................................................... 80,342 82,744 85,333 2,589 3% Basic Research Defense ...................................................................................................................... Health and Human Services ..................................................................................... National Aeronautics and Space Administration ...................................................... Energy ........................................................................................................................ National Science Foundation .................................................................................... Agriculture .................................................................................................................. Commerce ................................................................................................................. Transportation ............................................................................................................ Environmental Protection Agency ............................................................................. Veterans Affairs ......................................................................................................... Interior ........................................................................................................................ Education ................................................................................................................... Other .......................................................................................................................... 1,082 8,642 1,981 2,228 2,330 634 39 42 57 263 50 2 118 1,175 9,857 1,947 2,242 2,512 692 39 46 58 268 61 2 128 1,230 10,422 1,895 2,379 3,000 740 52 69 76 268 63 2 132 55 565 –52 137 488 48 13 23 18 0 2 0 4 5% 6% –3% 6% 19% 7% 33% 50% 31% 0% 3% 0% 3% SUBTOTAL ........................................................................................................... 17,468 19,027 20,328 1,301 7% Applied Research Defense ...................................................................................................................... Health and Human Services ..................................................................................... National Aeronautics and Space Administration ...................................................... Energy ........................................................................................................................ National Science Foundation .................................................................................... Agriculture .................................................................................................................. Commerce ................................................................................................................. Transportation ............................................................................................................ Environmental Protection Agency ............................................................................. Veterans Affairs ......................................................................................................... Interior ........................................................................................................................ Education ................................................................................................................... Other .......................................................................................................................... 3,064 4,998 2,306 1,810 147 743 799 368 401 365 418 141 355 3,383 5,728 2,365 1,913 164 807 770 384 387 370 482 150 290 3,087 5,935 2,817 2,174 193 821 834 477 377 370 486 165 290 –296 207 452 261 29 14 64 93 –10 0 4 15 0 –9% 4% 19% 14% 18% 2% 8% 24% –3% 0% 1% 10% 0% SUBTOTAL ............................................................................................................... 15,915 17,193 18,026 833 5% Development Defense ...................................................................................................................... Health and Human Services ..................................................................................... National Aeronautics and Space Administration ...................................................... Energy ........................................................................................................................ National Science Foundation .................................................................................... Agriculture .................................................................................................................. Commerce ................................................................................................................. Transportation ............................................................................................................ Environmental Protection Agency ............................................................................. 34,423 1,919 5,092 2,003 0 109 137 161 96 33,913 2,229 5,093 2,036 0 109 106 145 93 33,937 2,408 4,920 2,163 0 118 176 171 84 24 179 –173 127 0 9 70 26 –9 0% 8% –3% 6% NA 8% 66% 18% –10% 185 7. RESEARCH AND DEVELOPMENT FUNDING Table 7–1. FEDERAL RESEARCH AND DEVELOPMENT SPENDING—Continued (Budget authority, dollar amounts in millions) 1999 Actual 2000 Estimate 2001 Proposed Dollar Change: 2000 to 2001 Percent Change: 2000 to 2001 Veterans Affairs ......................................................................................................... Interior ........................................................................................................................ Education ................................................................................................................... Other .......................................................................................................................... 16 25 62 259 17 24 81 225 17 34 104 189 0 10 23 –36 0% 42% 28% –16% SUBTOTAL ........................................................................................................... 