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To Avoid Losing Millions, States Tweak Gas Tax Laws

States that tie their taxes to the price of gas are in a tight spot as fuel prices hit six-year lows.

A gas station in Newark, Del., on Thanksgiving weekend, promoting prices as low as $1.97.
(AP/Mark Lennihan)
Not too long ago, the handful of states that tax gasoline based on its price -- rather than the volume of gas sold -- were in an enviable position. With the average price of gas at $3.38 a gallon last year, they were raking it in. But now that the national average is $2.01 per gallon -- the lowest level since 2009, according to auto club AAA -- states like Kentucky, North Carolina and Virginia are in a financial bind.

Virginia is the most recent state to feel that pressure. John Lawson, the chief financial officer for the Virginia Department of Transportation, said that low gas prices could deplete the state's $5.4 billion transportation funding package by $530 million through 2019. "The reduction that we are seeing is mostly due to the fact that we were expecting fuel prices to rise, and they didn't," he said.

Those figures are actually more favorable than what forecasters predicted earlier this year. As recently as March, state analysts were predicting that the low prices would reduce fuel tax revenues by $670 million.

The numbers would be even worse, except that Virginia lawmakers set a floor on how low its gas taxes can go. No matter how cheap gas gets, it will be taxed as if the price is $3.11 a gallon.

Nicole Kaeding, an economist with the Tax Foundation, said Virginia's approach of establishing a minimum rate is common among states that tax fuel based on prices. "The downside of going to this model is that it makes it more volatile and a bit harder to do long-term budgeting for the state when you don't have a reliable source of revenue," she said.

Indeed, lawmakers in Kentucky and North Carolina scrambled earlier this year to change the structure of their gas taxes to avoid huge revenue dropoffs because of changing gas prices. Kentucky legislators, concerned that the state would otherwise run out of transportation money by 2016, stepped in to prevent the state's gas tax from automatically dropping in April from 26.2 cents a gallon to 21.1 cents a gallon. Instead, the legislature set the tax at 26 cents a gallon and established that as the minimum tax going forward.

Similarly, North Carolina also set a minimum tax of 36 cents per gallon through the end of this year. Even with intervention, funding for the North Carolina Department of Transportation dropped $13.5 million.

Richard Auxier, a researcher who has studied gas taxes for the Tax Policy Center, said there's no easy way for legislators to avoid raising or adjusting gas taxes.

"You cannot leave [gas taxes] on autopilot," he said. "Tying them to the price of gasoline is not a get-out-of-jail free card. It's a get-out-of-a-vote free card in good times, but you need to go back and vote on them in the bad times."

Virginia lawmakers could face one of those tough decisions when they reconvene next year. Part of its transportation deal included local sales taxes on gasoline in the traffic-choked regions of Hampton Roads and Northern Virginia, outside of Washington, D.C. The regional gas taxes, though, do not have a minimum level. Gov. Terry McAuliffe's administration supports adding that minimum threshold, but many legislators oppose the idea.

The low prices took a particularly big hit on funds for the Hampton Roads area in and around Norfolk. The state originally predicted that the regional gas taxes would raise $1.25 billion for the area between 2014 and 2019; now it expects $219 million less.

The volatility also hurts the region's ability to issue bonds for big projects, or at least makes the interest on them more expensive, said VDOT's Lawson. But Lawson noted that the volatility in the gas tax drove one of the other major changes in Virginia's 2013 transportation package: shifting the funding of transportation away from gas taxes and toward general sales taxes.

"Anyone will tell you that fuel isn't the answer going forward. Virginia has recognized that transportation is a core function of government and, as such, it's putting a greater reliance on taxes that come from sources other than fuel," he said. "We actually collect more now for transportation through sales taxes than we do through gas taxes."

Dan is Governing’s transportation and infrastructure reporter.
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