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Fuel Taxes - a Rational Little Policy Proposal

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Those who travel America's roads and highways agree that our infrastructure needs attention. The condition of our once-vaunted transportation networks is rapidly deteriorating as ever greater numbers of trucks and automobiles punish its roadbeds.

The Federal Aid Highway Act of 1956 [1] established a trust fund fed by a new fuel tax that was to be used exclusively for highway construction and maintenance. The rate was originally set at three cents per gallon, but was raised in the Eisenhower, Reagan, H.W. Bush, and Clinton administrations to its current rate of 18.4 cents on gasoline and 24.4 cents on diesel fuel. Along the way, the trust fund was raided to finance things other than highways.

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Today about two-thirds of federal fuel taxes are used to fund the maintenance and repair of our nation's roads and bridges. [2] This fuel tax is an excise tax - a tax imposed selectively on the purchase of goods or services. [3] At its core, an excise tax is a consumption tax. Consumption taxes affect people with lower incomes more than those with higher incomes because a bigger part of a smaller income by necessity must be consumed. Taxes on consumption are regressive because they weigh most heavily on poor people.

Even so, consumption taxes have their place. They raise the price of a commodity and thus reduce its demand. This can be a useful public policy when the commodity in question is harmful to society. Taxes on cigarettes and alcohol are good examples, and the fuel tax is another. Excise taxes against these products tend to reduce their consumption, and society at large benefits from less pollution and less dependence on public health services. [4]

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Today excise taxes fund less than 4% of the federal budget, but they have not always been so insignificant. Sixty years ago, they accounted for 20% of federal revenues. Why the decline? All taxes are unpopular, but excise taxes face a special political barrier because they are targeted at a particular product or industry. A powerful fossil fuel lobby has prevented any changes in the gas tax for 22years - during which time the value of the dollar has declined by more than 40 percent!

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Ideally, the composition of federal tax revenues should have nothing to do with the composition of federal expenditures. Money is fungible - any one dollar can be substituted for any other dollar, whether on the revenue or expense side of the ledger. But when priorities like roads and bridges are funded explicitly by a specific class of revenue - fuel taxes - the priorities are vulnerable to targeted restrictions brought on by political interests. The condition of today's highways reflects the 40% cut in funding brought about by a fuel tax rate frozen in the nineties.

Ideally, funding of highway maintenance should be a small part of a large tax overhaul. Real reform would eliminate all the payroll taxes that suppress wages and create unemployment. Meaningful reform would eliminate all of the capital subsidies embedded in the tax code. True reform would capture economic externalities by application of excise and import taxes. And comprehensive reform would finance the bulk of the federal budget with a modest, uniform, and progressive tax on income of all kinds. [4]

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But we live in a world of political realities, so let's consider a plausible and viable mini-reform to address highway maintenance and construction. The goal of our tiny reform will be to recover that 40% of funding lost to inflation over the past 22 years.

Today's fuel tax consists of 18.4 cents per gallon of gasoline, 24.4 cents per gallon of diesel fuel, and 21.9 cents per gallon of jet fuel. [5] We'll include the latter so that air terminal facilities can benefit in the same way as highway transportation. I estimate that these taxes generate about $90 billion, $80 billion, and $23 billion respectively, but not all of this money finds its way into our transportation systems.

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First, let's recognize that to regain the lost funding through a simple increase in the fuel tax, the tax on gasoline would need to increase from 18.4 cents to 30.7 cents, a raise of 12.3 cents a gallon. Similar raises would be required for the tax on diesel fuel and jet fuel. An increase this big would be a hardship on many people, especially those least able to absorb its cost without cutting back on other essential expenses.

So let's build a better fuel tax system. We'll start by increasing the base tax by a modest amount. Then, recognizing that the price of fuel varies over time, we'll implement an extra tax only when the price is low. And to take the complication out of the retail level, we'll apply the tax to products as they leave the refiner. An increase in the base tax of 7.5 cents a gallon across the board gets us a little more than half the way there. The new base tax rates for gasoline, diesel, and jet fuel would become 25.9, 31.9, and 29.4 cents a gallon respectively.

The surtax is a little more complicated. Start with the price of crude oil - West Texas Intermediate spot, to be precise. As of July, 2015 the price stood at $50.90 per barrel. [6] Then compare to the ten-year average of the same index, which stood at $78.73 per barrel. You can see that oil prices were down, and down sharply - about 35% below the average. So let's create an index that compares the 10-year average to the spot price (Average divided by spot) and multiply that by the base tax rate.

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For July, 2015 that would be 78.73 / 50.9 x 25.9, or 40.06 cents per gallon of gasoline. The surtax of a little more than 14 cents would be insignificant, since the market price of gas at the pump would already reflect lower crude oil prices. The index could be updated monthly, and since it would be applied to deliveries from the refinery, would be transparent to retailers and motorists. As the price of crude oil normalizes, the surtax will decline to zero and offset some of the increase at the pump.

Fuel taxes would increase, but a large portion of the increase would come at times when consumers are best able to absorb it without hardship. And it would recover the lost revenues that are so valuable to the maintenance of our transportation infrastructure.

If you took a road trip over the Labor Day weekend this year, you might have noticed that gasoline was something of a bargain - in some regions well under $2.00 per gallon. [7] You might have also noticed that you had to slow down on some of your favorite roads and highways just to dodge the cracks and potholes. It's time to bring the safety of our highways, roads, and bridges into the twenty-first century. And put some of the lost fun back into motoring!

[1] click here

[2] click here

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Years ago I made a decision to commit to a life of business management. After thirty five years as a small business consultant, CFO, and university educator specializing in quantitative business and economic modeling, everything changed. A (more...)

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