Should the US raise its fuel tax?

It is well known that the US has a major infrastructure problem with our national highway system. Many of our bridges are in a very poor state of repair and highway maintenance is not keeping up with needs. The American Society of Civil Engineers in 2013 gave the US road system the grade of a D and estimated that US$190 billion would be needed annually to significantly improve conditions.

The main source of funding for highway and bridge investment is the gasoline tax. And with the rapid drop in gasoline prices over the past several months, more commentators and policymakers are saying now is the right time to raise the tax.

Why haven’t gasoline revenues kept pace with highway funding needs? And if taxes should be adjusted, what’s the most effective way to meet highway funding objectives?

Roots of the shortfall

One reason for this highway infrastructure funding issue is that the gasoline and diesel taxes have not been increased since 1993 – 22 years ago. Meanwhile, the costs of building and maintaining our highway system have increased substantially, about 29 % in that time period.

That means that the purchasing power of the fixed gasoline and diesel taxes has fallen to such an extent that the tax revenues cannot meet the growing funding needs of our transportation system. In 2013, the gasoline tax, which is 18.4 cents per gallon, generated nearly $25 billion in revenue while the diesel tax, at 24 cents a gallon, generated $14 billion, according to my calculations using Department of Energy data.

The problem is that fuel tax revenues have not kept up with construction cost inflation. Tax revenues have also fallen because US fuel consumption has been declining since 2007 when gasoline consumption peaked at 142 billion gallons per year.

Gasoline consumption fell because of the recession, but more recently it has been declining because of the increase in average vehicle fuel economy. The US has fuel efficiency standards known as the corporate average fuel economy (CAFE) standards, which require that fuel economy increases to 54.5 miles per gallon by 2025. Fuel consumption is projected to continue to decline in the future. So it is the combination of the reduced purchasing power of the fixed gasoline and diesel taxes plus the declining fuel consumption that have brought us to the current situation.

Bridging the gap

There are a number of possible solutions to address the fuel tax shortfall, including the following:

• Transfer funds from general revenue to the highway trust fund to make up for the shortfall. In fact, that is being done now, but many people think that the level of the transfers is not adequate for the needed infrastructure maintenance and improvements.
• Change from a per-gallon tax to a tax on vehicle miles driven, an approach the State of Oregon is investigating. This option addresses the issue of increasing vehicle fuel efficiency because it’s a per-mile-driven tax regardless of the amount of fuel used to drive that mile. However, it does not address the increasing construction cost problem.
• Index the fuel taxes to the rate of increase in highway construction costs, an approach proposed by the Institute on Taxation and Economic Policy. In this case, Congress would not need to adjust the tax since it would be done automatically on an annual basis, similar to the way Social Security benefits are adjusted annually to account for inflation.
• Vary the fuel tax inversely with the wholesale price of gasoline. The advantage of this system is that it would impose higher fuel taxes when fuel prices are low and cut taxes when fuel prices are high. Thus, the higher taxes would come at a time when consumers could most afford them.

Hitching gas tax to wholesale prices

There are many ways a variable tax could be linked to the wholesale price of gasoline; one way is illustrated in the table below. In this system, gasoline and diesel prices are adjusted every quarter based on the previous quarters NYMEX wholesale gasoline price. It is anchored at a NYMEX wholesale gasoline price of $3 per gallon. Normally the retail price is about 75 cents higher than NYMEX, so there would be no incremental tax if retail gasoline price was above about $3.75.

The addition to the current tax would be 10% of the difference between $3 and the NYMEX price the previous quarter. The NYMEX gasoline price on January 7, 2015, was $1.35, so the tax increment would be 16.5 cents, and the total gasoline tax would be 34.9 cents, and the diesel tax 40.5 cents.

In this scenario, the impact on revenue added to the highway trust fund is significant: for gasoline alone, it would be $32 billion per year.

If crude oil and gasoline price remain low for a while as expected, this kind of tax system would provide enough revenue to help replenish the highway trust fund when consumers could best afford to pay.

Essentially, this system would change the tax from a constant per-gallon tax to one that varies inversely with gasoline prices, so that consumers pay more when they can most afford it and pay less when they can least afford it.

This article is published in collaboration with The Conversation. Publication does not imply endorsement of views by the World Economic Forum.

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Author: Wallace Tyner is an Energy Economist at Purdue University.

Image: Traffic moves through the rain along interstate 5 in Encinitas, California December 3, 2014. REUTERS/Mike Blake.