Funding a Bridge Over Troubled Waters

Depending on the news report – and how much effort is put into parsing quotes coming from the players involved – a gas tax increase this session to fund transportation will remain dead or might be reanimated (with the potential to create session mayhem much like the reanimated “walkers” on television.)

What is clear is that Republican legislators and many business advocacy groups are staunchly opposed to a gas tax increase.  The primary objection is philosophical – based on the belief that some of the revenue being generated by the large tax increases of a couple years ago should go toward this quintessential public good.  It’s an argument buoyed by the $900 million surplus that is seemingly tailor made to support “no-tails” spending like road construction. 

A majority of the state’s voters seem to share this objection.  Polling consistently has shown majority opposition to a gas tax increase – even though 100% of the money would be dedicated for what most acknowledge is a legitimate need.  Not too long ago, Minnesotans overwhelmingly approved increasing the general sales tax by 3/8ths of a cent for 25 years and dedicating the revenues to support arts and natural resource spending, regardless of merit or need.  Whatever enthusiasm for dedication washed over the populace back then does not seem to penetrate concrete and asphalt.

From the perspective of tax principle, most public finance economists would likely argue the gas tax remains an important and excellent way to fund transportation.[1]  It’s a simple-to-implement tax with low administrative and compliance costs.  Plus, its user fee-like qualities conform well to the benefit principle of taxation, and as a general rule we should try to retain a relationship between road funding and road use.

However, there is growing criticism of the tax based on substance – rooted in its increasing inability to keep up with growth in transportation needs (and costs).  That alone shouldn’t disqualify the state from continuing to rely on the tax any more than the increasing challenge of paying for a college education disqualifies putting more money into a college savings fund.  But the decline of the gas tax’s purchasing power is real and linked to two well documented issues: a shrinking tax base (the amount of gasoline sold) and the impact of construction cost growth.

A Gas Tax Low on Fuel?

How big are these problems?  Can the gas tax overcome them? To examine these questions we explored what Minnesota’s gas tax rate would be in 2016 if we had adjusted it over the short-term for both fuel efficiency and construction cost inflation.

The first step incorporates the effects of increases in vehicle fuel efficiency.  Since 2007, the University of Michigan Transportation Research Institute (UMTRI) has tracked the average sales-weighted fuel economy rating of new purchased vehicles.  Using this data set offers two advantages.  First, focusing on new purchases captures the greatest gains in car and truck fuel efficiency.  Because the fuel efficiency improvement of the total fleet of cars and trucks on the road will be less than this, the methodological bias is to overstate the “efficiency challenge” the gas tax faces.  Second, by sales-weighting the data, we are capturing the fuel efficiency gains resulting from vehicles actually being put into use on the nation’s highways.  Leapfrog fuel efficiency gains such as that provided by hybrids only impact the results to the extent these vehicles are actually purchased.

The second step is to adjust the tax rate to accommodate historical inflation in road construction and maintenance costs.  As we have discussed in Fiscal Focus before, what might seem like a simple, straightforward adjustment turns out to be mysterious, controversial, and worthy of a much better understanding. [2]  From 2003 to 2014, highway cost inflation as reported by the state has been over six times that of the Federal Highway Administration’s (FHA) Highway Cost Construction Index.  This large discrepancy has serious implications for adjusting gas tax rates for cost inflation.  Our analysis presents three findings: one based on the federal cost index, one based on the Minnesota cost index and one based on an average of the two.

To calculate how efficiency and cost inflation might change the gas tax rate, we assumed that Minnesota’s actual gas tax rate was recalculated each January 1 based on the average increase in sales weighted efficiency and construction cost inflation in the previous year, without regard to any actual changes in the rate.  We set January 2008 as the base from which to measure growth because the UMTRI data set begins during 2007, prohibiting analysis to an earlier date.  The accompanying table presents the results.

Since 2008, sales-weighted new vehicle fuel efficiency has increased by about 25%.  Over that time Minnesota’s gas tax increased 8.5 cents/gallon, which has more than accommodated that increase in fuel efficiency.

Perhaps surprisingly, since 2007 – at least based on federal measures – highway cost inflation has also worked to ensure that gas tax rates remain adequate.  Federal statistics indicate the Great Recession was a period of considerable deflation in highway construction costs (down around 19%) and the subsequent rebound in the inflation rate has been quite modest – averaging only around 1.4%.  The result is that the increases in Minnesota’s gas tax rate since the beginning of 2008 have far outpaced the combined effects of efficiency and federal inflation over this time and the rate has basically grown at efficiency plus the average of state and federal inflation rates.