44,302 44,071 44,321 250 1% Facilities and Equipment Defense ...................................................................................................................... Health and Human Services ..................................................................................... National Aeronautics and Space Administration ...................................................... Energy ........................................................................................................................ National Science Foundation .................................................................................... Agriculture .................................................................................................................. Commerce ................................................................................................................. Transportation ............................................................................................................ Environmental Protection Agency ............................................................................. Veterans Affairs ......................................................................................................... Interior ........................................................................................................................ Education ................................................................................................................... Other .......................................................................................................................... 281 238 336 951 225 159 109 215 116 0 7 0 20 248 249 348 900 227 165 158 10 110 0 17 0 21 386 233 403 939 271 149 90 14 142 0 7 0 24 138 –16 55 39 44 –16 –68 4 32 0 –10 0 3 56% –6% 16% 4% 19% –10% –43% 40% 29% NA –59% NA 14% SUBTOTAL ........................................................................................................... 2,657 2,453 2,658 205 8% NA = Not applicable. Table 7–2. AGENCY DETAIL OF MAJOR INITIATIVES (Budget authority, dollar amounts in millions) 1999 Actual 2000 Estimate 2001 Proposed Dollar Change: 2000 to 2001 Percent Change: 2000 to 2001 Information Technology R&D* National Science Foundation .................................................................................... Energy (Defense—Advanced Strategic Computing Initiative) .................................. Energy (Civilian programs) ........................................................................................ Defense ...................................................................................................................... Health and Human Services ..................................................................................... National Aeronautics and Space Administration ...................................................... Commerce ................................................................................................................. Environmental Protection Agency ............................................................................. 393 301 139 215 118 106 25 4 517 397 120 282 191 174 36 4 740 477 190 397 233 230 44 4 223 80 70 115 42 56 8 0 43% 20% 57% 41% 22% 32% 22% 0% TOTAL ................................................................................................................... 1,301 1,721 2,315 594 35% U.S. Global Change Research Program National Aeronautics and Space Administration ...................................................... National Science Foundation .................................................................................... Energy ........................................................................................................................ Commerce ................................................................................................................. Agriculture .................................................................................................................. Health and Human Services ..................................................................................... Interior ........................................................................................................................ Environmental Protection Agency ............................................................................. Smithsonian Institution .............................................................................................. 1,155 182 114 63 52 40 27 17 7 1,173 187 120 67 53 46 27 21 7 1,149 187 123 93 85 48 25 23 7 –24 0 3 26 32 2 –2 2 0 –2% 0% 2% 39% 60% 4% –7% 10% 0% TOTAL ................................................................................................................... 1,657 1,701 1,740 39 2% * Merges both the High Performance Computing and Communications program and the Information Technology Initiative (IT2). 8. CREDIT AND INSURANCE Federal programs offer direct loans and/or loan guarantees for a wide range of activities, primarily housing, education, business, and exports. At the end of 1999, there were $234 billion in Federal direct loans outstanding and $976 billion in guaranteed loans. The Federal Government also insures bank, thrift, and credit union deposits up to $100,000, guarantees private vested defined-benefit pensions, and insures against disasters, specified international investment risks, and various other risks. In addition, the net loans outstanding of Governmentsponsored enterprises (GSEs)—privately owned companies and cooperatives that operate under Federal charters—totaled $2.4 trillion, including asset-backed securities guaranteed by the GSEs. GSEs are chartered to carry out specified public purposes through financing activities in the housing, education, and agriculture sectors. GSEs are not part of the Federal Government, however, and their securities are not federally guaranteed. By law, the GSEs’ securities carry a disclaimer of any U.S. obligation. Congress has authorized the Secretary of the Treasury, at his discretion, to purchase up to $2.25 billion of obligations issued by Fannie Mae and Freddie Mac, up to $4 billion by the Federal Home Loan Bank System, and up to $1 billion by Sallie Mae. Farmer Mac may sell up to $1.5 billion of its obligations to Treasury under specified, limited conditions. These diverse programs and GSEs are operating in the context of an accelerating evolution of financial markets that is generating many new risks, as well as new opportunities. Federal program managers will need to reassess their roles and improve their effectiveness to adapt to dynamic market conditions. The introduction to this chapter summarizes key changes in financial markets and their effects on Federal programs. • The first section is a crosscutting 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. • The second section reviews Federal credit programs and GSEs in four sectors: housing, education, business and community development, and exports. It notes the rationale and goals of these programs and the related activities of the GSEs. • The final section assesses recent developments in Federal deposit insurance, pension guarantees, and disaster insurance. Evolving