Fueling a Tax

A drive toward increased efficiency in energy and reduced oil consumption means state revenue systems will undergo wrenching changes.
March 1, 2007 AT 3:00 AM
John E. Petersen
By John E. Petersen  |  Columnist
John E. Petersen was GOVERNING's Public Finance columnist. He was a Professor of Public Policy and Finance at the George Mason School of Public Policy.

While I was in New Delhi recently, I traveled on a toll road that had camels and ox-drawn wagons sharing the roadway with trucks and cars. Traffic would halt periodically to avoid colliding with a herd of goats or cows. The goats are merely a hazard, but cows are holy in India. Traffic gives them the right of way, and they cause congestion, not to mention copious amounts of "litter." Well, that's India, where spiritual values mix with secular pursuits.

Coming home, I thought of America's "Holy Cows" -- beliefs that we revere, even though they are very costly. I'm thinking of our iconic attachment to great mobility at low prices, which is rapidly colliding with sustainable energy policies and fiscal realities. A national problem, for sure, but states are riding on the front bumper of the change. A drive toward increased efficiency in energy and reduced oil consumption means state revenue systems will undergo wrenching changes.

Take the move to develop alternative fuels. Ethanol, which is based on corn, receives a heavy federal tax credit, and many states give tax breaks to farmers and car buyers to promote its use -- all of which raises the price of corn. In the curious logic of today's public finance, the "tax" extracted by the higher costs of grains and their products and the forgone federal and state revenues don't count.

Then there is the Bush Administration's desire to improve automobile gasoline mileage by imposing mileage standards. But standards can produce boondoggles and distortions, just as targeted subsidies can. (Remember, the SUV got so popular with automakers by being a truck for mileage-standard purposes.)

In addressing the low-cost energy push, we need to remember the spending needs of transportation. More efficient cars and trucks still take up space on the highways and wear them out. Growth will require more highway capacity. Since we finance transportation primarily through dedicated taxes, these need to be ample enough to support these needs.

Even before reform, there are unaddressed fiscal problems for transportation funding. We finance highways -- maintenance and construction -- through trust funds that rely on dedicated revenues, which are mainly motor fuel taxes. These taxes are largely based on gallons of fuel consumed. Moving toward greater efficiency or alternative, lower-taxed fuels will cause the trust funds, which are already running out of money, to shrink even as traffic volume grows.

Part of the problem is that motor fuel taxes are not indexed to inflation. The tax's rates react neither to the price of gasoline nor the costs of construction. The value of the taxes has been declining in real terms over the years while construction indices have spiraled, affected by oil, cement and steel prices. Worse yet, when oil prices spike, there are efforts to roll back fuel taxes.

Meanwhile, economists of every stripe agree that the best way to economize on gasoline use is to increase its cost -- namely, to tax it. Higher prices force efficiency and the search for alternatives. But gasoline taxes at all levels of government are kept low and do not reflect the overall costs of driving, which are estimated at twice what we now pay in gas taxes. The combined state and federal gas tax per gallon is only 70 percent in price-deflated terms of what it was 30 year ago. Back then, combined federal and state taxes made up 30 to 35 percent of the retail price of a gallon of gas. Today, they make up 20 percent of the price.

Here comes an American Holy Cow: Legislatures are larded with folks who, rather than tax to achieve desired behavior, are more comfortable giving tax credits, adopting regulations and voluntary compliance schemes -- even when research shows these to be inefficient and susceptible to manipulation.

Back in India, New Delhi solved the Holy Cow problem by rounding up the bovines and shipping them to green pastures far from town. The U.S. Congress might do the same favor for states that are reluctant to raise gas taxes: take the decision off their hands. A motor fuel tax levied at the federal level could allow for a state tax credit of, say, 50 percent of the federal tax. A confirmed no-tax legislator would see a state's revenue increase as "free" -- and as a way to keep the money away from Washington. Voters already know our profligate energy use exacts a high toll and that markets should be pushed to recognize those costs. Sorry, but taxes do that best.