The Hidden Entitlements
4. Other personal tax breaks
The remaining items in the tax expenditure budget are generally an inoffensive lot. Some, in fact, serve quite praiseworthy goals, but a few raise fairness questions. Although almost all of these tax subsidies could just as easily be run as direct spending programs (and a few could conceivably be 
dispensed with entirely), the advantages of doing so would probably be very small in most cases.
Tax-free social security benefits for retired workers. Social security benefits are essentially supplemented for most recipients by the fact that,unlike private pensions, they are mostly not subject to income tax. This tax break--estimated to cost $186 billion over the next seven years--is phased out, however, for better-off retirees. Retired couples, for example,begin paying taxes on part of their social security benefits when their total income exceeds about $40,000. The portion subject to tax rises gradually,and eventually reaches 85% (at about $70,000 in total retirement income for couples). Thus, the tax code enhances the already progressive nature of social security benefits received compared to taxes paid into the fund during people's working years. (Similar rules apply to railroad retirement benefits.)
Other tax help for the elderly and the blind. Taxpayers 65 or older and blind people get a larger standard deduction (9 out of 10 don't itemize).The additional deduction is $1,000 for eligible singles and $800 per spouse for couples (that is, $1,600 if both qualify), indexed for inflation.26 The 1996-2002 cost of this tax break is $13 billion.
Capital gains on home sales. Homeowners who sell their homes for more than they paid for them can defer capital gains tax by purchasing or constructing a home of value at least equal to that of the prior home within two years. People 55 or older can completely exclude from tax up to $125,000 of the gain from selling a home. This once-in-a-lifetime exclusion converts prior deferrals of tax into complete forgiveness of tax (up to the $125,000 limit). If a house is passed on at death, capital gains taxes deferred on prior increases in the home's value (like other capital gains) are completely exempted from income tax without any limit.
As a result of these provisions, the overwhelming majority of capital gains from home sales are never subject to income tax. Clearly homes are special--and ought to be treated differently from purely financial investments. But one can wonder whether any of the special capital gains tax breaks for homes should go even to sales of the most expensive mansions.
Workmen's compensation, public assistance and disabled coal miner benefits.Workmen's compensation payments to disabled workers, welfare and disability payments to former coal miners out of the Black Lung trust fund are not subject to the income tax, although they clearly are income to their recipients.The cost of these "tax expenditures" is not insignificant-$40 billion from 1996 to 2002--mostly reflecting the exclusion of workmen's compensation. But most of the beneficiaries of these tax subsidies, especially those getting welfare payments, are rather low-income people.
Benefits and allowances to soldiers and veterans. Housing and meals provided military personnel, either in cash or in kind, are excluded from income subject to tax. Most military pension income received by current disabled retired veterans is excluded from their income subject to tax.
All compensation due to death or disability and pensions paid by the Veterans Administration are excluded from taxable income. In effect, this tax break is in lieu of paying soldiers higher pay while they are in the service. Of course, the benefits of this $35.4 billion tax subsidy (1996-2002)are considerably higher for those with the highest post-military earnings,because they depend on a person's tax bracket.
Child and dependent care expenses. Working families with children get a tax credit for a percentage of their child-care expenses. Married couples can claim the credit if one spouse works full time and the other works at least part time or goes to school. Single working parents (including divorced or separated parents who have custody of children) also can claim the credit.Child care costs (and loosely related maid-service expenses) of up to a maximum $2,400 for one dependent and $4,800 for two or more dependents are eligible for the credit. Unlike the "upside-down" subsidies provided by most special tax deductions and exclusions, the child-care credit's percentage subsidy declines as income rises. Specifically, the credit is equal to 30%of qualified child-care costs for parents with family incomes of $10,000 or less, phased down to 20% at $28,000 or more in income. Oddly, the same income rules apply to both married couples and single parents, meaning that the credit can be considerably larger for couples who choose not to marry.The 1996-2002 cost of the child care credit is $21.9 billion.
Scholarship and fellowship income. Scholarships and fellowships granted to students working for an academic degree are not taxable except to the extent they exceed tuition and course-related expenses. The distinction essentially treats scholarships as non-taxable discounts on educational fees, but treats any excess amounts as taxable because they constitute payments for services (often the case with fellowships) or coverage of normal living expenses (such as room and board).
Deduction for part of the cost of self-employed health insurance.Self-employed people can deduct 30% of their health insurance costs--a scaled-back version of the 100%-exclusion workers enjoy for employer-provided health insurance. Currently pending legislation would increase the percent that can be deducted.
U.S. savings bonds for education. The general rule for interest on U.S. savings bonds is that tax is due when the bonds mature. But if savings bonds (and the interest thereon) are used to fund educational expenses,then the deferred tax on the interest is completely forgiven. (The exclusion applies only to bonds issued after 1989.) This exclusion is phased out between$65,250 and $96,900 of adjusted gross income for joint returns and between$43,450 and $59,300 for single and head of household returns (at 1996 levels,indexed for inflation). Generally, the income phase-outs effectively limit the tax subsidy to about 15% of savings bond interest used to pay for educational expenses.
Dependent students age 19 or older. Taxpayers can claim personal exemptions for dependent children age 19 or over who receive parental support payments of $1,000 or more per year, are full-time students and do not claim a personal exemption on their own tax returns--even if the students would normally not qualify as dependents because the parents do not provide more than half the students' support. In effect, this allow students to transfer their personal exemptions to their parents--an arrangement beneficial to families in which the parents' marginal tax rate is higher than the student's marginal rate.
Foster care payments. Foster parents provide a home and care for children who are wards of a state, under a contract with the state. Foster parents are not taxed on the payments they receive for their services and their expenses are consequently nondeductible. Thus, this activity is tax-exempt.It's not likely, however, that much tax would be due if foster-parenting were treated as a business, since expenses would be approximately equal to income.
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