Financial Markets The Financial Services Modernization Act, signed November 12, 1999, replaces a legal structure created in the Great Depression with one that is more appropriate to the rapidly changing and integrated financial markets of today. The Act repeals restrictions on bank affiliation with securities firms and removes the remaining statutory limitations on the financial activities allowable in banking organizations for qualified bank holding companies. It permits securities and insurance agency activities to be conducted in bank and financial holding company subsidiaries, municipal securities underwriting to be conducted in a national bank or in bank subsidiaries, and merchant banking and insurance underwriting to be conducted in financial holding company subsidiaries. The financial sector has already undergone substantial change. The number of banking organizations has shrunk by a quarter in the last decade and is roughly half the level 20 years ago. Consolidation has raised the share of industry assets at the 100 largest banks to 70 percent in 1998 from about 50 percent in the mid-1980s. With easing restrictions over the years, interstate banking and branching have become nationwide, and 51 securities affiliates are operating in bank holding companies. International lending by U.S. commercial banks resumed growth in the early 1990s following large losses on developing country loans in the 1980s, but has become increasingly concentrated in large banks. Meanwhile, U.S. banking assets of foreign banks have grown from 12 percent of all U.S. commercial banking assets in 1980 to a 23–25 percent share during the 1990s. Financial innovation and integration have enabled funds to flow more readily to their most productive uses across the country and around the world. Capital market financing is available to smaller companies and for a broader range of purposes than before. Specialized financial firms and nonfinancial firms, particularly suppliers, are helping to funnel funds from capital markets to small clients in cities and in rural areas. Venture capital providers and sub-prime lenders are fueling the growth of new businesses. Data on small business lending show that institutions outside the local community have become an important source of credit for many businesses. The 1990s have been a time of robust growth in mortgage markets; the net change in home mortgages rose from $180 billion in 1995 to $424 billion in the second quarter of 1999. Federal Reserve staff estimate that about 40 percent of the growth in outstanding home mortgage debt during the past five years financed the extraction of home equity. 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. 187 188 ANALYTICAL PERSPECTIVES Both intermediaries—banks and the many nonbank firms engaged in financial services—and capital markets have been reaching out to new clients that they did not serve a few years ago. Massive data bases and increasingly sophisticated analytical methods are finding creditworthy borrowers among people and businesses previously unlikely to receive private credit. Faster and cheaper information and communications systems also have revolutionized ‘‘back office’’ functions. These have been consolidated to achieve economies of scale and located anywhere in the world where capable workers are available. From these locations, satellite communications can bring the ‘‘back office’’ to any desktop computer. From a timely information base, credit servicing and workout have become much more efficient. While the increased globalization of financial institutions and capital markets provides extensive benefits, it also makes domestic market conditions more sensitive to events abroad. In 1997 and 1998, the Asian crisis and further events in Russia and Brazil resulted in a flight to liquidity and safety. Market conditions also worsened in 1998 when a heavily exposed hedge fund required a capital contribution from major lenders to avoid bankruptcy and further market disruption. These events drove down U.S. Treasury bond yields dramatically, and raised rates on all but the highest quality corporate bonds. Some credit markets were temporarily disrupted; related to this was an increase in business borrowing from banks, rather than directly from capital markets. Less-creditworthy borrowers faced higher rates or were temporarily unable to find funds. Conditions returned to near normal liquidity during 1999, but rate spreads between most private loans and securities and Treasury debt remained abnormally high. Problem loans at banks have increased about 70 percent compared with 1998, and banks have tightened underwriting standards. As a result of these experiences, awareness of the potential for discontinuities in financial markets has increased. Impact on Federal Programs These changes are affecting the roles, risks, and operations of Federal credit and insurance programs. I. • 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 Federal programs 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—a particular program. If the Government is caught unaware, the result may be greater cost for taxpayers. • At the same time, managers of Federal programs can take advantage of the growing private capability. 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. It now backs a recovered industry, but one with an increasing concentration of ‘‘large complex banking organizations’’ that have assumed the risks inherent in providing a growing array of increasingly sophisticated services, including many off-balance sheet activities, often on a worldwide basis. Regulators face challenges ranging from the complexity of assessing the risks of evolving financial services firms to the continuing need to monitor for fraud. In pensions, the Government guarantees defined benefit plans, but their role is diminishing as defined contribution plans attract 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 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 are they achieving their goals? And finally, could they be re-engineered to achieve greater benefits in relation to costs? 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, 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. 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 8. CREDIT AND INSURANCE 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 better health, these individuals 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 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 situa- 189 tions, 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 needed 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 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
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