The story is very different if we use trends in MnDOT’s composite construction cost index to adjust the tax rate.  The Great Recession caused only a modest 3.8% temporary drop in 2009, followed immediately by a 9.2% rebound by the end of 2011.  As we have previously discussed, because cost inflation trends are so crucial to estimates of future transportation spending needs – let alone any ambition to adjust the gas tax rate for purchasing power – an investigation into the causes of this extraordinary discrepancy is very warranted.  Nevertheless, adjusting the tax rate using Minnesota’s inflation measure yields a rate of 33.4 cents per gallon, among the nation’s highest.  Adjusting the rate up by 4.9 cents (relative to the actual 28.5 cent rate) would bring in an estimated $157 million dollars annually – about two-thirds of the $234 million in the precedent-concerning proposal to dedicate sales tax revenues from auto-related purchases.

Can It Be Replaced With Something Better?

An estimate based on a recent eight-year snapshot does not fully capture the growing challenges of the gas tax.  An analysis over a longer time period would likely find “adjusted” gas tax rates even higher.  But nor do these findings seem to justify the increasingly pessimistic claims that gas taxes are anachronistic and hopelessly inadequate given the raging trends in construction cost inflation and fuel efficiency.

Considering the viability and adequacy of new user fee approaches suggests that continued reliance on the gas tax is merited.  In recent years user fees based on vehicle miles traveled have received growing attention – not just as a supplement to the gas tax but as a replacement.  A 2011 University of Minnesota Center for Transportation Studies (CTS) report.[3]  evaluated the replacement of the gas tax with a mileage based user fee system.  It concluded mileage based user fees scored better on every transportation finance principle – except implementation and compliance costs (hardly minor issues).  The authors concluded that “fuel taxes are not sustainable for funding surface transportation but a mileage based use fee would be.”

Recognizing the real pragmatic implementation barriers to this switch, the authors offered a vision of a future “transitional” transportation funding structure.  Under this approach, the gas tax rate would be lowered to the level needed to generate sufficient revenues for “baseline transportation needs” – essentially the maintenance and operating costs of the existing system plus “user system safety” and enforcement.  Revenues from a mileage based user fee would fund road and bridge capital costs – reconstruction, expansion, and right of way.

What would the result look like in Minnesota?  For starters, the premise that a lower gas tax rate could fund “baseline transportation needs” appears very questionable.  According to the most recently available data, state and local government combined spent $1.82 billion on road operating and maintenance spending – far exceeding the $878 million brought in by fuel taxes.  Every penny of the existing gas tax and then some is needed just to operate and maintain the existing system.

With respect to supporting construction costs with mileage-based user fees, evidence suggests such fees would need regular increases just to maintain the status quo in purchasing power – creating the same challenge the gas tax now faces.  According to the FHWA, vehicle miles traveled in Minnesota have essentially flatlined over the recent decade (56.90 billion in 2005 to 56.97 billion in 2013).  Minnesota gasoline consumption may have peaked in 2004, but vehicle miles traveled peaked only four years later in 2008.

A Public Good in Theory, Less So in Practice

Nearly 200 years ago Whigs and Jacksonian Democrats were engaged in bare knuckle brawls over whether the federal government should even be involved in developing transportation infrastructure.  Today, the concept of transportation as a public good has been well established – at least in principle.  With respect to the practice of actually funding transportation, that idea is on a much more fragile foundation.

The prescribed ideal from the early 20th century of allocating an equitable share of transportation funding responsibility among “users, beneficiaries, and the business man and citizen through general taxation” has given way to a popular expectation that users and beneficiaries must pick up most – if not all – of the tab.  (At least where state government is concerned – local governments have been employing general fund dollars for transportation purposes since time immemorial.)  That’s true for both transit and roads resulting in debates about which receives the bigger subsidies and theories of transportation modes “paying for itself” – all without ever questioning if and how the concept of “government subsidy” should even apply to transportation infrastructure.

Perhaps that’s why some of the world’s most admired surface transportation systems share a common characteristic: general fund financing that includes the deposits of transportation user fees and taxes into government general funds.  A recent report by the Eno Center for Transportation.[4]  concluded traditional dedicated trust fund approaches to transportation financing – and the highly divisive modal / distributional squabbles that inevitably result – can distract from a focus on overall transportation system performance and the strategic allocation of resources towards that objective.  An argument can also be made that requiring transportation to compete for general fund resources would stimulate process redesign and efficiency improvements within transportation agency operations.

Such a radical transformation of transportation finance will never happen here, but this does point to a need to return to a fundamental public finance idea.  If all the blue ribbon panels and MnDOT estimates are correct, an “all hands on deck” approach to transportation funding will be needed.  The gas tax – and gas tax increases – will have to remain part of the portfolio.  At the same time, spending interests will have to get used to the idea that not only will transportation start competing for general fund dollars; such competition is appropriate and beneficial.