A Good Grade On a Possible Gasoline Tax

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The Wall Street Journal reports about a possible compromise tax proposal being pushed by the American Association of State Highway and Transportation Officials: Democrats might agree to an extension of all the Bush tax cuts if Republicans agree to convert the gasoline tax from a specific excise of 18.4 cents per gallon to an "ad valorem" tax set as a percentage of the price of gas. Gas taxes wouldn't be any higher today but they would rise over time with gas prices; Congress would use the added revenues to fund an expanded highway bill.

On its face, this sounds like the classic Washington compromise: Democrats will agree to cut taxes if Republicans agree to increase spending. But the idea deserves consideration. As I have written before, Congress should be extending all the Bush tax cuts for a limited period, so that we can complete the coming fiscal adjustment all at once, when the economy is stronger, and avoid raising taxes while the economy is fragile. Meanwhile, a change to ad valorem gas taxation would allow for stealth gasoline tax increases in years to come - which is a good thing.

Really, this change shouldn't be thought of as a tax increase - instead, think of it as canceling the annual gas tax cut. The federal gasoline tax hasn't been raised since 1993, when it was set at 18.4 cents per gallon. That means it has fallen by a third in real terms over that period - if the tax had kept pace with CPI, it would sit at 27.8 cents per gallon today. While many states have raised gas and other vehicle taxes since 1993, they have generally been reluctant to keep pace with inflation.

As a result, gas and motor vehicle tax receipts have lagged the economy. From 1994 to 2008, nominal GDP grew 103 percent, from $7.1 trillion to $14.4 trillion. But total motor fuel and vehicle taxes collected by federal, state and local governments grew only by 70 percent.

This is not necessarily a problem - as the economy grows, it undergoes structural changes that cause certain sectors to grow or shrink as a share of the economy. If we are spending less of GDP to build and maintain road infrastructure, then it's fine that vehicle tax receipts are shrinking as a share of the economy.

But that's not happening. In fact, spending on road construction and maintenance grew almost exactly in line with the economy from 1994 to 2008 - a 102 percent increase. Federal, state and local governments grew road spending faster than road revenues by borrowing more and by diverting general tax revenues to spend on roads. As in other areas of government, "starving the beast" has failed to reduce expenditure on road infrastructure.

This is a bad trend. The beneficiaries of investments in road infrastructure are easily identifiable and should be directly taxed to pay for roads. Motor vehicle taxes that are set at the proper level are good for the economy; setting the gas tax and other related taxes too low encourages people consume more highway than is economically efficient and to live farther away from their workplaces than is ideal.

And when gas and license taxes aren't high enough to pay for all the government's road construction and maintenance projects, governments have to divert general tax revenues to pay for roads. They have been doing so, to the tune of $61 billion per year in 2008, more than three times as much as was diverted in 1994. While too-low gas taxes lead to the wrong kind of consumption, higher sales and income taxes simply reduce consumption overall and shrink the economy.

Critics of higher gas taxes will note that some gas tax revenue is diverted to non-highway purposes. That's true, but the amount was only $24 billion in 2008, less than half the amount of general revenue diverted to highways. $15 billion of the gas tax diversion was to mass transit, whose use produces positive externalities for drivers by reducing traffic. And that $24 billion only approximately offsets the value of a major tax preference for drivers: the fact that in almost all states, gasoline sales are not subject to general sales tax. Overall, drivers are net recipients of a significant and growing government subsidy, which a change to the gas tax could help offset.

Changing to an ad valorem gasoline tax is not a perfect reform. The gasoline tax should be set so that revenues keep pace with the cost of highway construction and maintenance. The price of gasoline might rise more slowly or more quickly than that pace; it would be better to index the tax to CPI or a more specific measure of road costs. However, changing to ad valorem (which effectively indexes the gas tax to gas prices) is preferable to not indexing at all.

In addition to reforming the federal gas tax, Congress could take several steps to improve our system of road financing. One step would be to let states toll interstate highways if they spend money to improve them. Tolls provide useful incentives to road consumers and are the most effective tool to fight traffic congestion. As with any good, mispriced roads become misallocated; traffic jams result because the per-gallon tax on gasoline is not a high enough price for the most demanded roads at the most demanded hours.

Congress should also repeal an archaic ban on food and gas service areas on federally funded highways; the reason you only see such service plazas in the northeast is that they are prohibited on interstate highways built since the 1958. Pennsylvania generates $60 million per year from fuel sales alone on its Turnpike, but most other states cannot access this revenue source. Unfortunately, the truck stop lobby has stymied efforts to repeal the ban.

And finally, Congress should repeal the Davis-Bacon act, which artificially inflates the cost of federally financed road construction.

But even before doing any of this, either indexing the gasoline tax to inflation or converting it to an ad valorem tax would be a good first step to making our system of road financing more rational. And if such a move can be the bargaining chip that gets Democrats to agree to extend the full Bush tax cuts for several years, so much the better.

Josh Barro is the Walter B. Wriston Fellow at the Manhattan Institute.

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