Certain capital costs necessary to bring a mineral deposit into production may be deducted as current expenses rather than spread over the useful life of the property. Included in this category are the intangible drilling costs of oil and gas wells and the cost of developing other mineral deposits, such as mine shafts, tunnels, and stripping.

Extractive industries may choose between two methods of recovering capital costs invested in the development of natural resources. Under one method, actual outlays to the extent not immediately expensible may be deducted as "cost depletion" over the productive life of the property, much as other businesses may take deductions for the depreciation of capital goods. Alternatively, businesses in the extractive industries may deduct a prescribed percentage of gross income (at rates ranging from 27.5 percent for oil and gas to 5 percent for certain minerals, but not more than 50 percent of net income) where such "percentage depletion" exceeds "cost depletion." Percentage depletion is not limited to the cost of the investment as is cost depletion. The basis for "cost depletion" is reduced to the extent certain costs are recovered through expensing of exploration and discovery costs and intangible drilling costs. There is no comparable reduction in "percentage depletion" to allow for costs which are allowed as expenses.

Royalties from coal or iron ore deposits are treated as capital gains.

1 In the absence of the expensing of exploration and development costs and percentage depletion, the 1st year revenue effect would be $750,000,000 and $1,500,000,000 respectively, The difference from the estimates shown which are based on longrun effect is due to the fact that taxpayers with mineral properties would initially have little or no tax basis because of deductions in prior years.

2 Less than $50,000,000.

Commerce and Transportation

Investment credit.-Most businesses may take a tax credit equal to 7 percent of the cost of investments in new machinery and equipment made during the year. This credit does not lower the basis of the property for calculating the deduction for depreciation.

Excess depreciation on buildings.—To the extent that allowable depreciation for tax purposes exceeds the rate at which assets actually depreciate, business tax liabilities are deferred. Businesses may employ a variety of depreciation schedules for tax purposes, some of which cause a much larger part of asset values to be written off in early years of the asset's useful life than do others. The revenue cost of allowing for buildings depreciation methods for tax purposes that reduce asset value more rapidly than straight-line depreciation (the method typically used in financial statements) is shown below. The part based on rental housing is listed under community development and housing. The tax depreciation allowed for machinery and equipment is closer to actual depreciation than that allowed on buildings. In addition, the code permits full recapture as ordinary income of profits resulting from excess depreciation on machinery and equipment, but recapture of only a declining and then disappearing proportion of such profits on buildings. In view of this and the difficulty of estimating the divergence, if any, between depreciation allowed for tax purposes and actual depreciation, depreciation for machinery and equipment is not included here as a tax expenditure.

Dividend exclusion.—Individual income taxpayers may exclude $100 of dividends from income subject to tax.

Capital gains-Corporation income tax.--Capital gains of corporations are subject to a tax of 25 percent while the rate applicable to other corporate income above $25,000 is 48 percent (excluding the temporary surcharge).

Bad debt reserves of banks and other financial institutions-Commercial banks, mutual savings banks, building and loan associations, and cooperative banks are permitted to set aside bad debt reserves based on stipulated fractions of deposits, of loans outstanding, or of taxable income before computation for bad debts. The amounts set aside typically greatly exceed actual loss experience and reasonable expectations as to future losses.

Credit unions.-Credit unions are exempt from Federal income tax.

Deduction of interest on consumer credit.-Interest paid on consumer credit is allowed as an itemized nonbusiness deduction for individuals.

Expensing of research and development expenditures.-Expeditures by businesses for research and development (R&D) are carried out to find new products or processes, to reduce costs, or for other purposes. In nearly all cases, benefits from such expenditures will accrue for well over 1 year. For tax purposes business may deduct all R&D expenditures in the year during which they are incurred, or they may amortize them over not less than 5 years.

Surtax exemption ($25,000).—Corporations pay income tax at the rate of 22 percent on all taxable income plus a surtax of 26 percent on taxable income in excess of $25,000 (excluding the temporary surcharge). Each corporation therefore enjoys a surtax exemption of $25,000. This exemption is intended to encourage small or new businesses.

Deferral of tax on shipping companies.-Certain companies which operate U.S. flag vessel on foreign trade routes receive an indefinite deferral of income taxes on that portion of their net income which is used for shipping purposes, primarily construction, modernization, and major repairs of ships.

1 The revenue cost for 1968 under this category differs from that in exhibit 29 of the Secretary's annual report due to the exclusion of capital gains-individual and its presentation as a separate item in this revised analysis. 2 Less than $50,000,000.

Community Development and Housing

Owner-occupants of homes may deduct mortgage interest and property taxes (but not maintenance outlays or depreciation) as itemized nonbusiness deductions. The owners of rental housing may claim in early years depreciation in excess of straight-line depreciation. (See Table 5.)

Health and Welfare

A large variety of direct expenditures and transfer payments contribute to health and welfare of families and individuals, both currently and in later years. A considerable number of special tax provisions serve related ends.

Provisions relating to the aged, blind, and disabled.—Individual taxpayers age 65 and over may claim two personal exemptions of $600 and a second $100 minimum standard deduction (while persons under age 65 may claim only one of each). The revenue cost of these additional items is $500 million.

• Aged recipients of old age, survivors, and health benefits under the OASDHI program and of railroad retirement benefits are not required to include such benefits in computing tax liability. This revenue cost is $525 million.1

Individuals over age 65 may claim a tax credit of up to $228.60 (15 percent of $1,524) for a single person or $342.90 (15 percent of $2,286) for a married couple based on retirement income from all sources except social security, railroad retirement, or other tax-exempt benefits. In effect, the provision permits taxpayers with taxable retirement income a tax benefit approximately comparable to that accorded recipients of social security and similar tax-exempt benefit payments. The revenue cost is $200 million.

The combined revenue cost of these three provisions is $2.3 billion. Because of the effect of the interrelationship of the three provisions on the tax base, the combined cost exceeds the sum of the three provisions taken separately, since the absence of one provision would increase the residual significance of the others. The blind qualify for two $600 personal exemptions and an extra $100 minimum standard deduction.

"Sick pay" exclusions.-Certain payments financed by an employer in lieu of wages during periods of employee injury or sickness are excluded from the employee's income.

Exclusion of unemployment insurance benefits.—Benefits paid by State unemployment insurance plans are financed by a tax on wages paid by the employer and deductible by him, but these benefits are excluded from the employee's income.

Exclusion of workmen's compensation benefits.-Benefits paid under workmen's compensation are excluded from employee's income. These payments are primarily intended to replace earnings lost due to a work-related injury or illness, although some small part of the total payments is compensation for physical loss, such as an eye or an arm. As in the case of unemployment insurance, the benefits are financed by the employer's contributions and are deductible by him.

Exclusion of public assistance.-Public assistance payments are excluded from taxable income.

Exclusion for employee pensions.-Employer contributions to qualified employee pension and annuity plans are deductible by the employer. Income earned by these plans on their investments is not taxable. When an employee retires and is paid a pension or annuity, only part of the amount received is taxable to the employee. He does not pay taxes on the percentage of the benefit purchased by his contributions excluding from the percentage income earned on his contributions.

The revenue cost of the exclusion of investment income earned by all private pension funds, based on the corporate tax rate is $1.9 billion. The revenue cost of deduction of the total amount contributed by employers to these qualified plans, based on the corporate tax rate, is $3.4 billion.

The revenue cost, based on the individual income tax rates applicable to employees, is $0.7 billion as respects the investment income and $1.4 billion as respects the employers' contributions.

The greater the extent to which the benefits are vested, the more relevant is the use of the individual tax rate in' estimating the revenue cost. Taking this vesting into account, the revenue cost of the treatment of pension plans can be put at $3 billion.

1 This revenue estimate is based on treatment comparable to other pensions and regards one quarter of the benefits as approximately the cost of employee contribution.

Deduction for self-employed retirement.-Self-employed individuals are permitted a deduction from taxable income for funds they set aside currently in qualified retirement plans.

Exclusion of other employee benefits.In addition to the benefits already enumerated, a number of other employee benefits (shown in Table 7), the cost of which is paid at least in part by the employer, are also excluded from income subject to tax. The cost to the employer is deductible, and the benefit to the employee not taxable, in all of these cases.

Exclusion of interest on life insurance savings.-Life insurance policies other than term policies, generally have a savings element in them. Savings in the form of policyholders' reserves are accumulated from the premium payment, and interest is earned on these policyholders' reserves. Such interest income is neither taxable as it accrues nor as an element of death benefits.

Deductibility of contributions for other than education.-Contributions to charitable, religious, or certain other nonprofit organizations are allowed as an itemized deduction for individuals generally up to 30 percent of adjusted gross income. Unlimited contributions, however, may be deducted by those taxpayers (a relatively small number) whose contributions plus income taxes equal 90 percent of taxable income in 8 out of the preceding 10 years.

Taxpayers whose contributions to charitable or educational organizations are in the form of capital assets, usually securities, which have appreciated in value above their cost, obtain a deduction for the contribution at the appreciated value of the asset without taxation on the appreciation in value.

Deductibility of medical expenses.-Medical expenses in excess of 3 percent of adjusted gross income and expenditures for prescribed drugs and medicines in excess of 1 percent of adjusted gross income may be deducted by individuals as itemized nonbusiness deductions. Individuals may also deduct half of the premiums paid for medical care insurance up to a maximum deduction of $150 per year, without regard to the 3 percent limitation.

Deductibility of child and dependent care expenses.-Deductions for a limited amount of expenditures for the care of children under 13 or incapacitated dependents to enable the taxpayer to work are permitted under certain circumstances.

Deductibility of casualty losses.-Taxpayers may deduct as an itemized nonbusiness deduction the amount in excess of $100 for each loss due to fire, theft, or other casualty to the extent not compensated by insurance.

Standard deduction.-Individuals may itemize deductions for certain personal nonbusiness expenditures, including charitable contributions, interest payments, and medical and drug expenses above a stated percent of income, and certain other items referred to earlier. The taxpayer is also given the option of deducting-instead of this itemization-standard deduction of 10 percent of adjusted gross income or $1,000 ($500 if married and filing separately), whichever is less.